-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, G+CNNdBdgvjkQ+wLqhptMbFsEH3GqaJOQT3pyP9CUsAadYsxaeeE88DXhu+n8W2B jo9kt2GPbpJi9q3Fy8l/0A== 0000893220-97-001580.txt : 19970927 0000893220-97-001580.hdr.sgml : 19970927 ACCESSION NUMBER: 0000893220-97-001580 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 13 CONFORMED PERIOD OF REPORT: 19970630 FILED AS OF DATE: 19970919 SROS: NYSE 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: SEC FILE NUMBER: 001-10875 FILM NUMBER: 97682694 BUSINESS ADDRESS: STREET 1: 1016 W NINTH AVE CITY: KING OF PRUSSIA STATE: PA ZIP: 19406 BUSINESS PHONE: 2159927200 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, 1997 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 SEPTEMBER 5, 1997, 61,076,427 SHARES OF COMMON STOCK WERE OUTSTANDING, AND THE AGGREGATE MARKET VALUE OF THE SHARES OF COMMON STOCK HELD BY NON-AFFILIATES WAS APPROXIMATELY $806,909,547. (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 1997 ANNUAL MEETING OF SHAREHOLDERS TO BE HELD ON OCTOBER 30, 1997. ================================================================================ 2 NOVACARE, INC. AND SUBSIDIARIES FORM 10-K -- FISCAL YEAR ENDED JUNE 30, 1997 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 Industry Background................................... 1 Company Strategy...................................... 3 Plan for Growth and Operations........................ 5 Business Profile...................................... 8 Competition........................................... 14 Reimbursement/Government Relations.................... 15 Government Regulation................................. 17 Insurance............................................. 20 Employees............................................. 20 Executive Officers of the Registrant.................. 21 2 Properties................................................... 22 3 Legal Proceedings............................................ 23 4 Submission of Matters to a Vote of Security Holders.......... 23 II 5 Market for Registrant's Common Equity and Related Stockholder Matters.................................................... 23 6 Selected Financial Data...................................... 24 7 Management's Discussion and Analysis of Financial Condition and Results of Operations.................................. 25 8 Financial Statements and Supplementary Data.................. 32 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................................... 51 III 10 Directors and Executive Officers of the Registrant........... 51 11 Executive Compensation....................................... 51 12 Security Ownership of Certain Beneficial Owners and Management................................................. 51 13 Certain Relationships and Related Transactions............... 51 IV 14 Exhibits, Financial Statement Schedules and Reports of Form 8-K........................................................ 51 Signatures........................................................................... 52
i 3 PART I ITEM 1. BUSINESS THE COMPANY NovaCare, Inc. ("NovaCare" or the "Company") was organized and formed in 1985 and is a national leader in physical rehabilitation services and employee services. As the clinical leader in rehabilitation services, the Company treats 37,000 patients per day in cost-effective outpatient and long-term care settings and has achieved number one market shares in long-term care and orthotics and prosthetics. In addition, NovaCare is the nation's second largest provider of outpatient rehabilitation services and the second largest employee services, or professional employer organization ("PEO"), administering the full array of human resource functions, including the management of health care benefits and workers' compensation, principally for small and medium-sized businesses. Rehabilitation services are the processes that restore individuals disabled by trauma or disease to their optimal level of functionality and self-sufficiency. Over 80% of individuals receiving rehabilitation services return to the community in productive endeavors or to active retirement. NovaCare's comprehensive medical rehabilitation services include (i) providing rehabilitation therapy and rehabilitation program consulting and management services on a contract basis to health care institutions, primarily long-term care facilities, and (ii) providing outpatient, orthotic and prosthetic ("O&P") and occupational health rehabilitation services through a national network of patient care centers and integrated delivery systems. The Company operated medical rehabilitation hospitals until April 1, 1995, the effective date of the sale of such hospitals, discussed in Part II to this Form 10-K. For the fiscal year ended June 30, 1995, the medical rehabilitation hospitals represented 12% of the Company's consolidated net revenues. Employee services are generally provided to small and medium-sized businesses and are comprehensive, fully integrated outsourcing solutions to human resource management, including payroll management, workers' compensation, risk management, benefits administration, unemployment services and human resource consulting services. The Company creates relationships with both its clients and worksite employees by contractually assuming certain administrative and financial employer responsibilities with respect to worksite employees in a "co-employment" relationship. By focusing on employee services, the Company helps create a more satisfying, more productive relationship between clients and employees. The Company supports its clients by: (i) improving profitability through lowering or controlling costs associated with workers' compensation, health insurance, other benefit coverage and regulatory compliance; (ii) improving productivity through reducing the time and effort required by business owners and executives to deal with the complexities of employment management, enabling them to focus on their business core competencies and growth; and (iii) improving employee satisfaction and performance. The Company helps employers improve job satisfaction and performance of their employees by: (i) providing improved health care and related benefits; (ii) delivering training programs; and (iii) delivering dependable payroll and benefits administration. INDUSTRY BACKGROUND REHABILITATION SERVICES Depending on an individual's diagnostic and therapeutic needs, rehabilitation services are delivered in a variety of settings, including rehabilitation hospitals, rehabilitation units in acute care hospitals, long-term care facilities, outpatient rehabilitation facilities, rehabilitation agencies and clinics, industrial settings, schools and patients' homes. These services are provided by a variety of health care professionals including physiatrists and other qualified rehabilitation physicians, occupational, physical and respiratory therapists, rehabilitation nurses, speech-language pathologists, audiologists, psychologists, social workers, orthotists, prosthetists, recreational therapists, rehabilitation counselors and others. 1 4 Recent industry analysis suggests that medical rehabilitation is an approximately $27 billion industry. The industry's growth has been fueled primarily by the following three factors: Increased demand for services. Advances in technology, the aging population and high quality of life expectations among disabled people continue to drive demand for rehabilitation services. Technological advances in medical care have lengthened lifespans and improved the quality of life for patients who have suffered severe injury or disease. The U.S. Bureau of the Census statistics show that the fastest growing segment of the population is the group over 65 years of age. This group, among the 33 million Americans who have a disability and cannot perform basic physical activity or need assistance to do so, 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. Proven cost-effectiveness of services. Payers (insurance companies, managed care plans, employers, government programs and individual patients) now recognize the benefits of rehabilitation in reducing lifetime costs of health care. Recent studies suggest that from $11.00 to $30.00 in medical costs are saved for every dollar spent on rehabilitation. Efforts to reduce workers' compensation expenses also have stimulated demand for rehabilitation of injured workers and the installation of work-hardening and injury-prevention programs in the work place. Comprehensive reimbursement for services. Rehabilitation services are covered for payment by Medicare and Medicaid and are typically covered by commercial health insurance policies, workers' compensation and managed care plans. EMPLOYEE SERVICES The National Association of Professional Employer Organizations ("NAPEO") estimates the PEO or employee services industry is currently approximately $18 billion in revenues with an annual growth rate over the last five years of approximately 30%. The U.S. Small Business Administration estimates there were approximately 6 million businesses in the United States with fewer than 100 employees in 1996. These businesses employed approximately 52 million persons and had an aggregate annual payroll of approximately $1.1 trillion. Management believes approximately 49 million of these employees are currently unserved by the PEO industry. The PEO industry is highly fragmented. NAPEO data suggest that as many as 2,400 PEOs are currently in operation and that the ten largest PEOs account for less than 10% of the existing market. The Company expects there will continue to be significant industry consolidation as smaller PEOs face increasing regulatory complexity and capital requirements associated with developing larger service delivery infrastructures and management information systems. Increased demand for services. The PEO industry evolved in the early 1980's in response to increasing employment and benefit costs, and the complexities of the legal and regulatory environment for the rapidly expanding small to medium-sized business sector. The Company believes demand for PEO services will continue to increase as (i) employment-related governmental regulation grows more complex, (ii) growth continues within the small to medium-sized business community, (iii) the need to provide health and retirement benefits in a cost-effective convenient manner increases, and (iv) the business and regulatory communities accept and recognize the PEO industry. The Company believes PEO services will continue to experience growing demand because of anticipated growth in the number of small businesses in the United States and the growing trend among small to medium-sized employers to: (i) outsource non-core competencies; (ii) reduce employee benefit costs; (iii) avoid employee-related risks and regulatory complexities, and (iv) attract better employees and retain them through improved benefit plans. Cost effectiveness of services. According to estimates by the U.S. Small Business Administration, the management of an average small to medium-sized business devotes from 7% to 25% of its time to employee-related matters, leaving management with less time to focus on core competencies. A National Federation of Independent Business survey of small businesses in 1996 showed that six of the top 13 major problem areas for small business are issues that can be addressed by PEOs. These include (with their rank in importance) cost of health insurance (1), workers' compensation costs (3), federal paperwork (7), frequent 2 5 changes in federal tax laws (9), finding qualified employees (11), and state/local paperwork (13). Work-related injuries cost employers over $70 billion in medical expenses and employee productivity each year. Employees are attracted to small and medium-sized businesses that provide employees with human resources services characteristic of large employers. An industry analyst's study indicated that 40% of the clients that outsourced services with a PEO were able to upgrade their employee benefits offerings and one-fourth of those clients were able to offer health care and other benefits for the first time. COMPANY STRATEGY VALUES-BASED BUSINESS NovaCare believes that the most important and differentiating quality of outstanding organizations is the set of values which inspires, unites and sustains them. Values are constant and enduring, and precede and underlie business plans, policies, procedures, practices, performance and outcomes. The Company's values are: Credo Helping Make Life a Little Better Beliefs Respect for the Individual Service to the Customer Pursuit of Excellence Commitment to Personal Integrity Purpose Rehabilitation To effectively meet the rehabilitation needs of our patients Services through clinical leadership Employee Services To be the brand, service and performance leader in the PEO industry by creating a more satisfying, more productive relationship between employers and employees
It is management's belief that the strong commitment to these values by all employees enables the Company to provide a unique level of service to its customers by enabling employees to build the business and enhance their careers. STRATEGY STATEMENT OVERALL NovaCare's strategy is to achieve a leading market position in each of its businesses. The Company selects industry sectors that are large, fragmented, growing rapidly and would benefit from the Company's core competencies: outsourcing, information technology and human resource management. Outsourcing. NovaCare provides creative, cost-effective outsourced solutions to business. Instrumental in the Company's success in outsourcing is an ability to understand and anticipate the needs of customers, while smoothly integrating into their operations, so they can focus on their business' core competencies. NovaCare manages activities that its customers may not have the necessary scale, expertise, time or staff to handle. The Company seeks to be a partner with its customers, whether a small business or a health care organization, adding and adapting services as customer needs change. Information Technology. NovaCare strives to improve its customers' performance by providing knowledge-based services and technology beyond the reach of their internal systems. The same information technology capability that adds value for customers is utilized to improve NovaCare's efficiency and profitability. Human Resource Management. Due to the competitive environment for clinical rehabilitation professionals in which demand exceeds supply, NovaCare has developed strong capabilities to attract and retain employees. With approximately 19,000 employees working in small groups in customer facilities and NovaCare outpatient centers, the Company has experience in effectively managing a highly dispersed workforce on a national level. 3 6 NovaCare's market leadership starts with a consolidation and integration program designed to achieve the scale required to create margin opportunity and warrant the investment made in service differentiation. The Company focuses its consolidation activities in target geographic markets to leverage the cost of field management and concentrate its resources on the most critical relationships in a community. NovaCare orients the employees of acquired businesses to the Company's values, creating alignment with common goals which, in turn, facilitates integration. REHABILITATION SERVICES NovaCare's rehabilitation services strategy is to leverage its core competencies and expert rehabilitation and specialty health care services to expand and integrate with physicians, hospitals, long-term care, post-acute care and managed care delivery systems. The Company's strategy is to enhance NovaCare's position as the largest provider of low-cost, clinically excellent medical rehabilitation services outside the medical rehabilitation hospital setting. The strategy is based on the belief that: - Medical rehabilitation services will continue to experience steady or growing demand because health care payer cost-containment efforts will continue to drive patients toward the most cost-effective health care solution to satisfy patients' needs and customers' requirements. - Large integrated delivery systems comprising health care providers and payers will be networked to facilitate integrated patient care, to ease administration, and reduce costs for payers and providers and to ensure high quality care at competitive cost in local and regional geographic markets. - The 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 cost-effective, clinically proven outcomes in the selection of rehabilitation providers. - Costs can be lowered through clinical and information systems innovations coupled with "flat" organizations having broad spans of control. - Effective data management capabilities can enhance quality health care. - Medical rehabilitation services, outside the medical rehabilitation hospital setting, are not capital intensive, allowing for responsiveness to changes in reimbursement or market conditions, without the use of substantial capital resources. EMPLOYEE SERVICES The Company's strategy is to be the brand, service and performance leader in the PEO industry by leveraging its expertise in human resource management, information systems and outsourcing, in focused geographic markets. The strategy is based on management's beliefs that: - PEO services will continue to experience growing demand because of the trend among small to medium-sized employers to: (i) outsource non-core competencies, (ii) reduce employee benefit costs, (iii) avoid employee-related risks and regulatory complexities, and (iv) attract better employees through improved benefit plans. - The industry for PEO services, based on analyst reports, is more than 95% unserved with the served portion expected to grow at the rate of 30% per year for the next five years. - The PEO industry is highly fragmented with significant consolidation opportunities for companies with access to capital, larger service delivery infrastructures, and well-developed and sophisticated management information systems. - PEOs typically take a transaction processing approach to their services and do not emphasize the improved workforce performance characteristic of satisfied employees. 4 7 - In selecting PEO providers, small to medium-sized businesses will increase their emphasis on cost-effectiveness, service excellence and the breadth of services provided. - Employees are attracted to small and medium-sized businesses that provide employees with human resources services characteristic of large employers. PLAN FOR GROWTH AND OPERATIONS REHABILITATION SERVICES The rehabilitation services growth plan has four principal components: (i) expand outpatient services, (ii) develop occupational health services, (iii) focus growth and integration efforts in select target markets, and (iv) meet the needs of the long-term care industry. Expand Outpatient Services. NovaCare plans to continue to expand the Company's extensive network of outpatient rehabilitation and O&P sites in target geographic markets through acquisitions and start-up centers. Management believes that the size and density of NovaCare's outpatient services network in many markets positions the Company favorably to affiliate with integrated delivery systems and to compete for referrals from managed care organizations, physician groups, hospitals and commercial customers. In fiscal 1997, the Company acquired 52 outpatient businesses with aggregate annualized revenues of $140 million, increasing its network of facilities by 34% to 644 locations. Develop Occupational Health Services. Occupational health integrates injury prevention, physician, rehabilitation, case management and other ancillary services to return the work injured employee to the workplace as safely and quickly as possible. NovaCare provides "workplace-to-workplace" service which combines worksite evaluation, injury/illness diagnosis, physician treatment, rehabilitation and back to work programs. The goal is to minimize health care and disability costs to employers while providing the employee the opportunity to recover, as fully as possible, from a work-place injury. The system includes a network of physician practices specializing in occupational health care which oversee the workers' initial evaluation, care planning, and clinical progress through their return to work. Treatment of patients is generally performed in health care centers equipped in a manner similar to NovaCare's outpatient rehabilitation centers. The Company plans to build on its existing foundation and to acquire established occupational health services practices, clinics and services in target geographic markets. The Company believes such acquisitions will complement the Company's expansion of outpatient services, capitalize on patient flow synergies and further position NovaCare for affiliation with hospital systems, managed care payers and commercial customers. Focus Growth and Integration Efforts in Select Target Markets. NovaCare intends to build and maintain leading market positions in 17 target geographic markets by affiliating its rehabilitation services with leading health care systems in these target markets. The Company's goal is to enhance referral and health care system relationships, increase brand awareness and leverage its clinical resources and infrastructure investments in target markets. Management believes that with the largest combined outpatient rehabilitation and O&P services network as the largest provider of rehabilitation services to the long-term care industry and with the development of an occupational health services network, NovaCare is in a strong position to meet the needs of health care systems in a local or regional market. NovaCare offers the attributes that a health care system partner or payer looks for: (i) dispersed outpatient services capabilities, (ii) excellent clinical reputation and outcomes, (iii) sophisticated systems capabilities to track and measure patient progress through their plan of care, and (iv) a strong financial position to support network growth. In fiscal 1997, 87% of NovaCare's rehabilitation services acquisitions and start-up facilities were in target markets. Meet the Needs of the Long-Term Care Industry. NovaCare intends to continue to enhance its industry leadership position in long-term care. Management believes that NovaCare's clinical programs, information technology and ability to recruit and manage therapists will enable the Company to continue to grow at a disproportionately higher rate than the long-term care industry. 5 8 The Company's operating plan for rehabilitation services encompasses cost containment and clinical leadership. Cost Containment. A central aspect of the Company's strategy is to position itself as a low-cost provider of high quality rehabilitation services. Clinical improvements and innovation are expected to lower the cost of rehabilitation service delivery. Management believes its efforts to flatten and increase the flexibility of the organization to respond to change and its investment in common, efficiency-enhancing clinical and administrative systems will allow the Company to operate successfully in an increasingly challenging reimbursement environment. Clinical Leadership and Outcomes. Management believes that payers will ultimately demand that low cost be accompanied by proof of quality outcomes. The Company has committed resources to develop information analysis and display systems that capture outcomes in a useable format. Management believes that, as payers 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. EMPLOYEE SERVICES Through its subsidiary, NovaCare Employee Services, Inc. ("NCES"), the Company is the second largest PEO in the United States. NCES commenced operations in October 1996, concurrent with the acquisition of Resource One, Inc. in Florida. In February 1997, the Company acquired three additional PEOs -- Employee Services of America Inc. and Prostaff Human Resources, Inc. in Florida, and The TPI Group Ltd. in New York. As of June 30, 1997, the Company served approximately 1,700 client organizations with approximately 35,000 employees at over 3,000 worksites primarily in ten industries and 45 states. NCES was established by the Company because it recognized that NovaCare's core competencies are highly correlated with success in the PEO industry. NovaCare's rehabilitation services are delivered in over 2,000 facilities nationwide, and include worksite evaluation, injury prevention and work injury rehabilitation. The ability to deliver employment-related services to small, widely dispersed groups of employees and to effectively manage workers' compensation risk are central to a PEO. NovaCare's investments in human resource management, information technology, relationship selling and management control systems are directly applicable to and can be leveraged through the employee services business. The Company's employee services business intends to grow through: (i) increased investment in sales and marketing, (ii) focused geographic expansion; (iii) emphasis on specific industries; and (iv) acquisitions and strategic alliances. Increased Investment in Sales and Marketing. NCES intends to develop a brand identity. A recognized brand name is a valuable market tool. By utilizing the nationally advertised brand name of NovaCare, the Company believes it will achieve a strong brand identity in the PEO industry, at lower cost. The Company will utilize professional marketing tools and strategies to communicate its brand promise and performance to target audiences. Brand loyalty is expected to generate referrals and improve client retention. The Company plans to survey the marketplace, its worksite employees and potential clients on a continuous basis to measure satisfaction and the effectiveness of its marketing efforts. Focused Geographic Expansion. The Company has identified key attractive geographic target markets and has established a plan for entering those markets in a disciplined manner. The target markets are those 17 markets in which the rehabilitation services business is focusing its growth and integration efforts. Rehabilitation services customers and other extensive business-to-business relationships represent a significant opportunity to grow in these target markets. By concentrating on markets where NovaCare's rehabilitation services business has achieved density, NCES will immediately have scale because NCES already co-employs the NovaCare rehabilitation services employees. The Company believes its market development model will enable it to penetrate new markets quickly. This market development model consists of a highly structured sales management control system and efficient selling process. 6 9 Emphasis on Specific Industries. Target industries will vary from market to market depending on economic characteristics and business demographics of each geographic location. NovaCare intends to focus on industries with high gross profit per worksite employee and significant worker's compensation profit opportunities. The sales force is expected to utilize the key industry strategy and become expert in one or more select industries in the markets in which they are operating. Rehabilitation services customers represent a large potential client base of small to medium-sized long-term care providers and other health care customers who are currently obtaining outsourced contract rehabilitation or who are referring patients to the Company. Acquisitions and Strategic Alliances. The opportunities for PEO consolidation are substantial with approximately 2,400 PEOs operating in a highly fragmented industry. The Company believes that this industry consolidation will be driven by increasing industry and regulatory complexity, increasing capital requirements and the significant economies of scale available to PEOs. The Company intends to make opportunistic acquisitions where appropriate to achieve greater density in target geographic markets. The Company is creating strategic alliances with service providers to small and medium-sized businesses. With the trend toward outsourcing non-core competencies, small and medium-sized businesses typically have service relationships with accountants, attorneys, banks, trade associations and other business advisors. Alliances with these service providers offer a cross-selling opportunity for NCES. The Company intends to develop such referral opportunities as an extension of its sales and marketing capability. The NCES operating strategy is designed to control costs while supporting growth. The operating strategy encompasses leveraging NovaCare's core competencies and implementing a sophisticated business model. Leverage NovaCare's Existing Core Competencies. As a national provider of medical rehabilitation services, NovaCare has developed core competencies in (i) delivering employment-related services to a dispersed workforce in third-party worksites; (ii) establishing and maintaining national information systems networks connecting clients, worksite employees and service providers; (iii) developing and implementing workplace safety and injury prevention programs; and (iv) regulatory change management. Other synergies include (i) the ability to leverage to negotiate advantageous health care, workers' compensation and other benefit program costs given NovaCare's scale in many geographic markets and (ii) the availability of health care services for worksite employees from NovaCare and other health care providers in NovaCare's local and regional health care system networks in target markets. As a health care provider, NovaCare has been an industry leader in response to regulatory and legislative change in a highly regulated market. The Company's experience in and ability to effect change in the regulatory environment will be valuable as states and the federal government seek to implement new approaches to regulating the PEO industry. Implement Business Model. NCES has implemented a portfolio management system to control and improve its performance in the selection of new business, meeting its brand promise with respect to existing customers, and analyzing lapsed business in order to identify the reasons for and the corrective action necessary in response to client cancellations. The new business criteria orient marketing to potential clients in target industries with high gross profit per worksite employee and acceptable underwriting risk. Potential clients meeting preset criteria are the target audience for the sales effort. The current business portfolio component of the control system enables management to monitor new client start-ups, client-specific financial and risk performance and employee and employer satisfaction. By focusing management attention on key business variables, the system permits day-to-day management to direct actions consistent with the Company's strategy and business plan. Lapsed business is analyzed by reason to facilitate identification of service delivery system issues and to improve future client retention. NCES has established an operating model that delivers services from two different locations. The Company's local service center places an emphasis on servicing the customer through local front-line activities. The local service center conducts enrollment and orientation of new employees and clients, and worksite safety evaluation and monitoring. Sales activity and customer service will also be performed locally. Local activities relative to risk management promote safety, early intervention of workers' compensation 7 10 reported claims and early return to work. Centralized activity includes nationally directed telemarketing, standard development of marketing materials, a national accounts sales force, payroll processing, benefits administration and claims management. The major elements of finance, procurement and compliance will also be centralized. BUSINESS PROFILE REHABILITATION SERVICES OUTPATIENT SERVICES During fiscal year 1996, NovaCare merged its outpatient services businesses, comprising outpatient rehabilitation and O&P services, under a common management team to take advantage of administrative and operational economies of scale and the evolution of rehabilitation services toward affiliation with health care providers and payers. For the fiscal years ended June 30, 1997 and 1996, outpatient services represented 38% and 35%, respectively, of the Company's rehabilitation services net revenues. Outpatient Rehabilitation Services Management believes that NovaCare is a leading provider of freestanding outpatient rehabilitation services in the United States, with a national network of 336 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 injury and/or surgery. 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 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 $11 billion. NovaCare's share of the industry total, based on fiscal 1997 revenues, is approximately 2%. Orthotic and Prosthetic Services NovaCare is the largest custom O&P patient care services organization in the U.S. with an approximate 11% market share of a $1.5 billion industry, based on fiscal 1997 revenues. Services are provided by 663 orthotists and prosthetists, referred to as practitioners, through 274 patient care centers. Orthotic rehabilitation involves the fitting, design, 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. The Company, through its Sabolich socket and myoelectric technology, is a nationally renowned leader in prosthetic research, design and patient care. Its breakthrough technology and research is believed by management to clinically differentiate NovaCare in O&P services worldwide. 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 payers have emerged as 8 11 important referral sources. Secondary referral sources include physical therapists, orthopedic nurses, orthopedic technicians and other rehabilitation professionals. OCCUPATIONAL HEALTH SERVICES Occupational health services comprise treatment for work-related injuries and illnesses, physical and occupational rehabilitation therapy, pre-placement physical examinations and evaluations, case management, diagnostic testing and other employer-requested or government-mandated work-related health care services. The most common work related injuries are soft tissue injuries, lacerations, moderate trauma injuries to the spine or extremities, and exposure to hazardous materials. Treatments typically are provided by licensed physicians, physicians assistants, x-ray technicians and physical therapists. The physicians generally are trained and experienced in occupational and industrial medicine or have other medical backgrounds compatible with work-related injuries. The occupational health services market is highly fragmented. Industry analysts estimate that there are more than 2,000 occupational health care locations in the United States, representing a $30 billion industry. The Company believes that, due to increasing business and regulatory complexity, capital requirements and the development of health care systems in local and regional markets, an increasing number of physicians specializing in occupational health services are seeking to affiliate with larger health care service organizations. The dollar amount of workers' compensation claims has increased significantly in recent years, resulting in escalating employer costs. The increase is attributable to (i) an increase in work-related injuries and illnesses, (ii) the rise in the cost of health care, and (iii) the requirement that employers pay the majority of lost wages, replacement wages, legal and other benefit expenses. In the aggregate, workers' compensation costs amounted to $70 billion annually in the United States. Occupational health services is an employer's solution to controlling workers' compensation costs attributable to medical costs and lost time from work. NovaCare currently manages work injury rehabilitation and prevention programs for employers through on-site programs and outpatient care through the Company's six freestanding occupational health centers and its 336 outpatient rehabilitation clinics. NovaCare performs work-site analysis to assess workplace risk, provides work-site safety programs and helps employers comply with work-related state and federal requirements. By acquiring additional practices and related occupational health services in target markets, NovaCare plans to expand its linkage with workers needing occupational rehabilitation, enhance the patient volume of outpatient rehabilitation and increase the attractiveness of the Company to workers' compensation insurers, commercial customers and potential health care system affiliates. LONG-TERM CARE SERVICES NovaCare's long-term care services portfolio consists of contract therapy and management consulting delivered principally to long-term care providers. For the fiscal years ended June 30, 1997 and 1996, long-term care services represented 59% and 63%, respectively, of the Company's rehabilitation services net revenues. Contract Rehabilitation Services NovaCare provides multi-disciplinary rehabilitation therapy services on a contract basis, principally to long-term care 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 enhances muscular and neurological responses and is designed to improve the 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 rehabilitation provider to the long-term care industry with a market share of approximately 12%, as measured by fiscal 1997 net revenues. As of June 30, 1997, NovaCare provided these services in approximately 1,750 facilities located in 44 states. 9 12 Analysts estimate that the market for therapy services delivered under contract to long-term care facilities is approximately $4.5 billion. A 1995 management-sponsored survey indicated that 73% of long-term care facility rehabilitation services are performed on a contract basis. 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 fluctuating caseload, which makes it uneconomical to operate its own therapy program with full-time employment of therapists and the associated costs of management and administration. Supply of therapists. There is an inadequate supply of therapists and the workforce 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 long-term care facility. As a result, nursing facilities frequently choose to contract for specialized expertise. NovaCare has been successful in hiring therapists due in part to its "employer of choice" programs and clinical and systems support networks. The number of full-time-equivalent therapists hired in the Company's contract rehabilitation business during fiscal 1997 was 2,605. Employer of Choice Programs. NovaCare's employer of choice initiatives comprise defined career ladders for clinicians, clinical training and competitive compensation and benefit programs, as well as management and technological support designed to attract and retain therapists. At June 30, 1997, NovaCare employed 68 recruiters, which management believes is the largest therapist recruiting organization in the U.S. Over the past two years, one-fifth of the therapists who joined NovaCare's contract rehabilitation business chose NovaCare as a result of employee referrals. Clinical Support. A network of local and national clinical experts is available to all clinicians as support resources in all aspects of the clinical practice. Systems Support. NovaCare's proprietary information system, NovaNet PLUS, reduces therapist record-keeping burdens, streamlines administrative activities and captures information of value to clinicians, management and customers. Integrated outcomes measurement was incorporated into the system in fiscal 1997. Management believes that this innovative system continues to increase NovaCare's attractiveness as an employer of therapists. Clinical Leadership. NovaCare and the Harvard School of Public Health have jointly devised a standard system for measuring the effectiveness of rehabilitation outcomes for geriatric patients. The outcomes measurement system now serves as a vehicle to determine the treatment and payment for rehabilitation services to the geriatric population. Management believes that NovaCare's leadership in outcomes measurement has and will continue to enhance the Company's visibility in the clinical community and its attractiveness as an employer. Nursing facility operators have from time to time provided 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 long-term care 10 13 facilities with in-house programs. The study surveyed over 15,000 long-term care facilities and examined several years of Medicare cost reports for long-term care facilities with in-house therapy programs. Nevertheless, a number of national multi-facility long-term care companies have directly hired therapists to staff and manage their therapy program in-house. These in-house decisions appear to be based, at least in part, on a desire to gain greater management control over therapy programs, overriding economic concerns. This trend has been exacerbated by consolidation activity in the nursing home industry. During fiscal years 1995 through 1997, NovaCare reduced its dependence on national chains of long-term care facilities due primarily to the transition from outsourcing with NovaCare to providing therapy services in-house. The percentage of NovaCare's rehabilitation services revenue attributable to national chains declined to 21% at June 30, 1997 from 27% in fiscal 1994. Business lost due to the in-house transition was replaced with predominantly regional and independent customers, diversifying the Company's customer base. Management does not expect in-house transitions to have a significant impact on future results due to the Company's reduced dependency on national multi-facility long-term care companies and the economic opportunity outsourcing provides. The anticipated annualized revenue of new contracts has increased from approximately $120 million in fiscal 1996 to approximately $180 million in fiscal 1997. Contract turnover has also declined to 15% in fiscal 1997 from 26% in fiscal 1996. The anticipated annualized net revenue impact of new contracts sold less contracts canceled improved to $98 million in fiscal 1997. In fiscal 1996, the anticipated annualized net revenue impact of contracts canceled exceeded new contracts sold by $7 million. Employee turnover in the rehabilitation industry is high relative to other industries because of the therapist supply/demand imbalance. Also affecting turnover is the aggressive recruiting that occurs within the industry, and the highly mobile therapist population. Therapist turnover rates in long-term care facilities are traditionally higher than in other therapy settings. NovaCare's therapist turnover in the contract rehabilitation business decreased in fiscal 1997 to 35% from 44% in fiscal 1996. Therapist turnover initiated by employees decreased from 41.7% in fiscal 1996 to 31.23% in fiscal 1997. The balance of therapist turnover was based on the Company's decision to terminate employment. NovaCare is compensated for its contract services on a fee-for-service basis, and generally collects payment for services from the long-term care 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 long-term care services business. See "Reimbursement/Government Relations", discussed later. NovaCare generally indemnifies its customers against medical denials of reimbursement by third party payers, 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. NovaCare contracts predominantly with regional and local long-term care companies and independently-owned nursing facilities 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. In the current unsettled reimbursement environment (See "Reimbursement/Government Relations", discussed later), NovaCare believes that it is well-positioned to compete effectively with other contract therapy companies and the "in house" alternative due to: (i) its highly centralized administrative functions and flexible organization structure which can respond to business growth and industry change; (ii) a nationwide recruiting organization and substantial staffing capabilities; (iii) a multi-disciplinary team approach to therapy that is designed to deliver a high level of quality and efficient care, (iv) sophisticated management information systems to assist clinicians and management in analyzing clinical outcomes, therapy utilization, claim denials, staffing and educational activities; (v) a clinical support network to provide timely expert clinical advice to care providers; (vi) a nationwide sales organization to secure customer contracts in 11 14 support of business growth; and (vii) reimbursement and regulatory expertise to assist nursing facility operators in their dealings with third-party payers, principally Medicare. MANAGEMENT AND INFORMATION SERVICES The Company focuses on the delivery of expert management, information and specialty consulting services to health care and long-term care institutions. Such services currently include long-term care facility rehabilitation program management, consulting and subacute program development, and management and information services. Rehabilitation Program Management and Consulting. The Company provides rehabilitation program consulting and management services to long-term care and hospital facilities through Polaris Group, a NovaCare business unit, and a 40%-owned subsidiary, Gill/Balsano Consulting, L.L.C. Due to regulatory and reimbursement complexities in the long-term care and hospital industries, these services assist these providers with utilization, documentation, receivables and denials management, cost reporting, quality oversight and strategic direction setting. The Company had arrangements to provide such services to 797 long-term care facilities at June 30, 1997 as compared with 624 at June 30, 1996. Information Services. NovaCare delivers a range of services based on its proprietary NovaNet PLUS information system to its two largest long-term care customers. These customers utilize NovaNet PLUS throughout their organizations to: (i) promote a common clinical approach to case management; (ii) gather and analyze clinical outcomes information; (iii) increase therapist administrative and clinical efficiency; and (iv) provide operating unit financial information. EMPLOYEE SERVICES As co-employer of worksite employees, NovaCare assumes responsibility for and manages the risks associated with: (i) worksite employee payroll; (ii) workers' compensation insurance coverage; and (iii) compliance with certain employment-related governmental regulations that can be effectively managed away from the client's business. The client retains the right and responsibility for supervision and direction of worksite employees' services in its business and remains responsible for compliance with other employmentrelated governmental regulations that are more closely related to worksite employee supervision. The service fee charged by the Company to its clients covers the cost of certain employment-related taxes, workers' compensation insurance coverage, administrative and field services, salaries and wages of the worksite employees and the client's portion of health and retirement benefit plan cost. NovaCare also provides other value-added services such as temporary staffing, training and human resource consulting. In keeping with its strategy to create a more satisfying and more productive relationship between employers and employees, NovaCare provides six primary categories of employee services: (i) workers' compensation cost containment and safety management; (ii) unemployment insurance cost containment; (iii) employee benefits administration; (iv) human resources and compliance management; (v) payroll management and (vi) value-added services. By engaging the Company to provide these services, clients can focus on their core competencies and enhance their abilities to compete. These services are provided under the Company's standard services agreement which provides for an initial one-year term; thereafter, the agreement is renewed periodically. The agreement is subject to termination by the Company or the client at any time upon 30 days' prior written notice. Service revenues, billed to clients along with each periodic payroll, are based on a pricing model that takes into account the gross pay of each employee and a mark-up which includes the estimated costs of employment-related taxes, providing insurance coverage and benefit plans, performing human resources, payroll, benefits and compliance management and other services and an administration fee. The specific mark-up varies by client based principally on the workers' compensation classification of the worksite employees, their eligibility for health care benefits and the size of the client. Accordingly, the Company's average mark-up percentage will fluctuate based on client mix, which cannot be predicted with any degree of certainty. 12 15 Workers' Compensation Cost Containment and Safety Management. Workers' compensation is a state-mandated, comprehensive insurance program that requires employers to fund medical expenses, lost wages and other costs that result from work-related injuries and illnesses, regardless of fault and without any copayment by the employee. Annual workers' compensation costs exceed $70 billion in medical expenses and employee productivity each year (see "Government Regulation" below). Pursuant to the Company's services agreement, the Company assumes the obligations of its clients to pay workers' compensation claims. The Company seeks to control its workers' compensation costs through comprehensive risk evaluation of prospective clients, the prevention of workplace injuries, timely intervention with each employee injury, aggressive management of the medical costs related to such injuries and the prompt return of employees to work. The Company seeks to prevent workplace injuries by implementing a wide variety of training and safety programs. NovaCare's efforts to return employees to work quickly involve both rehabilitation services and the placement of employees in transitional, light duty positions until they are able to resume their former positions. Unemployment Insurance Cost Containment. Pursuant to the services agreement, NovaCare assumes the obligation of its clients to pay unemployment insurance costs. NovaCare manages its unemployment insurance costs by establishing employee termination procedures, quickly responding to unemployment claims, attending unemployment hearings and attempting to reassign employees to other worksites when a reduction in force occurs at any one worksite location. Employee Benefits Administration. In accordance with the services agreement, NovaCare offers worksite employees a benefits package which includes several health care options such as point-of-service ("POS"), HMOs and indemnity plans. Supplemental benefit programs include dental care, prescription drugs, and life and disability insurance options. The Company also offers 401(k) retirement savings and cafeteria-style plans to its eligible employees. The Company delivers participant benefits to worksite employees and monitors and reviews claims for loss control purposes. NovaCare believes that its ability to provide and administer a wide variety of employee benefits on behalf of its clients tends to mitigate the competitive disadvantage small and medium-sized businesses normally face in the areas of employee benefit cost control and employee recruiting and retention. Human Resources and Compliance Management. Pursuant to the services agreement, the Company provides comprehensive human resources services to reduce the employment-related administrative burdens faced by its clients, and provide worksite employees with a wide array of benefits typically offered by large employers. NovaCare develops and administers personnel policies and procedures for each of its clients, relating to, among other things, recruiting, retention programs, performance management, discipline and terminations. The Company also provides orientation, training and development, counseling and substance abuse awareness for worksite employees. By contract, NovaCare generally assumes responsibility for complying with many employment-related regulatory requirements. In addition, the Company assists its clients in understanding and complying with other employment-related requirements for which the Company does not assume responsibility. Laws and regulations applicable to employers include state and federal tax laws, state workers' compensation laws, state unemployment laws, occupational safety laws, immigration laws, and discrimination, sexual harassment and other civil rights laws. Payroll Management and Reporting. As a co-employer, NovaCare is responsible for payroll processing, check preparation, distribution and record keeping, payroll tax deposits, payroll tax reporting, employee file maintenance, unemployment claims, and monitoring and responding to changing regulatory requirements. Payroll reports are prepared for clients for financial and other record keeping purposes. By having the Company assume the responsibility for this significant administrative function, clients have certain guarantees of regulatory compliance, reduced employment liabilities and greater management resources to focus on their core business. Other Value-Added Services. NovaCare offers rehabilitation temporary staffing in the long term care industry. The rehabilitation temporary staffing service currently accesses an active clinician pool of over 6,000 to provide staff to skilled nursing facility clients at which over 1,300 worksite employees were performing 13 16 services at June 30, 1997. This business is supported by state-of-the-art technology, which provides precise recruitment and sales productivity information for management purposes. It also generates billing and utilization reports for clients. The Company plans to offer additional value-added services to clients and worksite employees. Such services may include employee recognition programs, travel discount arrangements, vision care, credit union membership, smart cards, warehouse club memberships and various financial services. Some of these services may generate fee income or commissions for the Company. COMPETITION REHABILITATION SERVICES 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 long-term care services and where its outpatient services patient care centers are located. The primary competitive factors in such local markets are (i) quality of patient care services, (ii) charges for services, (iii) responsiveness to meeting the needs of patients, customers, referral sources and payers, and (iv) increasingly, networked integration with other health care providers and payers. Key competitive factors in the long-term care services businesses 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, regional and local contract therapy providers. NovaCare believes that its ability to recruit therapists, manage geographically dispersed service professionals, provide expert clinical support and develop new services allows it to compete successfully with other contract therapy providers in the markets where NovaCare provides services. The demographics of potential customers have changed and will continue to change as some large long-term care facility chains choose to take all or part of their therapy services in-house. This may increase the competition for remaining customers. The Company has diversified its customer base in the long-term care industry to replace business lost because of such in-house programs (see "Contract Rehabilitation Services," previously discussed). In the outpatient services business, key competitive factors include the ability to develop and maintain relationships with referral sources (physicians, rehabilitation professionals, hospitals and payers) and to provide sufficient geographic coverage to allow the Company, alone or with other providers, to compete successfully for patients from managed care payers, workers' compensation payers and employers. The Company competes in local markets with other national, regional and local outpatient rehabilitation service providers, as well as hospital-based outpatient clinics and physician-directed therapy practices. Some of these competitors may have greater patient referral, personnel and geographic resources in certain local markets. Competition in the O&P industry is highly fragmented; however, there are several regional providers with multiple facilities in certain local markets. Management believes that the Company competes successfully within its local markets based on its reputation for quality and service, an ability to provide geographic coverage and competitive prices, affiliation with health care systems, and technologically superior O&P product offerings. In the occupational health services industry, the market is highly fragmented and competitive. The largest competitor in the industry has less than 4% market share. Competitors include other occupational health services companies, independent physicians, hospitals, insurance companies, HMO's, managed care providers and networks of primary care physician specialists. The ability to compete successfully is dependent upon (i) relationships with employers, employees and payer sources, (ii) quality of rehabilitative care, and (iii) returning employees to work quickly at the lowest cost for the care provided. 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 university level physical therapy and occupational therapy programs. 14 17 EMPLOYEE SERVICES The PEO industry consists of as many as 2,400 companies, most of which serve a single market or region. The Company believes that it is the second largest PEO in the United States. NovaCare considers its primary competition to include: (i) traditional in-house human resources departments; (ii) other PEOs, and (iii) providers of unbundled employment-related services such as payroll processing firms, temporary employment firms, commercial insurance brokers, human resource consultants, workers' compensation insurers, HMOs and other specialty managed care providers. Competition in the highly fragmented PEO industry is generally on a local or regional basis. Management believes that the primary elements of competition are quality of service, choice and quality of benefits, reputation and price. The Company believes that brand recognition, regulatory expertise, financial resources, risk management, information technology capability and economies of scale can distinguish a large-scale PEO from the rest of the industry. The Company believes that it competes favorably in these areas. NovaCare believes that barriers to entry into the PEO industry are increasing due to, among others, the following factors: (i) the complexity of the PEO business and the need for expertise in multiple disciplines; (ii) the three to five years of experience required to establish experience ratings in key cost areas of workers' compensation, health insurance and unemployment; and (iii) the need for sophisticated management information systems to track all aspects of business in a high growth environment. REIMBURSEMENT/GOVERNMENT RELATIONS REHABILITATION SERVICES Reimbursement for medical rehabilitation services is available through Medicare, Medicaid, commercial insurance, managed care programs, 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 Company's gross profit directly or indirectly attributable to Medicare for fiscal 1997 and 1996 was 45% and 49%, respectively. CONTRACT REHABILITATION SERVICES Contract rehabilitation services are covered and reimbursed in one of two ways. In most cases, NovaCare bills a facility, which, in turn, invoices a third-party payer, such as Medicare. NovaCare also provides services through its own certified rehabilitation agencies, which directly bill a third-party payer, such as Medicare. Medicare reimburses the long-term care 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 and there are general guidelines for evaluating the reasonable cost of occupational therapy and speech-language pathology services. With respect to physical therapy, the specific guideline 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, the portion of contract services that relate to physical therapy services are essentially a break-even business for many contractors, including NovaCare. 15 18 The Health Care Financing Administration ("HCFA"), the federal agency responsible for the rules governing Medicare and Medicaid, has issued proposed specific reimbursement guidelines for occupational therapy and speech-language pathology services and revisions to the existing guidelines for physical therapy services. The proposed rules specify that when occupational therapy and speech-language pathology services guidelines become effective, physical therapy salary equivalency guidelines will be increased in consideration of the substantial increases in salary and services standards since these guidelines were last revised. The proposed rules governing such guidelines have received public comment. Final rules are expected in the fourth quarter of calendar year 1997. Until such time as salary equivalency guidelines are finally 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 three years, HCFA has issued several directives to its fiscal intermediaries instructing them on how to ensure therapy costs are reasonable. Intermediaries have been 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. The Balanced Budget Act of 1997 (the "Act") enacted in August 1997, made several changes in the way Medicare will reimburse nursing homes and other providers for their services. Those changes will take effect for nursing homes at different times throughout calendar years 1998 and 1999, depending on the starting date for each facility's cost reporting year. By the middle of 1999, the Act mandates that each facility be reimbursed, in part, under a comprehensive prospective payment system, which will include payment for therapy services in a single all-inclusive per diem payment. Therapy services not covered by the prospective payment system will be covered by a fee schedule with total charges being subject to an annual cap. NovaCare also receives direct reimbursement by Medicare for 5% 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. The Act also mandates changes to the payment structure for services provided through certified rehabilitation agencies. Implementation of these changes stretches over the next 18 months. As with nursing homes, rehabilitation agencies will change from the current cost-based system to a system based on a fee schedule with an annual cap. NovaCare is actively involved in trade groups assisting HCFA in designing the regulations and reimbursement schedules necessary to implement the Act. By changing Medicare reimbursement to nursing homes from a cost basis to a fixed fee, the Act will make a fundamental change in the economic assumptions underlying patient care in nursing homes. It cannot be predicted at this time what effect this change will have on the demand for therapy services. Management is taking steps which it believes will help to mitigate any adverse economic impact of the changes made by the Act. There can be no assurance, however, that these changes will not have a material adverse effect on the future operations of the Company. OUTPATIENT AND OCCUPATIONAL HEALTH SERVICES The principal sources of reimbursement for outpatient and occupational health services are commercial and workers' compensation insurance, managed care plans, motor vehicle insurance and individual patients. Workers' Compensation. Workers' compensation is a state mandated, comprehensive insurance program that requires employers to fund medical expenses, lost wages and other costs resulting from 16 19 work-related injuries and illnesses. (See "Government Regulation" below.) Workers' compensation represented approximately 17% of fiscal 1997 outpatient and occupational health revenues. Managed Care. Managed care plans represented approximately 15% of fiscal 1997 outpatient and occupational health 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. Medicare. NovaCare receives reimbursement by Medicare for outpatient and occupational health care services primarily through NovaCare's certified rehabilitation agencies and on a fee schedule basis for O&P services. See "Government Regulation," discussed later. Medicare and other government health insurance programs represent approximately 10% of revenues. GOVERNMENT REGULATION REHABILITATION SERVICES 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 reimbursement for services provided. Government and other third-party payers' 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 long-term care services. In order to receive Medicare reimbursement directly, outpatient centers must be certified by Medicare as rehabilitation agencies or comprehensive outpatient rehabilitation facilities. The certification criteria relate to the type of facility and its equipment, record keeping, staffing and service as well as compliance with all state and local laws. In addition, certain states require facilities to obtain state licensure as a health facility as a requirement for reimbursement. As of June 30, 1997, NovaCare operated 18 and 72 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, have enacted legislation or regulations or have interpreted existing licensing laws to restrict business corporations, such as NovaCare, from practicing therapy through the direct employment of therapists. Management believes its operations are structured to comply with applicable laws and regulations. Various state and federal laws and regulations govern the relationships between providers of health care services and physicians, including employment or service contracts and investment relationships. These laws and regulations include the fraud and abuse provisions of the Medicare and Medicaid statutes, which prohibit the payment, receipt or offering of any direct or indirect remuneration for the referral of or to induce a referral of Medicare or Medicaid patients or for the ordering or providing of Medicare or Medicaid covered services, items or equipment and the self-referral provisions of federal and state law which generally prohibit referrals by a physician to persons with whom the physician has certain types of financial relationships. Violations of these provisions may result in civil or criminal penalties for individuals or entities and/or exclusion from participation in the Medicare and Medicaid programs. Management believes it is in compliance with these laws and regulations and has established a broad-based compliance program to ensure conformance with these rules as well as to other laws and regulations. 17 20 EMPLOYEE SERVICES The Company is subject to local, state and federal regulations which include operating, fiscal and licensing requirements. Adding complexity to the Company's regulatory environment are (i) uncertainties resulting from the non-traditional employment relationships created by PEOs; (ii) variations in state regulatory schemes, and (iii) the ongoing evolution of regulations regarding health care and workers' compensation. Many of the federal and state laws and regulations relating to labor, tax and employment matters applicable to employers were enacted prior to the development of non-traditional employment relationships and, accordingly, do not specifically address the obligations and responsibilities of PEOs or the co-employment relationship. Moreover, the Company's PEO services are regulated primarily at the state level. Regulatory requirements regarding the Company's business therefore vary from state to state, and as NovaCare enters new states it will be faced with new regulatory and licensing environments. There can be no assurance that the Company will be able to satisfy the licensing requirements or other applicable regulations of any particular state in which it is not currently operating, that it will be able to provide the full range of services currently offered, or that it will be able to operate profitably within the regulatory environment in any state in which it does not obtain regulatory approval. The absence of required licenses would require NovaCare to restrict the services it offers. New legislation or new interpretations of current licensing and regulatory requirements could impose operating or licensing requirements on the Company which it may not be able to satisfy or which could have a material adverse effect on NovaCare's business, financial condition, results of operations and liquidity. Additionally, interpretation of such legislation or regulation by regulatory agencies with broad discretionary powers could require the Company to modify its existing operations materially in order to comply with applicable regulations. The application of many laws to NovaCare's services will depend on whether the Company is considered an employer under the relevant statutes and regulations. The Internal Revenue Service (the "IRS") is examining this issue. See "Employee Benefit Plans" below. In addition, from time to time there have been proposals to enact a statutory definition of employer for certain purposes of the Internal Revenue Code of 1986, as amended (the "Code"). PEO Licensing Requirements. A critical aspect of the growth of the PEO industry has been increasing recognition and acceptance of PEOs by state authorities. While many states do not explicitly regulate PEOs, approximately one-third of the states, including Florida, have passed laws that have licensing or registration requirements for PEOs and several additional states, including Pennsylvania, are considering such regulation. Such laws vary from state to state but generally provide for monitoring the fiscal responsibility of PEOs. State regulation assists in screening insufficiently capitalized PEO operations and, in NovaCare's view, has the effect of legitimizing the PEO industry by resolving issues concerning an employee's status for specific purposes under applicable state law. However, because existing regulations are relatively new, there is limited interpretive or enforcement guidance available. The development of additional regulations and interpretation of existing regulations can be expected to evolve over time. Federal and State Employment Taxes. NovaCare assumes the sole responsibility and liability for the payment of federal and state employment taxes with respect to wages and salaries paid to its employees, including worksite employees. To date, the IRS has relied extensively on the common law test of employment in determining employer status and the resulting liability for failure to withhold. However, the IRS has formed a Market Segment Study Group for the stated purpose of examining whether PEOs, such as the Company, are the employers of the worksite employees under the Code provisions applicable to federal employment taxes and, consequently, whether they are exclusively responsible for payment of employment taxes on wages and salaries paid to such employees. Another stated purpose of the Market Segment Study Group is to determine whether owners of client companies can be employees of PEOs under the federal employment tax laws. The interpretive uncertainties raised by the Market Segment Study Group may affect the Company's ability to report employment taxes on its own account rather than for the accounts of its clients and would increase administrative burdens on NovaCare's payroll service function. In addition, while the Company 18 21 believes that it can contractually assume the client company's withholding obligations, in the event NovaCare fails to meet these obligations, the client company may be held jointly and severally liable. Employee Benefit Plans. NovaCare offers various employee benefit plans to its worksite employees, including 401(k) plans, cafeteria plans, group health plans, group life insurance plans, group disability insurance plans and employee assistance programs. Generally, employee benefit plans are subject to provisions of both the Code and the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). In order to qualify for favorable tax treatment under the Code, the plans must be established and maintained by an employer for the exclusive benefit of its employees. Most of these benefit plans are also offered to the Company's corporate employees. The Market Segment Study Group established by the IRS is also examining whether PEOs, such as NovaCare, are the employers of worksite employees under Code provisions applicable to employee benefit plans and consequently are able to offer to worksite employees benefit plans that qualify for favorable tax treatment. The Company is unable to predict the timing or nature of the findings of the Market Segment Study Group or the ultimate outcome of such conclusions or findings. If the IRS study were to conclude that a PEO is not an employer of its worksite employees for plan purposes, worksite employees could not continue to make contributions to the Company's 401(k) plans or cafeteria plans. The Company believes that although unfavorable to the Company, a prospective application by the IRS of an adverse conclusion would not have a material adverse effect on its financial position and results of operations. If such conclusion were applied retroactively, employees' vested account balances would become taxable immediately, the Company would lose its tax deduction to the extent the contributions were not vested, the plans' trusts would become taxable trusts and penalties could be assessed. In such a case, the Company would face the risk of client dissatisfaction as well as potential litigation. A retroactive application by the IRS of an adverse conclusion could have an adverse effect on the Company's business, financial condition, results of operations and liquidity. While the Company believes that a retroactive disqualification is unlikely, there can be no assurance as to the ultimate resolution of these issues. In addition to the employer/employee relationship requirement described above, pension and profit-sharing plans, including the Company's 401(k) plans, must satisfy certain other requirements under the Code. These other requirements are generally designed to prevent discrimination in favor of highly compensated employees to the detriment of non-highly compensated employees with respect to both the availability of, and the benefits, rights and features offered in, qualified employee benefit plans. The Company applies the nondiscrimination requirements of the Code at both a consolidated and client company level to ensure that its 401(k) plans are in compliance with the requirements of the Code. Workers' Compensation. Workers' compensation is a state mandated, comprehensive insurance program that requires employers to fund medical expenses, lost wages and other costs resulting from work-related injuries and illnesses. In exchange for providing workers' compensation coverage for employees, employers are not subject to litigation by employees for benefits in excess of those provided by the relevant state statute. In most states, the extensive benefits coverage (for both medical costs and lost wages) is provided through the purchase of commercial insurance from private insurance companies, participation in state-run insurance funds or employer self-insurance. Workers' compensation benefits and arrangements vary on a state-by-state basis and are often highly complex. These laws establish the rights of workers to receive benefits and to appeal benefit denials. Workers' compensation laws also regulate the methods and procedures which the Company may employ in its workers' compensation managed care programs. As a creation of state law, workers' compensation is subject to change by each state's legislature and is influenced by the political processes in each state. Several states have mandated that employers receive coverage only from state-operated funds. Other states have adopted legislation requiring that all workers' compensation injuries be treated through a managed care program. While such legislation may increase the market for the Company's workers' compensation services, it may also intensify the competition faced by 24-hour health coverage, in which the coverage of traditional employer-sponsored health plans is combined with workers' compensation coverage to provide a single insurance plan for health problems, whether or not related to work. Incorporating workers' compensation coverage into conventional health plans may adversely affect 19 22 the market for the Company's services and may intensify the competition faced by the Company from HMOs and other health care providers. Moreover, because workers' compensation benefits are mandated by law and are subject to extensive regulation, payers and employers do not have the same flexibility to alter benefits as they have with other health benefit programs. Finally, because workers' compensation programs vary from state to state, it is difficult for payers and multi-state employers to adopt uniform policies to administer, manage and control the cost of benefits. Other Employer Related Requirements. As an employer, NovaCare is subject to a wide variety of federal and state laws and regulations governing employer-employee relationships, including the Immigration Reform and Control Act, the Americans with Disabilities Act, the Family Medical Leave Act, the Occupational Safety and Health Act, wage and hour regulations, and comprehensive state and federal civil rights laws and regulations, including those prohibiting discrimination and sexual harassment. The definition of employer may be broadly interpreted under these laws. Responsibility for complying with various state and federal laws and regulations is allocated by agreement between the Company and its clients, or in some cases is the joint responsibility of both. Because NovaCare acts as a co-employer with the client company, it is possible that the Company could incur liability for violations of laws even though the Company is not contractually or otherwise responsible for the conduct giving rise to such liability. The Company's standard client agreement generally provides that the client will indemnify the Company for liability incurred as a result of an act of negligence of a worksite employee under the direction and control of the client or to the extent the liability is attributable to the client's failure to comply with any law or regulation for which it has specified contractual responsibility. However, there can be no assurance that NovaCare will be able to enforce such indemnification and the Company may therefore be ultimately responsible for satisfying the liability in question. INSURANCE The Company maintains professional liability insurance in amounts deemed appropriate by management based upon historical claims and the nature and risks of the business. The Company also maintains property and general liability insurance for the customary risks inherent in the operation of 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 At June 30, 1997, the Company had approximately 39,800 employees. Of these, approximately 19,300 are rehabilitation services personnel and 20,500 are employee services personnel. Only six of the Company's employees are represented by a labor union and the Company is not aware of any current activity to organize any of its non-worksite employees. Management considers relations between the Company and its employees to be good. For information with respect to the Company's worksite employees, see "Business Profile -- Employee Services" above. 20 23 EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of NovaCare who served during the fiscal year are as follows:
NAME POSITION AGE - ---------------------------- ----------------------------------------------------------- --- John H. Foster.............. Chairman of the Board and Director 55 Timothy E. Foster........... Chief Executive Officer and Director 45 James W. McLane............. President, Chief Operating Officer and Director 58 Daryl A. Dixon.............. President and General Manager, Contract Rehabilitation Division 37 Ronald G. Hiscock........... President and General Manager, Outpatient Division 46 Peter D. Bewley............. Senior Vice President, General Counsel and Secretary 51 Robert E. Healy, Jr. ....... Senior Vice President, Finance and Administration and Chief Financial Officer 44 Laurence F. Lane............ Senior Vice President, Regulatory Affairs 52 Aven Kerr................... Senior Vice President, Human Resources 51 Susan J. Campbell........... Vice President, Communications and Investor Relations 46 Richard A. McDonald......... Vice President, Treasurer 50 Barry E. Smith.............. Vice President, Controller and Chief Accounting Officer 44 James T. Walmsley........... Vice President, Reimbursement 47 Steven M. Wise.............. Vice President, Information Systems and Chief Information Officer 41
No family relationships exist among any of the directors or executive officers of NovaCare. Executive officers serve at the discretion of the NovaCare Board of Directors. JOHN H. FOSTER has been Chairman of the Board of NovaCare since December 1984. From 1984 to May 1997 he was also Chief Executive Officer of the Company. Mr. Foster is also Chairman of the Board and Chief Executive Officer of Apogee, Inc., a national mental health 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. TIMOTHY E. FOSTER has been Chief Executive Officer of the Company since May 1997. From October 1994 until May 1997 he was President and Chief Operating Officer. He served as Senior Vice President, Finance and Administration and Chief Financial Officer of NovaCare from November 1988 to October 1994, Treasurer 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. JAMES W. MCLANE has been President and Chief Operating Officer and a director of the Company since May 1997. From 1991 to 1997, Mr. McLane served as Chief Executive Officer of Aetna Health Plans and as Executive Vice President of Aetna Life and Casualty. He is also a director of FemRx, a medical device manufacturer. DARYL A. DIXON has been President and General Manager of NovaCare's Contract Rehabilitation Division since January 1994. He joined NovaCare in February 1992 as Regional Vice President in the Contract Rehabilitation Division and was Vice President, Operations of the Contract Rehabilitation 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 Outpatient Division since February 1996 and had been President and General Manager of NovaCare's Orthotics and Prosthetics Division from April 1995 to February 1996. He joined NovaCare in June 1992 as the East Region President 21 24 for the Orthotics and Prosthetics Division and was the Division's Vice President of Operations from July 1994 through March 1995. PETER D. BEWLEY has been Senior Vice President, General Counsel and Secretary of NovaCare since May 1994. Prior to joining NovaCare Mr. Bewley was Associate General Counsel at Johnson & Johnson, where he had been employed since 1977. ROBERT E. HEALY, JR. has been Senior Vice President, Finance and Administration and Chief Financial Officer since December 1995. From January 1994 to December 1995, he was Vice President Chief Financial Officer of NovaCare's Contract Rehabilitation Division. He served as Vice President Finance and Chief Accounting Officer of the Company from March 1992 to January 1994. 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. AVEN KERR has been Senior Vice President, Human Resources of NovaCare since October 1996. From November 1995 to September 1996, she was Senior Vice President Administration and Systems at United Healthcare. She was Senior Vice President, Human Resources at MetraHealth from May 1995 to November 1995. Prior to that, she was employed by Prudential Insurance Company for 27 years in various positions, most recently as Senior Vice President, Central Atlantic Operations. 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. RICHARD A. MCDONALD has been Vice President, Treasurer since August 1996 and was Director, Treasury Services from May 1995 until August 1996. Prior to joining the Company, he was a financial consultant to Continental Medical Systems, Inc. He served as an assistant treasurer with American Healthcare Management from 1990 until 1994. BARRY E. SMITH has been Vice President, Controller and Chief Accounting Officer of the Company since December 1995 and has been Vice President of Finance of the Contract Rehabilitation Division since March 1995. He was Vice President of Finance of the Medical Rehabilitation Hospital Division from February 1994 through the sale date of the division, April 1995. From May 1992 through February 1994 he served in various positions in NovaCare's Corporate Finance Department. JAMES T. WALMSLEY has been Vice President, Reimbursement of NovaCare since January 1994 and Director of Reimbursement from April 1992 to January 1994. STEVEN M. WISE has been Vice President Information Systems and Chief Information Officer since December 1995. He joined NovaCare in 1993 as Director, Systems and Programming, for the Contract Rehabilitation Division. Prior to joining NovaCare, he was employed at Ortho-McNeil Pharmaceutical Company where he held various management positions in business systems development. ITEM 2. PROPERTIES The Company's principal executive offices are located at 1016 West Ninth Avenue, King of Prussia, Pennsylvania 19406 where NovaCare leases approximately 132,500 square feet. The lease for this office space expires in June 2005. In addition, the Company leases other office space in various cities in the United States for terms which typically are three years or less. See Note 8 of Notes to the Company's Consolidated Financial Statements for information concerning the Company's leases for its facilities. The Company does not anticipate that it will experience any difficulty in renewing any such leases upon their expiration or obtaining different space on comparable terms if such leases are not renewed. The Company believes that these facilities are well maintained and are of adequate size for present needs and planned expansion in the near future. 22 25 NovaCare also has sublease agreements for approximately 24,748 square feet of office space, expiring February 2003 with companies in which NovaCare's Chairman of the Board is a Director and/or an Executive Officer. ITEM 3. LEGAL PROCEEDINGS From time to time, NovaCare is party to certain claims, suits and complaints which arise in the ordinary course of business. Currently, there are no such claims, suits or complaints which, in the opinion of management, would have a material adverse effect on the Company's business, financial condition, results of operations and liquidity. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS NovaCare's common stock is traded on the New York Stock Exchange (NYSE) under the symbol NOV. On September 5, 1997, there were 1,817 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, 1997 First Quarter............................................ $ 9.63 $ 6.88 Second Quarter........................................... 11.25 8.13 Third Quarter............................................ 13.75 9.63 Fourth Quarter........................................... 14.13 10.88 YEAR ENDED JUNE 30, 1996 First Quarter............................................ $ 9.50 $ 6.25 Second Quarter........................................... 8.50 5.13 Third Quarter............................................ 8.25 5.25 Fourth Quarter........................................... 7.63 6.25
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. 23 26 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, ------------------------------------------------------ 1997 1996 1995 1994 1993 ---------- -------- -------- -------- -------- STATEMENT OF OPERATIONS DATA:(1) Net revenues............................. $1,066,451 $793,038 $905,359 $789,745 $582,342 Gross profit............................. 260,086 208,082 256,240 255,511 186,265 Income from operations................... 80,541 37,499 143,881 108,208 78,819 Net interest (expense) income............ (13,504) (7,537) (17,893) (11,773) (2,841) Income before income taxes............... 66,801 29,866 125,584 95,892 75,542 Income taxes............................. 27,891 14,585 63,660 37,678 27,906 Net income............................... 38,910 15,281 61,924 58,214 47,636 Net income applicable to common stock(2).............................. 38,910 15,281 61,924 58,214 47,585 Net income per common share.............. .62 .24 .95 .90 .79
AS OF JUNE 30, ------------------------------------------------------ 1997 1996 1995 1994 1993 ---------- -------- -------- -------- -------- BALANCE SHEET DATA: Working capital.......................... $ 173,576 $223,712 $255,126 $194,324 $265,908 Total assets............................. 1,014,304 789,731 852,557 850,541 611,567 Total indebtedness....................... 342,678 192,215 225,015 344,602 206,415 Total liabilities(3)..................... 506,298 305,337 364,922 434,837 282,587 Shareholders' equity..................... 508,006 484,394 487,635 415,704 328,980
- --------------- (1) Certain amounts have been reclassified to conform with the fiscal 1997 presentation. (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. (3) Includes minority interests in consolidated subsidiaries. 24 27 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 The Company has experienced significant growth in the recent year through strategic acquisitions and growth in its existing businesses. During fiscal 1997, the Company purchased 52 outpatient businesses and 3 businesses which provide occupational health services. Of the outpatient businesses acquired, 33 provide orthotic and prosthetic ("O&P") rehabilitation services and 19 provide outpatient rehabilitation services. The Company entered into the professional employer organization ("PEO") industry through the acquisition of one PEO business in October 1996 and three in February 1997. PEOs, or employee service companies, provide human resource and payroll management, workers compensation risk management, benefits administration, unemployment service and human resource consulting services principally to small to medium-sized businesses. Effective January 25, 1997, employee services were also provided to the rehabilitation services segment of the Company. During fiscal 1996, the Company acquired seven businesses which provide outpatient rehabilitation services and six businesses which provide O & P rehabilitation services. Nonrecurring charges in fiscal 1996 included a $13.4 million pretax restructuring charge and a $10.5 million pretax charge for a change in estimate. Nonrecurring items in fiscal 1995 consisted of an $88.2 million pretax gain on the sale of the medical rehabilitation hospitals, a $29.9 million pretax restructuring charge, and a $1.0 million pretax charge relating to the settlement of certain shareholder litigation. The following are the results of operations for fiscal years ended June 30, 1997, 1996 and 1995. The results of operations for fiscal 1996 and 1995 have been reclassified to conform to the fiscal 1997 presentation. Other operating expenses includes selling, general & administrative expenses, provision for uncollectible accounts and amortization of excess cost of net assets acquired.
FISCAL YEAR ENDED JUNE 30, ----------------------------------- 1997 1996 1995 --------- -------- -------- Net revenues Rehabilitation services......................... $ 927,547 $793,038 $905,359 Employee services............................... 394,193 -- -- Elimination..................................... (255,289) -- -- ---------- -------- -------- Total net revenues.............................. 1,066,451 793,038 905,359 Gross profit Rehabilitation services......................... 253,549 208,082 256,240 Employee services............................... 12,238 -- -- Elimination..................................... (5,701) -- -- ---------- -------- -------- Total gross profit.............................. 260,086 208,082 256,240 Other operating expenses.......................... 179,545 157,213 169,727 Provision for restructure and other nonrecurring items........................................... -- 13,370 (57,368) ---------- -------- -------- Income from operations............................ $ 80,541 $ 37,499 $143,881 ========== ======== ========
Change in Estimate In the third quarter of fiscal 1996, the Company recorded a $10.5 million charge to revenues to fully reflect payer allowances that had not been sufficiently recognized by certain billing systems during the first three quarters of fiscal 1996 and prior years. The Company has implemented a new methodology for estimating allowances and commenced the implementation of a fully integrated billing and allowance system. Systems implementation is scheduled to be substantially completed in fiscal 1998. 25 28 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) Restructuring Charge The Company recorded provisions for restructure of $13.4 million and $29.9 million in fiscal 1996 and 1995, respectively. The 1996 and 1995 programs, consisting of the consolidation and reorganization of the Company's outpatient and O&P businesses, closing certain administrative offices, O&P branches and outpatient rehabilitation centers in selected markets, and the consolidation of certain finance and other administrative functions, are substantially complete. The Company estimates that these plans would reduce or eliminate in the aggregate approximately $30 million to $35 million of annual expenses. Of the total restructuring charges, $19.6 million related to amounts to be paid in cash. The noncash portion of the charge related to the write-off of certain assets, principally excess cost of net assets acquired, related to facilities closed or to be closed. Sale of Medical Rehabilitation Hospitals Effective April 1, 1995, the Company sold its medical rehabilitation hospitals in a transaction valued at $242.9 million. The transaction resulted in a pretax gain on the sale of $88.2 million. The medical rehabilitation hospitals contributed $110.6 million in net revenues, $31.3 million in gross profit and $15.1 million in income from operations in fiscal 1995. Year Ended June 30, 1997 Compared With the Year Ended June 30, 1996 Net revenues for the year ended June 30, 1997 increased from the prior year by $273.4 million, or 34.5%, to $1.1 billion and gross profit increased $52.0 million, or 25.0%, to $260.1 million, primarily as a result of acquisitions, internal growth and a prior year $10.5 million charge to revenues for a change in estimate, as discussed further under "Operating Results by Business". Other operating expenses increased $22.3 million from $157.2 million for the year ended June 30, 1996 to $179.5 million for the year ended June 30, 1997. The increased costs are primarily associated with businesses acquired in fiscal 1997. As a percentage of net revenues, other operating expenses decreased from 19.8% to 16.8% for the same periods, respectively, principally as a result of employee and facility cost savings from the productivity and cost reduction programs initiated in fiscal 1996 and 1995. Depreciation expense increased to $24.4 million for the year ended June 30, 1997 from $23.3 million for the year ended June 30, 1996 primarily due to the full year effect of assets acquired in fiscal 1996 and certain internally developed software placed in service during fiscal 1997. Amortization expense increased $3.6 million to $13.5 million from $9.9 million for the same periods, respectively, as a result of businesses acquired in fiscal 1997 and the full year effect of businesses acquired during fiscal 1996. Interest expense, net of investment income, increased $6.0 million compared with the prior period principally as a result of decreased interest income due to lower invested cash, and higher interest expense due to increased borrowings in the fiscal 1997 compared with the fiscal 1996 as discussed under "Liquidity and Capital Resources". Income tax expense as a percentage of pretax income decreased to 41.8% for the year ended June 30, 1997 from 48.8% for the year ended June 30, 1996. The decrease in the income tax rate resulted principally from the impact of nondeductible amortization of excess cost of net assets acquired ("amortization") on lower income subject to income tax in fiscal 1996 as a result of the provision for restructure and the charge to revenues. See Note 9 to the Consolidated Financial Statements for the reconciliation of expected tax rate to actual tax expense. 26 29 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) Year Ended June 30, 1996 Compared to the Year Ended June 30, 1995 Net revenues for fiscal 1996 decreased $112.3 million from fiscal 1995. The decrease resulted principally from the inclusion of $110.6 million of net revenues in fiscal 1995 from the medical rehabilitation hospitals sold in fiscal 1995 and the $10.5 million charge for the change in estimate in fiscal 1996. Gross profit decreased $48.2 million in fiscal 1996 compared to fiscal 1995. The decrease resulted principally from the inclusion of $31.3 million gross profit in fiscal 1995 from the medical rehabilitation hospitals sold in fiscal 1995 and the $10.5 million charge to revenues for the change in estimate in fiscal 1996. See "Operating Results by Business -- Rehabilitation Services" below for a further explanation of the comparison of net revenues and gross profit. Operating expenses in fiscal 1996 decreased $12.5 million compared to fiscal 1995. The decrease resulted primarily from the inclusion of expenses of $16.1 million from the medical rehabilitation hospitals sold in fiscal 1995, coupled with expense savings from the cost reduction programs undertaken in fiscal 1996 and 1995, which were offset, somewhat, by an increase in depreciation. Depreciation expense increased to $23.3 million from $19.3 million for the fiscal years 1996 and 1995, respectively. The increase was due primarily to the full year effect of assets acquired in fiscal 1995 and certain internally developed software, and other assets placed in service in fiscal 1996. Amortization of excess cost of net assets acquired decreased by $1.1 million. This decrease resulted from a reduction in the related assets being amortized which were written off in the restructure charge. In fiscal 1996, the Company recorded a $13.4 million provision for restructure pertaining to the consolidation and reorganization of its outpatient businesses and certain administrative functions. Interest expense, net of interest income, decreased $10.4 million compared with the prior period principally due to reduced amounts borrowed under the Company's credit facility and increased cash invested, both as a result of the sale of the medical rehabilitation hospitals. Income tax expense as a percentage of pretax income decreased to 48.8% for the year ended June 30, 1996 from 50.7% for the previous year. The principal reasons for the effective income tax rate being higher than the statutory federal income tax rate were state income taxes, non-deductible nonrecurring items and nondeductible amortization of excess cost of net assets acquired ("amortization"). See Note 9 to the Consolidated Financial Statements for the reconciliation of expected tax expense to actual tax expense. OPERATING RESULTS BY BUSINESS REHABILITATION SERVICES The following table displays the proforma results of operations,which have been reclassified to conform to the fiscal 1997 presentation, for the Company's rehabilitation services segment had the sale of the medical rehabilitation hospitals occurred July 1, 1994 and excluding restructuring and other nonrecurring charges:
PRO FORMA ---------------------------------- 1997 1996(1) 1995 -------- -------- -------- Net revenues........................................ $927,547 $793,038 $794,716 Gross profit........................................ 253,549 208,082 224,957 Gross profit %...................................... 27.3% 26.2% 28.4%
- --------------- (1) Includes the $10.5 million charge for a change in estimate. 27 30 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) Year Ended June 30, 1997 Compared with the Year Ended June 30, 1996 Net revenues for the year ended June 30, 1997 increased from the prior year by $134.5 million, or 17.0%. Gross profit for the year ended June 30, 1997 increased from the prior year by $45.5 million, or 21.9%. Gross profit as a percentage of net revenues increased from 26.2% for the year ended June 30, 1996 to 27.3% for the year ended June 30, 1997. The $134.5 million increase in net revenues resulted principally from: (i) net revenues from businesses acquired, (ii) an increase in contract rehabilitation net revenues resulting principally from new contract sales, (iii) the $10.5 million prior year charge discussed previously, and (iv) an increase in outpatient net revenues attributable to internal growth. These increases were offset somewhat by a decrease in revenues attributable to outpatient facilities closed or sold in fiscal 1997 and the full year effect of facilities closed, sold or contributed to joint ventures in the prior year. The $45.5 million increase in gross profit was primarily due to: (i) acquisitions in fiscal 1997 and the full year effect of acquisitions in fiscal 1996, (ii) new contracts, and (iii) an increase in productivity in the outpatient and contract rehabilitation businesses. The increase of 1.1% in the gross profit margin results principally from the increase in contract rehabilitation and outpatient productivity, an increase in the outpatient gross profit margin as a result of the consolidation and reorganization of certain outpatient rehabilitation and orthotic and prosthetic operations commenced in the third quarter of fiscal 1996 and the impact of the $10.5 million charge discussed previously. Year Ended June 30, 1996 Compared with the Year Ended June 30, 1995 Net revenues for the year ended June 30, 1996 decreased from the prior year by $1.7 million to $793.0 million and gross profit decreased by $16.9 million, or 7.5%, to $208.1 million. As previously described, net revenues and gross profit were effected by a $10.5 million charge to net revenues for a change in estimate. Excluding this charge, net revenues increased $8.8 million, or 1.1%, gross profit decreased $6.4 million, or 2.8%, and gross profit margin decreased to 27.6% from 28.4% in fiscal 1996 compared with fiscal 1995, respectively. The $8.8 million increase in net revenues in fiscal 1996 resulted principally from: (i) an increase in contract rehabilitation pricing; (ii) an increase in O&P net revenue per patient due to an increased mix of higher revenue prosthetics; (iii) an increase in long-term care management and consulting services; and (iv) the full year impact of the acquisition of 25 businesses in fiscal 1995, offset by a decrease in outpatient rehabilitation net revenue per visit due to higher managed care contract mix. The $6.4 million decrease in gross profit and decrease in gross profit margin in fiscal 1996 resulted principally from increased costs of competitive compensation and benefits, and decreased productivity and pricing pressure in outpatient rehabilitation services. EMPLOYEE SERVICES Year Ended June 30, 1997 The Company's employee services segment provides human resource management services to third party clients and the Company's rehabilitation services segment. Inter-company activity is eliminated in consolidation. Net revenues from third party clients increased from $10.9 million in the second quarter of fiscal year 1997 to $76.9 million in the fourth quarter of fiscal year 1997. This increase is primarily attributable to an increase in the weighted average number of worksite employees ("WSEs") from 1,757 to 16,656 during the same periods. The increases in WSEs is due principally to the acquisition of three PEOs in the third quarter of 28 31 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) fiscal 1997 with an aggregate 14,412 WSEs at the date of acquisition and an approximate 16.7% internal growth in the number of WSEs since the acquisition date (approximately a 40% annualized growth rate). Net revenues from employee services provided to the Company's rehabilitation segment increased from $99.9 million in the third quarter of fiscal 1997 to $155.4 million in the fourth quarter. The increase is due to a WSE increase from 15,546 to 16,061 and approximately one month of additional service during the fourth quarter. Gross profit from third party clients increased from $0.8 million in the second quarter to $3.2 million in the fourth quarter of fiscal year 1997. The increase is attributable primarily to acquisitions and internal growth. Gross profit pertaining to the Company's rehabilitation segment increased from $2.2 million in the third quarter to $3.5 million in the fourth quarter of fiscal 1997 due to the increased WSEs and the additional month of service. Overall, gross profit as a percentage of net revenues declined from 7.7% during the second quarter of fiscal 1997 to 2.9% for the fourth quarter of fiscal 1997. The primary reasons for the decrease in the gross profit percentage are the increased salaries, wages and employment taxes per WSE, which increased revenues but not gross profit dollars, and the relative impact of services provided to the Company's rehabilitation segment, which has a lower gross profit percentage (2.0%) due to a more highly compensated employee population. LIQUIDITY AND CAPITAL RESOURCES At June 30, 1997 cash and cash equivalents totaled $22.7 million, a decrease of $73.0 million from $95.7 million at June 30, 1996. Cash generated from operations decreased to $47.2 million in 1997 from $57.7 million in fiscal 1996, which was an increase from the $43.6 million generated in fiscal 1995. The $10.5 million decrease in cash flow from operating activities from fiscal 1996 to 1997 resulted principally from a decrease in cash flows from accounts and notes receivable of $41.2 million offset, somewhat, by an increase in cash flows from net income of $23.6 million and $8.2 million of non-cash charges consisting of depreciation, amortization and provision for doubtful accounts. The $14.1 million increase in cash flows from operating activities from fiscal 1995 to 1996 resulted principally from the $9.0 million use of cash in fiscal 1995 by the medical rehabilitation hospitals prior to their sale and the following items (each before the effect on cash flows of the sale of the medical rehabilitation hospitals and nonrecurring items): (i) an $11.6 million increase in depreciation and amortization, non-cash charges, (ii) a $16.1 million increase in income taxes due to the timing of payments for income taxes in fiscal 1996 compared with fiscal 1995, (iii) an $11.4 million decrease in accounts payable and accrued expenses due primarily to the timing of compensation related expenses, and (iv) a $6.3 million decrease in net income. Investing activities, net of the effects of the sale of the medical rehabilitation operations and the proceeds from the sale of marketable securities of $88.2 million in fiscal 1995, used $187.8 million of cash in fiscal 1997 compared to $51.7 million and $106.8 million in fiscal 1996 and 1995, respectively. Cash paid for acquisitions increased to $164.4 in fiscal 1997 compared to $20.8 million in fiscal 1996 which was a decline from the $71.8 million paid in fiscal 1995. Capital expenditures remained relatively constant during the three year period ended June 30, 1997 at $21.7 million, $26.6 million, and $29.5 million, respectively, as the Company continued to invest in internally and externally developed software and equipment needed for technological efficiency in clinical and administrative activities in support of clinical programs and outcomes, cost reduction initiatives and future growth plans. The Company's major financing activities consisted of borrowing, net of repayment, $87.0 million in fiscal 1997, whereas the Company repaid debt, net of borrowings, of $33.6 million and $113.1 million in fiscal 1996 and 1995, respectively. The net borrowing increase in fiscal 1997 was used principally to fund acquisition activity. The proceeds from the sale of the medical rehabilitation hospitals, cash generated from operations and excess cash, were used to repay debt in fiscal 1996 and 1995. 29 32 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) The Company amended its bank credit facility in fiscal 1997 to extend the term of the agreement from November 1997 to November 1999 and to increase the amount available to $190.0 million. As of June 30, 1997, $72.7 million of the credit facility was available after reduction of borrowings and letters of credit of $7.7 million. The Company is presently renegotiating its credit facility to further increase the amount available. The Company's growth strategy contemplates expansion of the outpatient, occupational health and employee services businesses, and affiliation with health care systems of providers and payers in target markets principally through acquisitions and start-ups. Given the Company's cash position of $22.7 million at June 30, 1997 and debt capacity as suggested by its favorable debt to total capital ratio of 40.3%, it is anticipated that the Company will take advantage of its underleveraged position and ability to borrow. Cash payments for acquired businesses under this strategy are expected to be approximately $160 million in fiscal 1998. Capital expenditures are expected to be approximately $35 million in fiscal 1998 as the Company acquires property and equipment for the establishment of start-up outpatient and orthotic and prosthetic facilities in selected markets and continues to invest in systems to enhance clinical productivity, outcomes measurement and administrative efficiencies. The Company believes that the cash flows generated by the Company's operations together with its existing cash and availability of credit will be sufficient to meet the Company's cash needs during fiscal 1998. 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 partially 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, it is uncertain whether the Company will be able to pass on the increased costs associated with providing health care services to customers insured by government or managed care payers. However, management believes that the Company will be able to somewhat offset this potential impact through business expansion and increasing operating efficiencies. RECENTLY ISSUED ACCOUNTING STANDARDS In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 125") as amended by the December 1996 issuance of Statement of Financial Accounting Standards No. 127, "Deferral of the Effective Date of Certain Provisions of SFAS No. 125" ("SFAS 127"). SFAS 125, as amended, provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. Management does not believe the adoption of SFAS 125, as amended, will have a material effect on the Company's financial position or results of operations. In February 1997, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128") which the Company is required to adopt no later than the second quarter of fiscal year 1998. SFAS 128 established accounting standards for computing and presenting earnings per share by replacing the presentation of weighted shares outstanding, inclusive of common stock equivalents, with a dual presentation of basic earnings per share which excludes dilution and diluted earnings per share which includes the dilutive effect of all potentially exercisable or convertible stock. Once adopted, SFAS 128 requires restatement of all prior period earnings per share data. See Note 1 to the Consolidated Financial Statements for the effect of adopting SFAS 128. 30 33 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) CAUTIONARY STATEMENT Except for historical information, matters discussed above are forward-looking statements that are based on management's estimates, assumptions and projections. Important factors that could cause results to differ materially from those expected by management include the timing and nature of reimbursement changes (including imposition of, and changes in, salary equivalency rates for Medicare, changes in workers' compensation and other governmental rate and reimbursement system changes), the number and productivity of clinicians, decisions by chain customers as to whether to take therapy and other services in-house, pricing of managed care and other third party contracts, the direction and success of competitors, management retention and development, management's success integrating acquired businesses and in developing and introducing new products and lines of business, adverse Internal Revenue Service rulings with respect to the employer status of PEOs, state legislative and regulatory efforts to control PEOs, adverse uninsured health or workers' compensation expenses in the PEO, and unanticipated market changes. 31 34 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA NOVACARE, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE DATA)
AS OF JUNE 30, ----------------------- 1997 1996 ---------- -------- ASSETS Current assets: Cash and cash equivalents.......................................... $ 22,716 $ 95,724 Accounts receivable, net of allowance in 1997 and 1996 of $33,263 and $18,995, respectively....................................... 256,477 192,636 Inventories........................................................ 18,450 13,948 Deferred income taxes.............................................. 13,939 14,875 Other current assets............................................... 18,313 14,976 ---------- -------- Total current assets....................................... 329,895 332,159 Property and equipment, net.......................................... 69,740 63,319 Excess cost of net assets acquired, net.............................. 568,027 354,117 Investment in joint ventures......................................... 12,719 11,984 Deferred income taxes................................................ 2,570 2,332 Other assets, net.................................................... 31,353 25,820 ---------- -------- $1,014,304 $789,731 ========== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of financing arrangements.......................... $ 15,978 $ 8,173 Accounts payable and accrued expenses.............................. 135,272 93,854 Income taxes payable............................................... 5,069 6,420 ---------- -------- Total current liabilities.................................. 156,319 108,447 Financing arrangements, net of current portion....................... 326,700 184,042 Deferred income taxes................................................ 14,779 9,625 Other................................................................ 4,851 2,451 ---------- -------- Total liabilities.......................................... 502,649 304,565 ---------- -------- Minority interests in consolidated subsidiaries...................... 3,649 772 Commitments and contingencies........................................ -- -- Shareholders' equity: Common stock, $.01 par value; authorized 200,000 shares, issued 66,630 shares in 1997 and 66,091 shares in 1996.......... 666 661 Additional paid-in capital......................................... 259,915 253,918 Retained earnings.................................................. 292,340 253,430 ---------- -------- 552,921 508,009 Less: Common stock in treasury (at cost), 5,590 shares in 1997 and 3,190 shares in 1996................................. (44,915) (23,465) Deferred compensation...................................... -- (150) ---------- -------- Total shareholders' equity................................. 508,006 484,394 ---------- -------- $1,014,304 $789,731 ========== ========
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 32 35 NOVACARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE YEARS ENDED JUNE 30, ------------------------------------ 1997 1996 1995 ---------- -------- -------- Net revenues.............................................. $1,066,451 $793,038 $905,359 Cost of services.......................................... 806,365 584,956 649,119 ---------- -------- -------- Gross profit......................................... 260,086 208,082 256,240 Selling, general and administrative expenses.............. 146,289 130,980 142,872 Provision for uncollectible accounts...................... 19,708 16,359 15,918 Amortization of excess cost of net assets acquired........ 13,548 9,874 10,937 Provision for restructure and other nonrecurring items.... -- 13,370 (57,368) ---------- -------- -------- Income from operations............................... 80,541 37,499 143,881 Investment income......................................... 1,740 4,999 5,405 Interest expense.......................................... (15,244) (12,536) (23,298) Minority interest......................................... (236) (96) (404) ---------- -------- -------- Income before income taxes........................... 66,801 29,866 125,584 Income taxes.............................................. 27,891 14,585 63,660 ---------- -------- -------- Net income........................................... $ 38,910 $ 15,281 $ 61,924 ========== ======== ======== Net income per common share.......................... $ .62 $ .24 $ .95 ========== ======== ======== Weighted average number of common shares outstanding........................................ 63,081 64,325 65,163 ========== ======== ========
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 33 36 NOVACARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
COMMON SHARES ISSUED STOCK ADDITIONAL DEFERRED ----------------- ($.01 TREASURY PAID-IN RETAINED COMPEN- VALUATION COMMON TREASURY PAR VALUE) STOCK CAPITAL EARNINGS SATION ALLOWANCE ------ -------- ---------- -------- ---------- -------- -------- --------- 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 -- -- -- Reversal of valuation allowance....... -- -- -- -- -- -- -- 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) -- Issued in connection with employee benefit plans....................... 199 198 1 1,624 1,336 -- -- -- Issued in connection with acquisitions........................ 416 203 4 1,478 1,725 -- -- -- Repurchase of common stock............ -- (3,404) -- (24,953) -- -- -- -- Amortization of deferred compensation........................ -- -- -- -- -- -- 263 -- Net income............................ -- -- -- -- -- 15,281 -- -- ------ ------ ---- -------- -------- -------- ----- ----- Balance at June 30, 1996.............. 66,091 (3,190) 661 (23,465) 253,918 253,430 (150) -- ISSUED IN CONNECTION WITH EMPLOYEE BENEFIT PLANS....................... 539 17 5 11 4,284 -- -- -- ISSUED IN CONNECTION WITH ACQUISITIONS........................ -- 344 -- 2,474 1,713 -- -- -- REPURCHASE OF COMMON STOCK............ -- (2,761) -- (23,935) -- -- -- -- AMORTIZATION OF DEFERRED COMPENSATION........................ -- -- -- -- -- -- 150 -- NET INCOME............................ -- -- -- -- -- 38,910 -- -- ------ ------ ---- -------- -------- -------- ----- ----- BALANCE AT JUNE 30, 1997.............. 66,630 (5,590) $666 $(44,915) $259,915 $292,340 -- -- ====== ====== ==== ======== ======== ======== ===== =====
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 34 37 NOVACARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
FOR THE YEARS ENDED JUNE 30, ------------------------------------ 1997 1996 1995 --------- -------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income......................................................... $ 38,910 $ 15,281 $ 61,924 Adjustments to reconcile net income to net cash flows from operating activities: Depreciation and amortization.................................... 37,978 33,159 30,190 Minority interest................................................ 236 96 404 Provision for uncollectible accounts............................. 19,708 16,359 15,918 Deferred income taxes............................................ 6,017 3,631 (1,525) Noncash portion of nonrecurring items............................ -- 8,256 15,415 Gain on sale of medical rehabilitation hospitals................. -- -- (88,243) Changes in assets and liabilities, net of effects from acquisitions: Accounts and notes receivable.................................. (53,844) (12,676) (31,164) Inventories.................................................... 2,502 (2,039) (2,875) Other current assets........................................... (1,434) 10 1,388 Accounts payable and accrued expenses.......................... (725) (6,152) 10,279 Income taxes payable........................................... 110 1,553 28,982 Other, net..................................................... (2,217) 220 2,925 -------- --------- --------- Net cash flows provided by operating activities................ 47,241 57,698 43,618 -------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Payments for businesses acquired, net of cash acquired............. (164,370) (20,764) (71,759) Net additions to property and equipment............................ (21,653) (26,621) (29,529) Net (payment for) proceeds from sale of medical rehabilitation hospitals........................................................ -- (13,208) 206,838 Proceeds from sales of investments................................. -- -- 88,151 Other, net......................................................... (1,752) (4,326) (5,513) -------- --------- --------- Net cash flows (used in) provided by investing activities...... (187,775) (64,919) 188,188 -------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from long-term debt and credit arrangements............... 263,200 133 74,077 Payment of long-term debt and credit arrangements.................. (176,174) (33,769) (187,206) Proceeds from common stock issued.................................. 3,750 2,898 3,947 Payment for purchase of treasury stock............................. (23,250) (24,953) (2,012) -------- --------- --------- Net cash flows provided by (used in) financing activities...... 67,526 (55,691) (111,194) -------- --------- --------- Net (decrease) increase in cash and cash equivalents............... (73,008) (62,912) 120,612 Cash and cash equivalents, beginning of year....................... 95,724 158,636 38,024 -------- --------- --------- Cash and cash equivalents, end of year............................. $ 22,716 $ 95,724 $ 158,636 ======== ========= =========
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 35 38 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1997 (IN THOUSANDS, EXCEPT PER SHARE DATA) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations: NovaCare, Inc. is a national leader of physical rehabilitation services and employee services. NovaCare's comprehensive medical rehabilitation services include (i) providing rehabilitation therapy, subacute and rehabilitation program consulting and management services on a contract basis to health care institutions, primarily long-term care facilities, and (ii) providing outpatient, orthotic and prosthetic ("O&P") and occupational health rehabilitation services through a national network of patient care centers and integrated delivery systems. The Company operated medical rehabilitation hospitals until April 1, 1995, the effective date of the sale of such hospitals. For the fiscal year ended June 30, 1995, the medical rehabilitation hospitals represented 12% of the Company's consolidated net revenues. Employee services are generally provided to small and medium-sized businesses and are comprehensive, fully integrated outsourcing solutions to human resource management, including payroll management, workers' compensation, risk management, benefits administration, unemployment services and human resource consulting services. 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"). Investments in 20% or more of the voting stock of an affiliate are accounted for under the equity method. All significant intercompany accounts and transactions have been eliminated. Reclassifications: Certain amounts in the fiscal 1996 and 1995 consolidated financial statements have been reclassified to conform with the fiscal 1997 presentation. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In 1996, the Company recorded a $10.5 million charge to net revenues to reflect payer allowances that had not been sufficiently recognized by certain billing systems. Cash and Cash Equivalents: The Company considers its holdings of highly liquid debt and money-market instruments to be cash equivalents if the securities mature within 90 days from the date of acquisition. These investments are carried at cost, which approximates fair value. Net Revenues: Rehabilitation services net revenues are reported at the net realizable amounts from customers and third party payers. Net revenues generated directly from Medicare and Medicaid reimbursement programs represented 12%, 12% and 18% of the Company's consolidated net revenues for fiscal 1997, 1996, and 1995, respectively. Settlement amounts due to or receivable from Medicare and Medicaid programs are determined by fiscal intermediaries. Management believes that adequate provision has been made in the consolidated financial statements for potential adjustments resulting from such determinations. Employee services revenues and related costs of wages, salaries, and employment taxes pertaining to worksite employees are recognized in the period in which the employee performs the service. Because the Company is at risk for all of its direct costs, independently of whether payment is received from its clients, and consistent with industry practice, all amounts billed to clients for gross salaries and wages, related employment taxes, and health care and workers' compensation coverage are recognized as revenue by the Company. The Company establishes an allowance for doubtful accounts for both related and third party accounts receivable based on prior experience. 36 39 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1997 (IN THOUSANDS, EXCEPT PER SHARE DATA) Inventories: Inventories consist of customized orthotic and prosthetic merchandise held for sale, work in process and raw materials and are carried at the lower of cost or market. Cost of inventories is determined by the first-in, first-out method. Property and Equipment: Property and equipment are stated at cost. Depreciation is provided on a straight-line basis over the estimated useful lives of the assets, which principally range from three to seven years for property and equipment and 30 to 40 years for buildings. Assets under capital leases and leasehold improvements are amortized over the lesser of the lease term or the asset's estimated useful life. Property and equipment also include external and incremental internal costs incurred to develop major business systems. Capitalized software costs are amortized on a straight-line basis over three to five years. Excess Cost of Net Assets Acquired: Assets and liabilities acquired in connection with business combinations accounted for under the purchase method are recorded at their respective fair values. Deferred taxes have been recorded to the extent of the difference between the fair value and the tax basis of the assets acquired and liabilities assumed. The excess of the purchase price over the fair value of net assets acquired, including the recognition of applicable deferred taxes, consists of non-compete agreements, customers lists, assembled workforce and goodwill and is amortized on a straight-line basis over the estimated useful lives of the assets which range from five to 40 years. The Company performs a periodic assessment of the recoverability of goodwill based on estimated future cash flows. Other Assets: Other assets consist principally of investments in affordable income housing partnerships, executive savings plan assets and miscellaneous receivables. Investments in affordable income housing partnerships are recorded at cost and are subject to an annual assessment as to carrying value. The executive savings plan is a qualified savings plan offered to Company executives. Contributions made to the fund by eligible employees are partially matched by the Company. Withdrawals from the fund by employees are limited to events specified by the plan document. Workers' Compensation: The Company is contractually obligated to provide workers' compensation coverage for its employees and co-employees. The Company accomplishes this through a combination of various commercial insurance policies and self insurance programs. The Company records estimated accruals for workers compensation and health care claims, including estimates for incurred but not reported claims, based upon review of the claims activity and past experience. Management believes any differences which may arise between actual settlement of claims and reserves at June 30, 1997 would not have a material impact on the Company's financial position. On July 1, 1997, the Company entered into a three-year contract with a commercial insurance company for workers' compensation coverage. Under this program, the Company's rehabilitation segment worksite employees will continue to be covered under a self insurance program. Third party worksite employees will be covered under a fixed cost insurance program, which is subject to certain per incident and aggregate deductibles. Income Taxes: The Company records deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. Net 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. Recently Issued Accounting Standards: In June, 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No.125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 125") as amended by the December 1996 37 40 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1997 (IN THOUSANDS, EXCEPT PER SHARE DATA) issuance of Statement of Financial Accounting Standards No. 127, "Deferral of the Effective Date of Certain Provisions of SFAS No. 125" ("SFAS 127"). SFAS 125, as amended, provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. Management does not believe the adoption of SFAS 125, as amended, will have a material effect on the Company's financial position or results of operations. In February 1997, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128") which the Company is required to adopt no later than the second quarter of fiscal year 1998. SFAS 128 establishes accounting standards for computing and presenting earnings per share by replacing the presentation of weighted shares outstanding, inclusive of common stock equivalents, with a dual presentation of basic earnings per share which excludes dilution ("earnings per share") and diluted earnings per share which includes the dilutive effect of all potentially exercisable or convertible stock ("earnings per share assuming dilution"). Once adopted, SFAS 128 requires restatement of all prior period earnings per share data. The following represents the pro forma earnings per share which would be required with the adoption of SFAS 128 for the three years ended June 30:
PRO FORMA ---------------------- 1997 1996 1995 ---- ---- ---- Earnings per share............................................. $.64 $.24 $.96 Earnings per share assuming dilution........................... .62 .23 .93
While the effect of adopting SFAS 128 for fiscal years ended June 30, 1997, 1996 and 1995 is not material, Management believes that the effect to the first quarter of fiscal 1998, once restated, may be material depending upon changes in the Company's stock price. 2. PROVISION FOR RESTRUCTURE AND OTHER NONRECURRING ITEMS The following table sets forth the Company's provision for restructure and other nonrecurring items for the two years in the period ended June 30, 1996. There were no nonrecurring items in fiscal 1997.
1996 1995 -------- -------- Productivity and cost reduction programs: Employee severance costs..................................... $ 2,931 $ 7,042 Lease terminations........................................... 4,032 6,847 Asset write-offs, net of estimated sale proceeds............. 5,965 15,415 Other........................................................ 442 571 Gain on sale of medical rehabilitation hospitals............... -- (88,243) Settlement of shareholder litigation........................... -- 1,000 -------- -------- $ 13,370 $(57,368) ======== ========
At June 30, 1997, approximately $5,286 remained accrued for the productivity and cost reduction programs initiated in fiscal 1996 and 1995. The 1996 productivity and cost reduction programs pertained to the consolidation and reorganization of the Company's outpatient and O&P operations and certain administrative functions. The 1995 program consisted of closing certain contract rehabilitation offices, O&P branches, and outpatient centers in selected markets and the consolidation of certain finance and other administrative 38 41 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1997 (IN THOUSANDS, EXCEPT PER SHARE DATA) functions. These programs are substantially complete. Of the amount accrued, approximately $4,232 relates to the fiscal 1996 provision for restructure. The remainder relates to the fiscal 1995 provision for restructure. The amounts accrued at June 30, 1997, for both programs combined, relate primarily to lease obligations on facilities which have been closed and the costs associated with the closure of certain facilities which were sold in conjunction with the restructure. Effective April 1, 1995, the Company sold its medical rehabilitation hospitals for $242,888 which consisted of cash of $232,394, debt of $19,156, and cash assumed by the purchaser of $8,662, respectively. Of the cash portion of the purchase price, $16,894 was unpaid at June 30, 1995 and was included as a component of other current assets. Substantially all of this amount was received in July 1995. Had the sale of the medical rehabilitation hospitals taken place on July 1, 1994, pro forma unaudited net revenues for the fiscal year ended June 30, 1995 would have been $794,716 and pro forma unaudited income from operations would have been $40,504. 3. ACQUISITION AND JOINT VENTURE TRANSACTIONS During the year ended June 30, 1997, the Company acquired 52 outpatient businesses, including 33 which provide O&P rehabilitation services, and 19 which provide outpatient rehabilitation services. The Company also acquired three businesses, which provide occupational health services, and four professional employer organizations ("PEO"). During fiscal year 1996, the Company acquired seven businesses which provide outpatient rehabilitation services and six businesses which provide orthotic and prosthetic rehabilitation services. The Company entered into two joint ventures in fiscal 1996. The carrying value of these investments is $12,719 and $11,984 at June 30, 1997 and 1996, respectively. The Company accounts for investments in joint ventures by the equity method. The following unaudited pro forma consolidated results of operations of the Company give effect to each of the acquisitions as if they occurred on July 1, 1995:
YEARS ENDED JUNE 30, ------------------------- 1997 1996 ---------- ---------- Net revenues................................................ $1,276,251 $1,217,419 Net income.................................................. 43,057 27,833 Net income per common share................................. $ .68 $ .43
The above pro forma information is not necessarily indicative of the results of operations that would have occurred had the acquisition been made as of July 1, 1995, or the results which may occur in the future. Information with respect to businesses acquired in purchase transactions was as follows (the allocation for fiscal 1997 acquisitions is preliminary):
AS OF JUNE 30, --------------------- 1997 1996 -------- -------- Excess cost of net assets acquired............................. $618,781 $391,324 Less: accumulated amortization................................. (50,754) (37,207) -------- -------- $568,027 $354,117 ======== ========
39 42 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1997 (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED JUNE 30, --------------------- 1997 1996 -------- -------- Cash paid (net of cash acquired)............................. $149,147 $ 5,850 Deferred purchase price obligations.......................... 19,294 -- Notes issued................................................. 44,275 990 Other consideration.......................................... 4,781 19 -------- -------- 217,497 6,859 Liabilities assumed.......................................... 11,685 617 -------- -------- 229,182 7,476 Fair value of assets acquired, principally accounts receivable and property and equipment...................... 19,501 1,430 -------- -------- Cost in excess of fair value of net assets acquired........ $209,681 $ 6,046 ======== ========
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, 1997 of approximately $42,112 in cash and 162 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, 1997, 1996 and 1995, the Company paid $15,223, $14,914 and $10,830, respectively, in cash and issued 344, 619 and 975 shares of common stock, respectively, in connection with businesses acquired in prior years. Deferred purchase price obligations represent guaranteed purchase price amounts due to former owners of four businesses acquired. Obligations of $19,233 remained accrued at June 30, 1997, and are included in accounts payable and accrued expenses. Approximately $17,500 of the total amount, is due upon the earlier of the initial public offering of a NovaCare, Inc. subsidiary's, NovaCare Employee Services, Inc., common stock or December 31, 1997. 4. INVENTORIES Inventories consisted of the following:
AS OF JUNE 30, --------------------- 1997 1996 -------- -------- Materials and supplies....................................... $ 12,569 $ 9,730 Work in process.............................................. 4,509 3,355 Finished goods............................................... 1,372 863 -------- -------- $ 18,450 $ 13,948 ======== ========
40 43 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1997 (IN THOUSANDS, EXCEPT PER SHARE DATA) 5. PROPERTY AND EQUIPMENT The components of property and equipment were as follows:
AS OF JUNE 30, -------------------- 1997 1996 -------- ------- Land and buildings.............................................. $ 3,983 $ 3,573 Property, equipment and furniture............................... 84,733 65,401 Capitalized software............................................ 31,792 31,515 Leasehold improvements.......................................... 20,559 15,124 ------- ------- 141,067 115,613 Less: accumulated depreciation and amortization................. (71,327) (52,294) ------- ------- $ 69,740 $63,319 ======= =======
Depreciation expense, including depreciation of property under capital lease, for fiscal 1997, 1996, 1995 was $24,430, $23,285, and $19,253, respectively. 6. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses are summarized as follows:
AS OF JUNE 30, -------------------- 1997 1996 -------- ------- Accounts payable................................................ $ 13,647 $ 8,026 Accrued compensation and benefits............................... 65,564 44,610 Deferred and contingent purchase price obligations (Note 3)..... 25,624 -- Accrued workers' compensation and health claims................. 8,471 6,862 Accrued costs of productivity and cost improvement programs (Note 2)...................................................... 5,286 8,241 Accrued interest................................................ 1,002 4,868 Other........................................................... 15,678 21,247 -------- ------- $135,272 $93,854 ======== =======
The Company is self-insured for certain health benefits up to $150 per individual per year. The Company expensed amounts for estimated losses occurring from both asserted and unasserted claims. The estimate of the liability for unasserted claims arising from unreported incidents is based on an analysis of historical claims rates. 41 44 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1997 (IN THOUSANDS, EXCEPT PER SHARE DATA) 7. FINANCING ARRANGEMENTS Financing arrangements consisted of the following:
AS OF JUNE 30, --------------------- 1997 1996 -------- -------- Convertible subordinated debentures (5.5%), due January 2000... $175,000 $175,000 $190,000 revolving credit facility (EuroDollar rate plus 0.5% to 1.125%), due November 28, 1999............................ 109,600 -- Subordinated promissory notes (5% to 10%), payable through 2007......................................................... 56,859 15,516 Notes (7.0% to 7.5%), payable through November 2000............ 456 172 Capitalized lease obligations, payable through 2016............ 763 1,527 -------- -------- 342,678 192,215 Less: current portion.......................................... 15,978 8,173 -------- -------- $326,700 $184,042 ======== ========
The Company established a revolving credit facility with a syndicate of lenders in fiscal 1996, which is collateralized by substantially all of the Company's subsidiaries' common stock. During fiscal 1997, the credit agreement was amended to extend the term of the agreement from November 1997 to November 1999 and to increase the available line of credit from $150,000 to $190,000. As of June 30, 1997, $72,737 of the line of credit was available after reduction for borrowings and letters of credit totaling $7,663. The revolving credit facility arrangement requires the maintenance of minimum working capital and net worth amounts as well as certain financial ratios. At June 30, 1997, the Company was in compliance with these requirements. The Company is charged a commitment fee of .25% per annum on the average daily available balance. The weighted average borrowing rate for fiscal 1997 was 6.94%. The Company has issued $175,000 of convertible subordinated debentures due January 15, 2000, priced at par to yield 5.5%. The debentures are convertible, at the option of the holder, into shares of the Company's common stock at a conversion price of $26.65 per share. The debentures are redeemable, in whole or in part, at the option of the Company. There is no sinking fund applicable to the debentures. The fair value of the Company's convertible subordinated debentures based on quoted market prices at June 30, 1997 and 1996 was $164,500 and $154,875, respectively. The estimated fair value of all other debt and financing arrangements approximates carrying value. At June 30, 1997, aggregate annual maturities of financing arrangements were as follows for the next five fiscal years and thereafter:
FISCAL YEAR ----------- 1998.............................................................. $ 15,978 1999.............................................................. 13,820 2000.............................................................. 295,875 2001.............................................................. 8,314 2002.............................................................. 5,609 Thereafter........................................................ 3,082 -------- $342,678 ========
Interest paid on debt during fiscal 1997, 1996 and 1995 amounted to $18,120, $11,730 and $20,377, respectively. 42 45 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1997 (IN THOUSANDS, EXCEPT PER SHARE DATA) 8. LEASES The Company is obligated under capital leases for office space and office, transportation and therapy equipment. All other capital leases expire over the next five years. Included in property and equipment in the accompanying Consolidated Balance Sheets are the following assets held under capital leases:
AS OF JUNE 30, ------------------- 1997 1996 ------- ------- Property and equipment................................... $ 3,316 $ 3,196 Less: accumulated amortization........................... (2,497) (1,605) ------- ------- $ 819 $ 1,591 ======= =======
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 which are controlled by the Company's Chairman. The Company is fully reimbursed for its lease costs for the aforementioned office space under non-cancelable sublease agreements. Future minimum lease commitments for all non-cancelable leases as of June 30, 1997 are as follows:
CAPITAL OPERATING SUB-LEASE FISCAL YEAR LEASES LEASES RECEIVABLES --------------------------------------------------------- ------- --------- ----------- 1998..................................................... $ 518 $27,965 $ 1,135 1999..................................................... 172 23,725 731 2000..................................................... 34 18,202 395 2001..................................................... 17 12,856 175 2002..................................................... 9 8,173 142 Thereafter............................................... 123 7,393 83 ------- ------- -------- Total minimum lease payments............................. 873 $98,314 $ 2,661 ======= ======== Less: amount representing interest....................... (110) ------- Present value of minimum payments under capital lease obligations............................................ $ 763 =======
43 46 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1997 (IN THOUSANDS, EXCEPT PER SHARE DATA) 9. INCOME TAXES The components of income tax expense were as follows:
YEARS ENDED JUNE 30, --------------------------- 1997 1996 1995 ------- ------- ------- Current: Federal................................................. $17,757 $ 8,048 $53,258 State................................................... 4,117 2,906 11,927 ------- ------- ------- 21,874 10,954 65,185 ------- ------- ------- Deferred: Federal................................................. 5,470 3,301 (1,182) State................................................... 547 330 (343) ------- ------- ------- 6,017 3,631 (1,525) ------- ------- ------- $27,891 $14,585 $63,660 ======= ======= =======
The components of net deferred tax assets as of June 30, 1997 and 1996 were as follows:
1997 1996 -------- ------- Accruals and reserves not currently deductible for tax purposes... $ 12,557 $10,484 Restructuring reserve............................................. 3,232 6,043 Other............................................................. 720 680 --------- -------- Gross deferred tax assets....................................... 16,509 17,207 --------- -------- Expenses capitalized for financial statement purposes............. (9,828) (6,274) Depreciation and capital leases................................... (3,586) (2,589) Other, net........................................................ (1,365) (762) --------- -------- Gross deferred tax liabilities.................................. (14,779) (9,625) --------- -------- Net deferred tax asset.......................................... $ 1,730 $ 7,582 ========= ========
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, --------------------------- 1997 1996 1995 ------- ------- ------- Expected federal income tax expense....................... $23,380 $10,453 $43,954 State income taxes, less federal benefit.................. 3,244 2,108 7,530 Non-deductible nonrecurring items......................... 549 1,027 9,178 Non-deductible amortization of excess cost of net assets acquired................................................ 2,974 2,011 2,370 Dividend exclusion and non-taxable interest income........ 59 (395) (401) Other, net................................................ (2,315) (619) 1,029 ------- ------- ------- $27,891 $14,585 $63,660 ======= ======= =======
Income taxes paid during fiscal 1997, 1996 and 1995 amounted to $21,981, $38,699 and $37,604, respectively. 44 47 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1997 (IN THOUSANDS, EXCEPT PER SHARE DATA) 10. MINORITY INTEREST Minority interest resulted from investments in the following entities:
AS OF JUNE 30, ------------- 1997 1996 ------ ---- NovaCare Employee Services, Inc..................................... $3,334 -- All other entities.................................................. 315 772 ------ ----- $3,649 $772 ====== =====
During fiscal 1997, one of the Company's consolidated subsidiaries, NovaCare Employee Services, Inc., issued equity instruments on its own behalf. The Company recognizes a minority interest liability for NovaCare Employee Services, Inc. equity issued to third party investors plus the portion of NovaCare Employee Services, Inc.'s net income attributable to those investors. 11. BENEFIT PLANS Stock Option Plan: The Company's 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. In May 1996, the Board approved an option exchange whereby option holders were allowed to acquire new options to purchase shares of common stock in exchange for the surrender by such option holders of certain existing options under the plan. The exchange formula took into account the vesting schedule and exercise price of the surrendered options. Under the exchange program, 1,157 options were surrendered and 888 new options were granted. The options granted as a result of the exchange vest over 5 years, although vesting can be accelerated if the Company's stock price achieves certain levels. The following summarizes the activity of the stock option plan:
YEARS ENDED JUNE 30, ---------------------------------------------- 1997 1996 1995 ------------ ------------ ------------ Options: Outstanding at beginning of year....... 3,188 2,649 2,771 Granted................................ 551 2,592 1,162 Exercised.............................. (364) (71) (77) Canceled............................... (475) (1,982) (1,207) ----------- ----------- ----------- Outstanding at end of year............. 2,900 3,188 2,649 =========== =========== =========== Option price per share ranges: Outstanding at beginning of year....... $ .09-$20.58 $ .09-$21.00 $ .09-$23.50 Granted................................ 7.38- 13.38 5.75- 7.50 7.25- 13.00 Exercised.............................. .09- 10.63 .09- 9.13 .09- 14.38 Canceled............................... 2.00- 16.50 .12- 20.58 .12- 20.58 Outstanding at end of year............. $ .09-$20.58 $ .12-$20.58 $ .09-$21.00 Options exercisable at end of year....... 1,464 363 1,109 Exercisable option price ranges.......... $ .09-$20.58 $ .09-$20.58 $ .09-$21.00 Options available for grant at end of year under stock option plan........... 1,034 982 1,601
45 48 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1997 (IN THOUSANDS, EXCEPT PER SHARE DATA) Other Stock Option Awards: During 1997, the Board decided, subject to shareholder approval, to grant to the President of the Company 850 options to purchase the Company's common stock at an exercise price equal to the fair market value on the grant date. During May 1996, the Board also decided, subject to shareholder approval, to offer certain officers of the Company a modified exchange. Under the modified exchange, the Chairman received fewer options than would have been warranted under the Black-Scholes formula while the Chief Executive Officer was offered an exchange and additional options, resulting in a net reduction of outstanding options of 909. The new options were at the same price and with the same vesting term as the options issued pursuant to the exchange described above, except that 3,317 options of the 3,500 total options issued have a seven year term. The following summarizes the other stock option award activity:
YEAR ENDED JUNE 30, ----------------------------------------------- 1997 1996 1995 ------------ ------------- ------------ Options: Outstanding at beginning of year...... 3,554 4,704 4,708 Granted............................... 850 3,500 -- Exercised............................. -- -- (4) Canceled.............................. -- (4,650) -- ------------ ------------- ------------ Outstanding at end of year............ 4,404 3,554 4,704 ============ ============= ============ Option price per share: Outstanding at beginning of year...... $ 2.25-$6.88 $ 2.25-$19.50 $2.25-$19.50 Granted............................... 10.88 6.88 -- Exercised............................. -- -- 2.25 Canceled.............................. -- 10.44-19.50 -- Outstanding at end of year............ $2.25-$10.88 $ 2.25-$6.88 $2.25-$19.50 Options exercisable at end of year...... 2,254 54 1,914 Exercisable option price ranges......... $2.25-$10.88 $ 2.25-$4.88 $2.25-$19.50
The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") and applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for the plans. The table below sets forth the proforma information as if the Company had adopted the compensation recognition provisions of SFAS 123:
1997 1996 ------------ ------------- Decrease to: Net income............................ $5,268 $1,585 Net income per common share........... $ .08 $ .02 Assumptions: Expected life (years)................. 1.6 1.6 Risk-free interest rate............... 4.2%-7.8% 4.2%-7.8% Volatility............................ 43.93% 59.01% Dividend yield........................ N/A N/A
46 49 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1997 (IN THOUSANDS, EXCEPT PER SHARE DATA) The weighted average fair value per share of the stock options, calculated using the Black-Scholes option pricing model, granted during the fiscal year ended June 30, 1997 and 1996 is $10.59 and $6.76, respectively. The remaining contractual life of all options granted as of June 30, 1997 is 7.29 years. 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. Retirement Plans: The Company has defined contribution 401(k) plans covering substantially all of its employees. Company contributions for fiscal 1997, 1996 and 1995 were $3,916, $3,634, and $3,878, respectively. The Company established a non-qualified supplemental benefit plan covering certain key employees. The Company's matching contribution was $224, $582 and $302 for fiscal 1997, 1996 and 1995, respectively. 12. FINANCIAL DATA BY BUSINESS SEGMENT Beginning in the second quarter of fiscal 1997, the Company operates in two service industries, rehabilitation services and employee services as described in Note 1 -- Nature of Operations. Income from operations by business segment is total net revenues less operating expenses. In computing operating profit by business segment, none of the following items has been added or deducted: other income, interest expense or income taxes. Identifiable assets by segment are those assets that are used in the Company's operations in each industry. Employee services revenues and the related costs of wages, salaries, and employment taxes pertaining to worksite employees are recognized in the period in which the employee performs the services. Because the Company is at risk for all of its direct costs, independently of whether payment is received from its clients, and consistent with industry practice, all amounts billed to clients for gross salaries and wages, related employment taxes, and health care and workers' compensation coverage are recognized as revenue by the Company. The Company's rehabilitation services segment is a client of the employee services segment, resulting in the net revenues and asset eliminations. 47 50 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1997 (IN THOUSANDS, EXCEPT PER SHARE DATA) Operating results and other financial data are presented for the principal business segments of the Company as follows:
REHABILITATION EMPLOYEE SERVICES SERVICES ELIMINATION CONSOLIDATED -------------- -------- ----------- ------------ YEAR ENDED JUNE 30, 1997: Net revenues............................. $927,547 $394,193 $ (255,289) $ 1,066,451 Income from operations................... 77,610 2,931 -- 80,541 Depreciation expense..................... 24,265 165 -- 24,430 Net capital expenditures................. 21,324 329 -- 21,653 AS OF JUNE 30, 1997 Assets................................... $945,653 $ 95,998 $ (27,347) $ 1,014,304
13. 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. 14. 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 at 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. 15. SUBSEQUENT EVENTS One of the Company's subsidiaries, NovaCare Employee Services, Inc. ("NCES") plans to file a registration statement with the Securities and Exchange Commission to register for the sale of up to 4,500 shares of its common stock. NCES intends to use the net proceeds of the offering to satisfy $17,500 of deferred purchase price obligations incurred in connection with NCES acquisitions. The remaining net proceeds will be used for expansion of the NCES operations, including further penetration of existing markets, and as opportunities arise, to expand the NCES's client base in new or existing markets through acquisitions, and to pay down debt under the Company's credit facility. 48 51 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1997 (IN THOUSANDS, EXCEPT PER SHARE DATA) 16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
FOURTH THIRD SECOND FIRST QUARTER QUARTER QUARTER QUARTER -------- -------- -------- -------- YEAR ENDED JUNE 30, 1997: Net revenues................................ $331,555 $290,454 $235,012 $209,430 Gross profit................................ 73,957 69,439 60,911 55,779 Income from operations...................... 25,506 21,222 18,795 15,018 Net income.................................. 12,057 10,093 9,216 7,544 Net income per common share................. $ .19 $ .16 $ .15 $ .12 YEAR ENDED JUNE 30, 1996: Net revenues................................ $202,551 $191,393 $200,957 $198,137 Gross profit................................ 55,018 42,972 55,209 54,883 Income from operations...................... 16,428 (9,549) 15,123 15,497 Net income (loss)........................... 8,411 (8,580) 7,447 8,003 Net income (loss) per common share.......... $ .13 $ (.13) $ .12 $ .12
Results from the third quarter of fiscal 1996 included a $13,370 provision for restructure and a $10,462 charge to fully reflect payer allowances that had not been sufficiently recognized by certain billing systems. 49 52 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of NovaCare, Inc. In our opinion, the consolidated financial statements listed under Item 14(a)(1) and (2) on page 51 present fairly, in all material respects, the financial position of NovaCare, Inc. and its subsidiaries at June 30, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1997, 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 July 31, 1997 50 53 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) Beneficial Ownership Reporting Compliance" of the Proxy Statement to be filed with respect to the 1997 annual meeting of shareholders to be held on October 30, 1997 (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 "Compensation of Executive Officers of the Company", "Compensation of Directors of NovaCare", "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 August 31, 1997" 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. 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:
PAGE NUMBER ------ (1) FINANCIAL STATEMENTS: Consolidated Balance Sheets at June 30, 1997 and 1996................ 32 Consolidated Statements of Operations for the three years ended June 30, 1997............................................................. 33 Consolidated Statements of Changes in Shareholders' Equity for the three years ended June 30, 1997...................................... 34 Consolidated Statements of Cash Flows for the three years ended June 30, 1997............................................................. 35 Notes to Consolidated Financial Statements........................... 36 Report of Independent Accountants.................................... 50 (2) FINANCIAL STATEMENT SCHEDULES: II -- Valuation and Qualifying Accounts for each of the three years in the period ended June 30, 1997.................................... 53 (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............................................................. 54
(b) Current Reports on Form 8-K: (None) 51 54 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/ ROBERT E. HEALY, JR. ------------------------------------ (ROBERT E. HEALY, JR., SENIOR VICE PRESIDENT, FINANCE AND ADMINISTRATION AND CHIEF FINANCIAL OFFICER) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE - ----------------------------------------------- ------------------------------------ ------------------- /s/ JOHN H. FOSTER Chairman of the Board and Director September 19, 1997 - ----------------------------------------------- (JOHN H. FOSTER) /s/ TIMOTHY E. FOSTER Chief Executive Officer and Director September 19, 1997 - ----------------------------------------------- (TIMOTHY E. FOSTER) /s/ JAMES W. MCLANE President, Chief Operating Officer September 19, 1997 - ----------------------------------------------- and Director (JAMES W. MCLANE) /s/ ROBERT E. HEALY, JR. Senior Vice President, Finance and September 19, 1997 - ----------------------------------------------- Administration and Chief Financial (ROBERT E. HEALY, JR.) Officer /s/ BARRY E. SMITH Vice President, Controller and Chief September 19, 1997 - ----------------------------------------------- Accounting Officer (BARRY E. SMITH) /s/ E. MARTIN GIBSON Director September 19, 1997 - ----------------------------------------------- (E. MARTIN GIBSON) /s/ SIRI S. MARSHALL Director September 19, 1997 - ----------------------------------------------- (SIRI S. MARSHALL) /s/ STEPHEN E. O'NEIL Director September 19, 1997 - ----------------------------------------------- (STEPHEN E. O'NEIL) /s/ GEORGE W. SIGULER Director September 19, 1997 - ----------------------------------------------- (GEORGE W. SIGULER) /s/ ROBERT G. STONE, JR. Director September 19, 1997 - ----------------------------------------------- (ROBERT G. STONE, JR.) /s/ DANIEL C. TOSTESON, M.D. Director September 19, 1997 - ----------------------------------------------- (DANIEL C. TOSTESON, M.D.)
52 55 SCHEDULE II NOVACARE, INC. VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED JUNE 30, 1996, 1995 AND 1994 (IN THOUSANDS)
BALANCE AT CHARGED TO BALANCE BEGINNING COSTS AND AT END DESCRIPTION OF PERIOD EXPENSES OTHER DEDUCTIONS OF PERIOD - ----------------------------------------- ---------- ---------- ------ ---------- --------- Year ended June 30, 1997: Allowance for uncollectible accounts... $ 12,751 19,708 11,295(1) (13,207) $ 30,547 Allowance for Medicare denials and other allowances.................... $ 6,244 -- 8,270(2) (11,798) $ 2,716 Year ended June 30, 1996: Allowance for uncollectible accounts... $ 16,023 16,359 1,187(1) (20,818) $ 12,751 Allowance for Medicare denials and other allowances.................... $ 3,695 -- 9,018(2) (6,469) $ 6,244 Year ended June 30, 1995: Allowance for uncollectible accounts... $ 17,692 15,918 643(1) (18,230) $ 16,023 Allowance for Medicare denials and other allowances.................... $ 15,039 -- 5,887(2) (17,231) $ 3,695
- --------------- (1) Allowances for doubtful accounts related to acquired receivables. (2) Charged against net revenues. 53 56 INDEX TO EXHIBITS
EXHIBIT PAGE NUMBER EXHIBIT DESCRIPTION NUMBER - ------- ----------------------------------------------------------------------- ----------- 3(a)* Certificate of Incorporation of the Company, as amended to date -- (incorporated by reference to Exhibit 3(a) to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1992). 3(b) By-laws of the Company, as amended to date (incorporated by reference -- to Exhibit 3 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995). 4(a) Stock Option Plan, as amended to date. 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) (i) 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). (ii) 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(b) 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 (incorporated by reference to Exhibit 10(i) to the Company's Annual Report on Form 10-K for the year ended June 30, 1995). 10(c) Employment agreement dated as of January 24, 1996 between the Company -- and Ronald G. Hiscock (incorporated by reference to Exhibit 10 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1996). 10(d) Employment agreement dated as of March 17, 1995 between the Company and -- Robert E. Healy, Jr. (incorporated by reference to Exhibit 10(i) to the Company's Annual Report on Form 10-K for the year ended June 30, 1996). 10(e) Employment Agreement dated as of July 1, 1996 between the Company and Timothy E. Foster. 10(f) Employment agreement dated as of October 9, 1996 between the Company -- and Barry E. Smith (incorporated by reference to Exhibit 10(c) to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1997). 10(g) Employment agreement dated as of October 16, 1996 between the Company -- and Aven Kerr (incorporated by reference to Exhibit 10(b) to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1996). 10(h) Employment Agreement dated as of April 14, 1997 between the Company and -- James W. McLane (incorporated by reference to Exhibit 10(a) to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997). 10(i) Stock Purchase Agreement dated as of May 1, 1997 between NovaCare Employee Services, Inc. and James W. McLane.
54 57
EXHIBIT PAGE NUMBER EXHIBIT DESCRIPTION NUMBER - ------- ----------------------------------------------------------------------- ----------- 10(j) (i) Revolving Credit Facility Agreement dated as of May 27, 1994 by and -- among NovaCare and certain of its subsidiaries and PNC Bank, First Union National Bank of North Carolina, Mellon Bank, N.A., Nations Bank of North Carolina, N.A., CoreStates Bank, N.A., and National Westminster Bank, N.A. (incorporated by reference to Exhibit 10(g) to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994). (ii) Revolving Credit Facility Credit Agreement First Amendment dated -- as of September 20, 1994 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank of North Carolina, Mellon Bank, N.A., Nations Bank of North Carolina, N.A., CoreStates Bank, N.A., and National Westminster Bank, N.A. (incorporated by reference to Exhibit 10(a) to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1994). (iii) Revolving Credit Facility Agreement Second Amendment dated as of -- November 28, 1994 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank of North Carolina, Mellon Bank, N.A., Nations Bank of North Carolina, N.A., CoreStates Bank, N.A., National Westminster Bank, N.A., and Fleet Bank of Massachusetts, N.A. (incorporated by reference to Exhibit 10(b) to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1994). (iv) Revolving Credit Facility Agreement Third Amendment dated as of -- May 15, 1995 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank of North Carolina, Mellon Bank, N.A., Nationsbank, N.A. (Carolina), CoreStates Bank, N.A., NatWest Bank, N.A., and Fleet Bank of Massachusetts, N.A. (incorporated by reference to Exhibit 10 (a) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995). (v) Revolving Credit Facility Agreement Fourth Amendment dated as of -- May 19, 1995 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank of North Carolina, Mellon Bank, N.A., Nationsbank, N.A. (Carolina), CoreStates Bank, N.A., NatWest Bank, N.A., and Fleet Bank of Massachusetts (incorporated by reference to Exhibit 10 (a) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995). (vi) Revolving Credit Facility Agreement Fifth Amendment dated as of -- June 30, 1996 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank of North Carolina, Mellon Bank, N.A., Nationsbank, N.A. (Carolina), CoreStates Bank, N.A., and Fleet Bank of Massachusetts. (incorporated by reference to Exhibit 10(j)(vi) to the Company's Annual Report on Form 10-K for the year ended June 30, 1996). (vii) Revolving Credit Facility Agreement Sixth Amendment dated as of -- June 30, 1996 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., CoreStates Bank, N.A., First Union National Bank of North Carolina, Fleet Bank of Massachusetts, N.A., Mellon Bank, N.A. and Nationsbank, N.A. (incorporated by reference to Exhibit 10(j)(vii) to the Company's Annual Report on Form 10-K for the year ended June 30, 1996). (viii) Revolving Credit Facility Agreement Seventh Amendment dated as -- of November 4, 1996 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank of North Carolina, Mellon Bank, N.A., Nationsbank, N.A. (Carolina), CoreStates Bank, N.A., and Fleet Bank of Massachusetts, N.A. (incorporated by reference to Exhibit 10(a) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996). (ix) Revolving Credit Facility Agreement Eighth Amendment dated as of January 30, 1997 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank of North Carolina, Mellon Bank, N.A., Nationsbank, N.A., CoreStates Bank, N.A., Fleet Bank of Massachusetts, N.A., The Bank of New York, and SunTrust Bank (Central Florida), N.A.
55 58
EXHIBIT PAGE NUMBER EXHIBIT DESCRIPTION NUMBER - ------- ----------------------------------------------------------------------- ----------- (x) Revolving Credit Facility Agreement Ninth Amendment dated as of January 30, 1997 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank of North Carolina, Mellon Bank, N.A., Nationsbank, N.A., CoreStates Bank, N.A., Fleet Bank of Massachusetts, N.A., The Bank of New York, and SunTrust Bank (Central Florida), N.A. (xi) Revolving Credit Facility Agreement Tenth Amendment dated as of March 31, 1997 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank of North Carolina, Mellon Bank, N.A., Nationsbank, N.A., CoreStates Bank, N.A., Fleet National Bank, The Bank of New York, and SunTrust Bank (Central Florida), N.A. (xii) Revolving Credit Facility Agreement Eleventh Amendment dated as of June 27, 1997 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank of North Carolina, Mellon Bank, N.A., Nationsbank, N.A., CoreStates Bank, N.A., Fleet National Bank, The Bank of New York, SunTrust Bank (Central Florida), N.A., and Bank One (Kentucky), N.A. 10(k) Supplemental Benefits Plan as amended to date. 13 Annual Report to Shareholders for the fiscal year ended June 30, 1997. 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 shareholders of the Company. The Company will furnish a copy of any of such exhibits to any stockholder requesting the same. Exhibits denoted by an asterisk were filed prior to the Company's adoption of filing via EDGAR. 56 EX-4.(A) 2 STOCK OPTION PLAN, AS AMENDED TO DATE 1 EXHIBIT 4(a) NOVACARE, INC. 1986 Stock Option Plan (as amended October 31, 1996) 1. Purposes of Plan. The purposes of this Plan, which shall be known as the 1986 Stock Option Plan and is hereinafter referred to as the "Plan", are (i) to provide incentives for key employees of NovaCare, Inc. (the "Company") and its subsidiary or parent corporations (within the respective meanings of Section 425(f) and 425(e) of the Internal Revenue Code of 1986, as amended (the "Code"), and referred to herein as "Subsidiary" and "Parent", respectively) by encouraging their ownership of the common stock, $.01 par value, of the Company (the "Stock") and (ii) to aid the Company in retaining such key employees, upon whose efforts the Company's success and future growth depends, and attracting other such employees. 2. Administration. The Plan shall be administered by the Stock Option Committee (the "Committee") of the Board of Directors, as hereinafter provided. For purposes of administration, the Committee, subject to the 2 2 terms of the Plan, shall have plenary authority to establish such rules and regulations, make such determinations and interpretations, and take such other administrative actions as it deems necessary or advisable. All determinations and interpretations made by the Committee shall be final, conclusive and binding on all persons, including Optionees (as hereinafter defined) and their legal representatives and beneficiaries. The Committee shall be appointed from time to time by the Board of Directors and shall consist of not fewer than three of its members. Unless otherwise determined by the Board of Directors, no member of the Board of Directors who serves on the Committee shall be eligible to participate in the Plan. The Board of Directors shall designate one of the members of the Committee as its Chairman. The Committee shall hold its meetings at such times and places as it may determine. A majority of its members shall constitute a quorum. All determinations of the Committee shall be made by a majority of its members. Any decision or determination reduced to writing and signed by all members shall be as effective as if it had been made by a majority vote at a 3 3 meeting duly called and held. The Committee may appoint a secretary (who need not be a member of the Committee). No member of the Committee shall be liable for any act or omission with respect to his service on the Committee, if he acts in good faith and in a manner he reasonably believes to be in or not opposed to the best interests of the Company. Service on the Committee shall constitute service as a director of the Company for all purposes. 3. Stock Available for Options. There shall be available for options under the Plan a total of 5,800,000 shares of Stock, subject to any adjustments which may be made pursuant to Section 5(f). Shares of Stock used for purposes of the Plan may be either authorized and unissued shares, or previously issued shares held in the treasury of the Company, or both. Shares of Stock covered by options which have terminated or expired prior to exercise shall be available for further options hereunder. 4. Eligibility. Options under the Plan may be granted to key employees of the Company or any Subsidiary or Parent, including officers or directors of the Company or any Subsidiary or Parent. Options may be granted to 4 4 eligible employees whether or not they hold or have held options previously granted under the Plan or otherwise granted or assumed by the Company. In selecting employees for options, the Committee may take into consideration any factors it may deem relevant, including its estimate of the employee's present and potential contributions to the success of the Company and its Subsidiaries. Service as a director or officer of the Company or any Parent or Subsidiary shall be considered employment for purposes of the Plan. In the event the Company becomes obligated to grant options, through the assumption of, or in substitution for, outstanding awards previously granted by an acquired company or a company with which the Company combines, options may be granted to a non-continuing director of such acquired or combining company who does not become an employee or director of the Company or any Subsidiary or Parent. 5. Terms and Conditions of Options. The Committee shall, in its discretion, prescribe the terms and conditions of the options to be granted hereunder, which 5 5 terms and conditions need not be the same in each case, subject to the following: (a) Option Price. Except in the case of an option granted in assumption of or substitution for an outstanding award of a company acquired by the Company or with which the Company combines, the price at which each share of Stock covered by an option granted under the Plan may be purchased shall be determined by the Committee and shall not be less than the market value per share of Stock on the date of grant of an option as determined pursuant to Section 5(c). The date of the grant of an option shall be the date specified by the Committee in its grant of the option. (b) Option Period. The period for exercise of an option shall in no event be more than ten years from the date of grant. Options may, in the discretion of the Committee, be made exercisable in installments during the option period. Any shares not purchased on any applicable installment date may be purchased thereafter at any time before the expiration of the option period. 6 6 (c) Exercise of Options. In order to exercise an option, the holder thereof (the "Optionee") shall deliver to the Company written notice specifying the number of shares of Stock to be purchased, together with cash or a certified or bank cashier's check payable to the order of the Company in the full amount of the purchase price therefor; provided that, for the purpose of assisting an Optionee to exercise an option, the Company may make loans to the Optionee or guarantee loans made by third parties to the Optionee, on such terms and conditions as the Board of Directors may authorize; and provided further that such purchase price may be paid in shares of Stock owned by the Optionee having a market value on the date of exercise equal to the aggregate purchase price, or in a combination of cash and Stock. For purposes of the Plan, the market value per share of Stock shall be the last sale price regular way on the date of reference, or, in case no sale takes place on such date, the average of the closing high bid and low asked prices regular way, in either case on the principal national securities exchange on which the Stock is listed or admitted to trading, or if the Stock is not listed 7 7 or admitted to trading on any national securities exchange, the last sale price reported on the National Market System of the National Association of Securities Dealers Automated Quotation System ("NASDAQ") on such date, or the average of the closing high bid and low asked prices of the Stock in the over-the-counter market reported on NASDAQ on such date, whichever is applicable, or if there are no such prices reported on NASDAQ on such date, as furnished to the Committee by any New York Stock Exchange member selected from time to time by the Committee for such purpose. If there is no bid or asked price reported on any such date, the market value shall be determined by the Committee in accordance with the regulations promulgated under Section 2031 of the Code, or by any other appropriate method selected by the Committee. If the Optionee so requests, shares of Stock purchased upon exercise of an option may be issued in the name of the Optionee or another person. An Optionee shall have none of the rights of a stockholder until the shares of Stock are issued to him. An option may not be exercised for less than ten shares of Stock, or the 8 8 number of shares of Stock remaining subject to such option, whichever is smaller. (d) Effect of Termination of Employment. An option may not be exercised after the Optionee has ceased to be in the full-time employ of the Company or any Subsidiary or Parent, except in the following circumstances: (i) If the Optionee's employment is terminated by action of his employer, or by reason of disability or retirement under any retirement plan maintained by the Company or any Subsidiary or Parent, the option may be exercised by the Optionee within three months after such termination, but only as to any shares exercisable on the date the Optionee's employment so terminates; (ii) In the event of the death of the Optionee during the three month period after termination of employment covered by (i) above, the person or persons to whom his rights are transferred by will or the laws of descent and distribution shall have a period of one year from 9 9 the date of his death to exercise any options which were exercisable by the Optionee at the time of his death; (iii) In the event of the death of the Optionee while employed, the option shall thereupon become exercisable in full, and the person or persons to whom the Optionee's rights are transferred by will or the laws of descent and distribution shall have a period of one year from the date of the Optionee's death to exercise such option. The provisions of the foregoing sentence shall apply to any outstanding options which are incentive stock options to the extent permitted by Section 422A(b)(7) of the Code and such outstanding options in excess thereof shall, immediately upon the occurrence of the event described in the foregoing sentence, be treated for all purposes of the plan as nonstatutory stock options and shall be immediately exercisable as such as provided in the foregoing sentence. 10 10 (iv) If the Optionee is not an employee or director of the Company or any Subsidiary or Parent and is a non-continuing director of a company acquired by the Company or with which the Company has combined and the Company has become obligated to grant options to such Optionee as a result of such acquisition or combination. In no event shall any option be exercisable more than ten years from the date of grant thereof. Nothing in the Plan or in any option granted pursuant to the Plan (in the absence of an express provision to the contrary) shall confer on any individual any right to continue in the employ of the Company or any Subsidiary or Parent or interfere in any way with the right of the Company to terminate his employment at any time. (e) Nontransferability of Options. During the lifetime of an Optionee, options held by such Optionee shall be exercisable only by him. No option shall be transferable other than by will or the laws of descent and distribution. 11 11 (f) Adjustments for Change in Stock Subject to Plan and Other Events. In the event of a reorganization, recapitalization, stock split, stock dividend, combination of shares, merger, consolidation, rights offering, or any other change in the corporate structure or shares of the Company, (i) except as provided in (ii) below, the Committee shall make such adjustments, if any, as it deems appropriate in the number and kind of shares subject to the Plan, in the number and kind of shares covered by outstanding options, or in the option price per share, or both and (ii) the Board of Directors of the Company shall make such adjustments, if any, as it deems appropriate in the maximum number of shares which may be subject to options granted to all directors of the Company and in the maximum number of shares which may be subject to options granted to each director, in each case pursuant to Section 5(i), in the number and kind of shares covered by outstanding options, or in the option price per share, or both, with respect to options held by directors of the Company. In connection with any merger or consolidation in which the Company is not the surviving corporation or any 12 12 sale or transfer by the Company of all or substantially all of its assets or any tender offer or exchange offer for or the acquisition, directly or indirectly, by any person or group of all or a majority of the then outstanding voting securities of the Company, all outstanding options granted to any Optionee on or before December 31, 1989 or to a Director during the period of his directorship at any time before or after December 31, 1989 shall become exercisable in full, notwithstanding any other provision of the Plan or of any such outstanding options granted thereunder, on and after (i) the fifteenth day prior to the effective date of such merger, consolidation, sale, transfer, acquisition or change in control or (ii) the date of commencement of such tender offer or exchange offer, as the case may be. The Committee may, in its sole discretion determine that certain other options granted after December 31, 1989 shall become exercisable in full under such circumstances determined by the Committee. The provisions of this paragraph shall apply to any outstanding options which are incentive stock options to the extent permitted by Section 422A(b)(7) of the Code and such outstanding options in excess thereof shall, 13 13 immediately upon the occurrence of the event described in clause (i) or (ii) of the foregoing sentence, be treated for all purposes of the Plan as nonstatutory stock options and shall be immediately exercisable as such as provided in the foregoing sentence. Notwithstanding the foregoing, in no event shall any option be exercisable after the date of termination of the exercise period of such option specified in Sections 5(b), 5(d) and 5(i)(2). (g) Registration, Listing and Qualification of Shares of Stock. Each option shall be subject to the requirement that if at any time the Board of Directors shall determine that the registration, listing or qualification of the shares of Stock covered thereby upon any securities exchange or under any federal or state law, or the consent or approval of any governmental regulatory body is necessary or desirable as a condition of, or in connection with, the granting of such option or the purchase of shares of Stock thereunder, no such option may be exercised unless and until such registration, listing, qualification, consent or approval shall have been effected or obtained free of any conditions not acceptable to the Board of Directors. The 14 14 Company may require that any person exercising an option shall make such representations and agreements and furnish such information as it deems appropriate to assure compliance with the foregoing or any other applicable legal requirement. (h) Other Terms and Conditions. The Committee may impose such other terms and conditions, not inconsistent with the terms hereof, on the grant or exercise of options, as it deems advisable. (i) Terms and Conditions of Options Granted to Directors. Notwithstanding any provision contained in this Plan to the contrary, in the event that the Board of Directors shall determine to authorize grants of options to members of the Committee pursuant to Section 2, then, the terms and conditions of options granted under the Plan to any director of the Company shall be as follows: (1) The price at which each share of Stock subject to an option may be purchased shall, subject to any adjustments which may be made pursuant to Section 5(f), in no event be less than the market value per share of Stock on the date of grant, and provided further that in the event 15 15 the option is intended to be an incentive stock option pursuant to Section 6 and the Optionee owns on the date of grant securities possessing more than 10% of the total combined voting power of all classes of securities of the Company or of any Parent or Subsidiary, the price per share shall not be less than 110% of the market value per share of Stock on the date of grant. (2) The option may be exercised to purchase shares of Stock covered by the option: A. in accordance with the following schedule:
Cumulative Percentage of Aggregate Number of Shares of Stock Covered by Option Which May Exercise Period be Purchased --------------- ------------------------------------------- Within 1st year from date of grant..................... 0% Beginning one year from date of grant..................... 33-1/3% Beginning two years from date of grant..................... 66-2/3% Beginning three years from date of grant..................... 100%
16 16 less, in the case of each exercise period, the number of shares of Stock, if any, previously purchased under the option; or B. in accordance with a price-triggered vesting schedule that permits exercise of specific increments of options upon achievement of identified target prices above the exercise price in accordance with the terms of similar options approved within ninety days prior to the Directors' option grant date by the Stock Option Committee for members of the Company's management. Any option granted under this subparagraph (i)(2) shall terminate and no shares of Stock may be purchased thereunder more than ten years after the date of grant, provided that if the option is intended to be an incentive stock option pursuant to Section 6 and the Optionee owns on the date of grant stock possessing more than 10% of the total combined voting power of all classes of securities of the Company or of any Parent or Subsidiary, the Option shall not be exercisable after the fifth anniversary of the date of grant. 17 17 (3) The maximum number of shares of Stock which may be subject to options granted to all directors pursuant the Plan shall be 1,750,000 shares in the aggregate and the maximum number of shares of Stock which may be subject to options granted to any director pursuant to the Plan (including any options granted under the Plan to a director in his position as an officer or employee of the Company) shall be 500,000 shares. 6. Provisions Applicable to Incentive Stock Options. The Committee may, in its discretion, grant options under the Plan to eligible employees which constitute "incentive stock options" (within the meaning of Section 422A(b) of the Code), provided, however, that (a) no such incentive stock options granted before January 1, 1987 shall (i) be exercisable while there is "outstanding" (within the meaning of Section 422A(c)(7) of the Internal Revenue Code of 1954) any incentive stock option previously granted to the holder thereof to purchase Stock of the Company, or of any Parent or Subsidiary, or of any predecessor of any such corporations, or (ii) cover a number of shares in excess of the maximum number of shares 18 18 permitted to be covered pursuant to the provisions of Section 422A(b)(8) of the Internal Revenue Code of 1954, (b) the aggregate fair market value of the Stock with respect to which incentive stock options granted after 1986 are exercisable for the first time by the Optionee during any calendar year shall not exceed the limitation set forth in Section 422A(b)(7) of the Code, and provided further that Section 5(d)(ii) hereof shall not apply to any incentive stock option. 7. Amendment and Termination. Unless the Plan shall theretofore have been terminated as hereinafter provided, the Plan shall terminate on, and no option shall be granted hereunder after, December 31, 1996; provided, however, that the Board of Directors may at any time prior to that date terminate the Plan. The Board of Directors may at any time amend the Plan; provided, however, that, except as contemplated in Section 5(f), the Board of Directors shall not, without approval by a majority of the votes cast by the stockholders of the Company at a meeting of stockholders at which a proposal to amend the Plan is voted upon, (i) increase the maximum number of shares of Stock for 19 19 which options may be granted under the Plan, (ii) change the minimum option prices, (iii) extend the period during which options may be granted or exercised, or (iv) except as otherwise provided in the Plan, amend the requirements as to the class of employees eligible to receive options. No termination or amendment of the Plan may, without the consent of an Optionee, adversely affect the rights of such Optionee under any option held by such Optionee. 8. Effectiveness of Plan. The Plan will not be made effective unless approved by a majority of the votes cast by the stockholders of the Company at a meeting of stockholders duly called and held for such purpose, and no option granted hereunder shall be exercisable prior to such approval. 9. Other Actions. Nothing contained in the Plan shall be construed to limit the authority of the Company to exercise its corporate rights and powers, including but not by way of limitation, the right of the Company to grant or assume options for proper corporate purposes other than under the Plan with respect to any employee or other person, firm, corporation or association. 20 10. REPRICING. The Board of Directors shall not, without approval by a majority of the votes cast by the stockholders of the Company at a meeting of stockholders at which a proposal to reprice options is voted upon, adjust or amend the exercise price of stock options previously awarded under the Plan, whether through amendment, cancellation or replacement grants or any other means. EX-10.(E) 3 EMPLOYMENT AGREEMENT DATED JULY 1, 1996 1 Exhibit 10(e) EMPLOYMENT AGREEMENT AMENDED AND RESTATED EMPLOYMENT AGREEMENT dated as of the first day of July, 1996 by and between NOVACARE, INC., a Delaware corporation (the "Company"), and TIMOTHY E. FOSTER (the "Executive"). W I T N E S S E T H: WHEREAS, the Executive has served as President and Chief Operating Officer of the Company since October 1994; WHEREAS, the Company and the Executive entered into an Employment Agreement dated as of December 2, 1994; and WHEREAS, the Company and the Executive wish to amend and restate said agreement to set forth the terms and conditions on which the Executive will continue to serve in his current positions. 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 third anniversary of the date hereof, unless extended or sooner terminated in accordance with this Agreement. 1.3 Automatic Extension. As of June 30, 1998, and as of each subsequent June 30 (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 2 2. POSITION, DUTIES. The Executive shall serve in the positions of President and Chief Operating Officer of the Company. The Executive shall perform, faithfully and diligently, such duties, and shall have such responsibilities, appropriate to said positions, as shall be assigned to him from time to time by the Chief Executive Officer and the Board of Directors of the Company. The Executive shall report to the Chief Executive Officer of the Company. The Executive shall devote such time and attention to the performance of his duties and responsibilities hereunder as shall be necessary for the proper discharge thereof, as determined by the Chief Executive Officer of the Company. 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 $500,000 per annum, payable in accordance with the standard payroll practices of the Company. The Executive shall be entitled to such increases in base salary during the term hereof as shall be determined by the Chief Executive Officer of the Company 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 Company and the Executive, the size of the Company from time to time, 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 Incentive Bonuses. (a) In addition to the base salary provided for in Section 3.1, the Company shall pay to the Executive an incentive bonus with respect to each fiscal year of the Company ending during the term of this Agreement in accordance with this Section 3.2. The incentive bonus for each fiscal year under this Section 3.2 shall be the greater of the amounts determined under clause (X) or clause (Y): (X) an amount equal to the product of the Net Income (as hereinafter defined) of the Company multiplied by the Applicable Percentage (as hereinafter defined); provided that no incentive bonus shall be payable under this Section 3.2 with 3 3 respect to a fiscal year in which Net Income is less than ninety percent (90%) of Budgeted Net Income (as hereinafter defined). For purposes of this clause (X): (i) the term "Net Income" shall mean, for any fiscal year of the Company, the consolidated after-tax profit of the Company and its wholly-owned subsidiaries for such year, without regard to extraordinary non-operating profits and losses such as gain from sale of operating units, as shown in the audited financial statements of the Company for such fiscal year. In the event of any change in the fiscal year of the Company, appropriate adjustments shall be made to the provisions of this Section 3.2 in order to carry out the essential intent and principles of this Section 3.2; (ii) the term "Applicable Percentage" shall mean one half of one percent (0.5%) of Net Income for each fiscal year of the Company, beginning with the fiscal year ending June 30, 1996; provided that in any Fiscal Year in which Net Income is between 90% and 99% of Budgeted Net Income, the Applicable Percentage shall be the Applicable Percentage for such Fiscal Year determined without regard to this proviso multiplied by the "Adjustment Percentage" in the table below opposite the percentage (rounded down to the nearest complete percentage point) of Budgeted Net Income attained as Net Income in such Fiscal Year:
Percentage of Budgeted Net Income Attained Adjustment Percentage ---------------------- --------------------- 90% 45% 91% 51% 92% 56% 93% 62% 94% 67% 95% 73% 96% 78% 97% 84% 98% 89% 99% 95%
(iii) the term "Budgeted Net Income" shall mean, for any fiscal year of the Company, net income as set forth in the annual business plan of the Company for such fiscal year 4 4 as prepared by the Company's management and approved by the Board of Directors of the Company; and (iv) the term "extraordinary non-operating profits and losses such as gain from sale of operating units" shall include capital transaction outside the normal course of business but shall not include restructuring charges, charges to increase accounts receivable reserves or similar charges which relate to the operations of the Company or its business units. (Y) an amount of up to $100,000 for the fiscal year of the Company ending June 30, 1996, and an amount of up to $160,000 for the fiscal year of the Company ending June 30, 1997, based on achievement of the applicable performance measures set forth in Exhibit A to this Agreement. (b) In the event of the termination of employment of the Executive pursuant to Section 6.1 (Death), 6.2 (Disability), Section 6.4 (Without Cause), 6.5 (Voluntary Termination), 6.6 (Constructive Termination) or 6.7 (Change of Control) of this Agreement, the Executive (or his estate or other legal representative) shall be entitled to a bonus for the fiscal year in which such termination takes place in an amount equal to the product of (i) the bonus for such fiscal year determined pursuant to Section 3.2, multiplied by (ii) a fraction, the numerator of which is the number of days from the beginning of such fiscal year to the date of termination, and the denominator of which is 365. In the event of the termination of employment of the Executive pursuant to Section 6.3 (Due Cause) of this Agreement, the Executive shall not be entitled to a bonus for the fiscal year of the Company in which such termination takes place. The Executive shall not be entitled to a bonus for any fiscal year of the Company subsequent to the fiscal year in which the termination of his employment pursuant to Section 6.1 (Death), 6.2 (Disability), 6.3 (Due Cause) or 6.5 (Voluntary Termination) takes place. (c) The bonus payable to the Executive (or his estate or other legal representative) for any fiscal year of the Company pursuant to this Section 3.2 shall be paid by the Company within ten (10) days of receipt by the Company of the audited financial statements of the Company for such fiscal year. 3.3 Stock Options. (a) On May 3, 1996, the Company granted to the Executive options (the "Options") to purchase 1,000,000 shares of the Company's common stock, par value $.01 5 5 per share ("Common Stock"), at an exercise price per share equal to the market value of the Common Stock on the date of grant. The options were not granted under the 1986 Stock Option Plan (the "1986 Plan"), and are subject to stockholder approval. The Options: (i) have a term of seven (7) years from the date of grant; (ii) become exercisable as follows (but only after November 3, 1996): (A) 20% on the first to occur of the first anniversary of the date of grant or the average price (as defined in the Stock Option Certificate) of the common stock of NovaCare achieving $8 per share; (B) 40% on the first to occur of the second anniversary of the date of grant or the average price of the common stock of NovaCare achieving $10 per share; (C) 60% on the first to occur of the third anniversary of the date of grant or the average price of the common stock of NovaCare achieving $12 per share; (D) 80% on the first to occur of the fourth anniversary of the date of grant or the average price of the common stock of NovaCare achieving $14 per share; (E) 100% on the first to occur of the fifth anniversary of the date of grant or the average price of the common stock of NovaCare achieving $16 per share; (iii) except as provided in clause (iv) of this Section 3.3, remain exercisable for a period of twelve (12) months commencing on the date of termination of employment of the Executive, but only as to those shares as to which the Options were exercisable at the date of termination; and (iv) become exercisable in full upon a Change in Control of the Company (as defined in Section 6.7), whether or not the employment of the Executive shall be terminated, and upon the termination of the employment of the Executive pursuant to Section 6.1 (Death), Section 6.2 (Disability) or Section 6.4 (Without Due Cause) and, in any such case, shall remain exercisable for the balance of the ten year term. 6 6 The Options are or shall be evidenced by a Stock Option Certificate or other appropriate documentation embodying the foregoing terms and other standard terms and conditions not inconsistent with the foregoing terms. (b) The Executive has heretofore been granted options to purchase 500,000 shares of Common Stock pursuant to the Company's Option Exchange Program, which grant was approved by the Compensation Committee of the Board of Directors of the Company on May 2, 1996. The Executive has heretofore also been granted options to purchase an aggregate of 7,200 shares of Common Stock pursuant to the 1986 Plan. 4. EXPENSE REIMBURSEMENT. During the term of this Agreement, the Company shall reimburse the Executive for all reasonable and necessary out-of-pocket expenses incurred by him in connection with the performance of his duties hereunder, upon the presentation of proper accounts therefor in accordance with the Company's policies. 5. BENEFITS, PERQUISITES. 5.1 Generally. During the term of this Agreement, the Executive will be eligible to participate in all employee benefit plans and programs offered by the Company from time to time to its employees of comparable seniority, subject to the provisions of such plans and programs as in effect from time to time. 5.2 Perquisites. (a) During the term of this Agreement, the Company shall provide the Executive with the use of the Company's private corporate jet for personal travel in connection with two vacations annually; provided that the Company shall have no obligation to provide the Executive with the use of a private corporate jet under this Section 5.2 during any period that the Company does not own or lease a private corporate jet. (b) During the term of this Agreement, the Company shall also provide the Executive with the following: (i) a telephone in his automobile (for which the Company shall pay for all installation, service and other charges), (ii) first class airfare for travel in connection with the performance of his duties hereunder, (iii) a corporate credit card of the 7 7 Executive's choosing and (iv) a four-week paid vacation each year. 6. TERMINATION OF EMPLOYMENT. 6.1 Death. In the event of the death of the Executive, the Company shall (i) pay to the estate or other legal representative of the Executive (a) the base salary provided for in Section 3.1 (at the annual rate then in effect) accrued to the date of the Executive's death and not theretofore paid to the Executive and (b) any incentive bonus which shall be or become payable pursuant to Section 3.2. Rights and benefits of the estate or other legal representative or transferee of the Executive (a) with respect to the Options shall be determined in accordance with Section 3.3 and (b) under the benefit plans and programs of the Company shall be determined in accordance with the provisions of such plans and programs. Neither the estate or other legal representative of the Executive nor the Company shall have any further rights or obligations under this Agreement, except as provided in Section 15. 6.2 Disability. If the Executive shall become incapacitated by reason of sickness, accident or other physical or mental disability and shall be unable to perform his normal duties hereunder for a period of six (6) consecutive months, then, at any time following the conclusion of such six (6) month period, the employment of the Executive hereunder may be terminated by the Company or the Executive, upon thirty (30) days' notice to the other. In the event of such termination, the Company shall (a) pay to the Executive the base salary provided for in Section 3.1 (at the annual rate then in effect) accrued to the date of such termination and not theretofore paid and (b) pay to the Executive any incentive bonus which shall be or become payable under Section 3.2. Rights and benefits of the Executive or his transferee (a) with respect to the Options shall be determined in accordance with Section 3.3 and (b) under the other benefit plans and programs of the Company shall be determined in accordance with the terms and provisions of such plans and programs. Neither the Executive nor the Company shall have any further rights or obligations under this Agreement, except as provided in Sections 7, 8, 9 and 15. 6.3 Due Cause. The employment of the Executive hereunder may be terminated by the Company at any time for Due Cause (as hereinafter defined). In the event of such termination, the Company shall pay to the Executive the base 8 8 salary provided for in Section 3.1 (at the annual rate then in effect) accrued to the date of such termination and not theretofore paid to the Executive. The Company shall also pay to the Executive any incentive bonus which shall be or become payable to the Executive under Section 3.2 with respect to any fiscal year of the Company ended prior to the date of such termination. Rights and benefits of the Executive or his transferee (a) with respect to the Options shall be determined in accordance with Section 3.3 and (b) under the benefit plans and programs of the Company shall be determined in accordance with the provisions of such plans and programs. For purposes hereof, "Due Cause" shall mean (i) willful, gross neglect or willful, gross misconduct in the Executive's discharge of his duties and responsibilities under this Agreement, or (ii) the Executive's conviction of a felony; provided, however, that the Executive shall be given written notice by the Chief Executive Officer of the Company that it intends to terminate the Executive's employment for Due Cause, which written notice shall specify the act or acts upon which the Chief Executive Officer of the Company intends so to terminate the Executive's employment, and the Executive shall then be given the opportunity, within fifteen (15) days of his receipt of such notice, to have a meeting with the Chief Executive Officer of the Company to discuss such act or acts. If the basis of such written notice is other than an act or acts described in clause (ii), the Executive shall be given seven (7) days after such meeting within which to cease or correct the performance (or nonperformance) giving rise to such written notice and, upon failure of the Executive within such seven (7) days to cease or correct such performance (or nonperformance), the Executive's employment by the Company shall automatically be terminated hereunder for Due Cause. Neither the Executive nor the Company shall have any further rights or obligations under this Agreement, except as provided in Sections 7, 8, 9 and 15. 6.4 Termination by the Company Without Cause. (a) 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: (A) on the date of termination, the base salary provided for in Section 3.1 (at the annual rate then in 9 9 effect) accrued to the date of termination and not theretofore paid to the Executive; (B) severance pay, in the form of salary continuation for a period ("Severance Pay 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); (C) any incentive bonus which shall be or become payable to the Executive pursuant to Section 3.2; (D) on a date (the "Payment Date") within ten (10) days of receipt by the Company of the audited financial statements of the Company for the fiscal year in which such termination shall have occurred, an amount equal to the Final Bonus (as hereinafter defined) and, on the first anniversary of the Payment Date, an amount equal to one-half of the Final Bonus. As used herein, (X) if the date of termination of the Executive's employment shall occur during the first six months of any fiscal year of the Company, the term "Final Bonus" shall mean an amount equal to the bonus earned by the Executive for the last completed fiscal year of the Company preceding the date of termination of his employment and (Y) if the date of termination of the Executive's employment shall occur during the last six months of any fiscal year of the Company, the term "Final Bonus" shall mean an amount equal to the greater of (i) the bonus earned by the Executive for the last completed fiscal year of the Company preceding the date of termination of his employment or (ii) the bonus for the fiscal year in which the termination of employment occurs, as determined pursuant to Section 3.2(a) and before prorating pursuant to Section 3.2(b). (b) During the Severance Pay Period, the Executive shall diligently seek other full-time employment which is suitable and appropriate in light of his background, experience, seniority and stature. Amounts payable to the Executive pursuant to Section 6.4(a)(B) and 6.4(a)(D) shall be offset by amounts earned from other employment (whether as an employee, a consultant or otherwise) during the Severance Pay Period (provided that the Executive shall in no event be required to refund any amounts which he has previously received from the Company and provided, further, that there shall be no offset for the amounts earned by the Executive during the Severance Period from positions held by the Executive prior to commencement of the Severance Period). 10 10 (c) Rights and benefits of the Executive or his transferee (a) with respect to the Options shall be determined in accordance with Section 3.3 and (b) under the other benefit plans and programs of the Company shall be determined in accordance with the provisions of such plans and programs. Neither the Executive nor the Company shall have any further rights or obligations under this Agreement, except as provided in Sections 7, 8, 9 and 15. 6.5 Voluntary Termination. The Executive may terminate his employment with the Company at any time upon thirty (30) days' prior written notice to the Company. In the event of such termination (unless such termination is within one year following a Change in Control of the Company, in which case the provisions of Section 6.7 hereof shall be applicable), the Company shall pay to the Executive the base salary provided for in Section 3.1 (at the annual rate then in effect) accrued to the date of such termination and not therefore paid to the Executive. The Company shall also pay to the Executive any incentive bonus which shall be or become payable pursuant to Section 3.2. Rights and benefits of the Executive or his transferee (a) with respect to the Options shall be determined in accordance with Section 3.3 and (b) under the benefit plans and programs of the Company shall be determined in accordance with the provisions of such plans and programs. Neither the Executive nor the Company shall have any further rights or obligations under this Agreement, except as provided in Sections 7, 8, 9 and 15. 6.6 Constructive Termination. Anything herein to the contrary notwithstanding, if the Company: (A) demotes the Executive to a lesser position than provided in Section 2; (B) causes a material change in the nature or scope of the authorities, powers, functions, duties, or responsibilities attached to the Executive's position as described in Section 2; (C) decreases the Executive's base salary, changes the bonus formula provided for in Section 3 or eliminates any of the benefits or perquisites provided for in Section 5; or 11 11 (D) fails to cause the election of the Executive to the Board of Directors of the Company; then, within thirty (30) days after learning of the action (or inaction), the Executive may advise the Company in writing that the action (or inaction) constitutes a termination of his employment by the Company pursuant to Section 4.4 (Without Cause), in which event the Company shall have thirty (30) days (the "Correction Period") in which to correct such action (or inaction). If the Company does not correct such action (or inaction) during the Correction Period, such action (or inaction) shall (unless consented to in writing by the Executive) constitute a termination of the Executive's employment by the Company pursuant to Section 6.4 (Without Cause) effective on the first business day following the end of the Correction Period. 6.7 Termination of Employment Following a Change in Control. Anything herein to the contrary notwithstanding, the Executive may terminate his employment with the Company during the one (1) year period following a Change in Control, and such termination shall constitute a termination of the Executive's employment by the Company pursuant to Section 6.4 (Without Cause); provided, however, that the amounts referred to in paragraphs (A) and (B) of Section 6.4 shall be paid to the Executive in a lump sum on the date of termination and the amounts referred to in paragraph (D) of Section 6.4 shall be paid to the Executive in a lump sum on the Payment Date; and further provided that 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. 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 12 12 outstanding securities of the Company having a right to vote in elections of directors; or (B) Continuing Directors shall for any reason cease to constitute a majority of the Board of Directors of the Company; or (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, pursuant to a partial or complete liquidation of the Company, sale of assets (including stock of a subsidiary of the Company) or otherwise. For purposes of this Agreement, the term "Continuing Director" shall mean a member of the Board of Directors of the Company who either was a member of the Board of Directors on the date hereof or who subsequently became a Director and whose election, or nomination for election, was approved by a vote of at least two-thirds of the Continuing Directors then in office. 6.8 Acceleration of Payments. In the event that the Company shall fail to pay to the Executive any amount payable pursuant to this Section 6 at the time such payment is due, all amounts to be paid to the Executive (or his estate or legal representative) pursuant to this Section 6, Section 3 and any other provision of this Agreement shall become immediately due and payable without any further action by the Executive (or his estate or legal representative). 7. CONFIDENTIAL INFORMATION. 7.1 Nondisclosure. The Executive shall, during the term of this Agreement and at all times thereafter, treat as confidential and, except as required in the performance of his duties and responsibilities under this Agreement, not disclose, publish or otherwise make available to the public or to any individual, firm or corporation any confidential information (as hereinafter defined). 7.2 Confidential Information Defined. For the purposes hereof, the term "confidential information" shall mean all information acquired by the Executive in the course of the Executive's employment with the Company in any way concerning the products, projects, activities, business or affairs of the Company or the Company's customers, including, without 13 13 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, whether as principal, consultant, employee, partner, stockholder, limited partner or other investor (other than a passive 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 14 14 earnings before taxes for the fiscal year ended immediately prior to the conduct in question (the "Competition Restriction"); or (b) solicit or entice or endeavor to solicit or entice away from the Company any person who was an employee of the Company at job grade numbering 32 or higher, 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 employee of the Company at job grade numbering 32 or higher 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) twenty-four (24) months in the case of a termination of employment pursuant to Section 6.3 (Due Cause), Section 6.4 (Without Due Cause), Section 6.6 (Constructive Termination), or Section 6.7 (Change in Control); and 15 15 (b) twenty-four (24) months in the case of a termination pursuant to Section 6.2 (Disability) or Section 6.5 (Voluntary Termination), but only if the Company gives notice to the Executive within thirty (30) days of the date of termination of employment of its intention to enforce such restrictions against the Executive, and subject to the Company's continued payment to the Executive during such twenty-four (24) month period of the base salary provided for in Section 3.1 (at the annual rate in effect at the date of termination). 9. EQUITABLE RELIEF. In the event of a breach or threatened breach by the Executive of any of the provisions of Sections 7 or 8 of this Agreement, the Executive hereby consents and agrees that the Company shall be entitled to an injunction or similar equitable relief from any court of competent jurisdiction restraining the Executive from committing or continuing any such breach or threatened breach or granting specific performance of any act required to be performed by the Executive under any of such provisions, without the necessity of showing any actual damage or that money damages would not afford an adequate remedy and without the necessity of posting any bond or other security. Nothing herein shall be construed as prohibiting the Company from pursuing any other remedies at law or in equity which it may have. 10. SUCCESSORS AND ASSIGNS. 10.1 Assignment by the Company. The Company shall require any successors (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place. As used in this Section, the "Company" shall mean the Company as hereinbefore defined and any successor to its business and/or assets as aforesaid which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law and this Agreement shall be binding upon, and inure to the benefit of, the Company, as so defined. 10.2 Assignment by the Executive. The Executive may not assign this Agreement or any part thereof without the prior written consent of a majority of the Board of Directors of the Company; provided, however, that nothing herein shall preclude 16 16 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. 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 17 17 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. ADVANCE OF DEFENSE EXPENSES. In the event of any action, proceeding or claim against the Executive arising out of his serving or having served in his capacity as an officer and/or director of the Company, which in the Executive's sole judgment requires him to retain counsel (such choice of counsel to be made in his sole and absolute discretion) or otherwise expend his personal funds for his defense in connection therewith, the Company shall be obligated to advance to the Executive (or pay directly to his counsel) counsel fees and other costs associated with the Executive's defense of such action, proceeding or claim; provided, however, that in such event the Executive shall first agree in writing, without posting bond or collateral, to repay all sums paid or advanced to him pursuant to this Section 15 in the event that the final disposition of such action, proceeding or claim is one for which the Executive would not be entitled to indemnification pursuant to the provisions of the laws of the State of Delaware or the Certificate of Incorporation or By-laws of the Company. 16. NOTICES. Any notice to be given hereunder shall be in writing and delivered personally or sent by certified mail, postage prepaid, return receipt requested, addressed to the party 18 18 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 Executive Officer If to the Executive: 17. SEVERABILITY. Should any provision of this Agreement be held by a court or arbitration panel of competent jurisdiction to be enforceable only if modified, such holding shall not affect the validity of the remainder of this Agreement, the balance of which 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. 19 19 18. WITHHOLDING. Anything to the contrary notwithstanding, all payments required to be made by the Company hereunder to the Executive or his beneficiaries, including his estate, shall be subject to withholding of such amounts relating to taxes as the Company may reasonably determine it should withhold pursuant to any applicable law or regulation. In lieu of withholding such amounts, in whole or in part, the Company, may, in its sole discretion, accept other provision for payment of taxes as permitted by law, provided it is satisfied in its sole discretion that all requirements of law affecting its responsibilities to withhold such taxes have been satisfied. 19. SURVIVORSHIP. The respective rights and obligations of the parties hereunder shall survive any termination of this Agreement to the extent necessary to the intended preservation of such rights and obligations. 20. TITLES. Titles of the sections and paragraphs of this Agreement are intended solely for convenience and no provision of this Agreement is to be construed by reference to the title of any section or paragraph. 21. COUNTERPARTS. This Agreement may be executed in counterparts, each of which shall be deemed an original, but all of which taken together shall constitute one and the same instrument. * * * 20 20 IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. NOVACARE, INC. By /s/ John H. Foster -------------------------------- John H. Foster Chairman of the Board /s/ Timothy E. Foster -------------------------------- Timothy E. Foster The foregoing Agreement has been Approved by the Compensation Committee of the Board of Directors: /s/ Robert G. Stone - ---------------------------------- Robert G. Stone Chairman of Compensation Committee EX-10.(I) 4 STOCK PURCHASE AGREEMENT DATED AS OF MAY 1, 1997 1 EXHIBIT 10(i) NOVACARE EMPLOYEE SERVICES, INC. 2621 Van Buren Avenue Norristown, PA 19403 May 1, 1997 Mr. James W. McLane 20 Colony Road West Hartford, CT 06117 Dear Jamie: The undersigned, NovaCare Employee Services, Inc., a Delaware Corporation (the "Company"), and James W. McLane (the "Purchaser"), hereby agree as follows: 1. Authorization and Sale of the Shares. The Company has authorized the issuance to the Purchaser of and proposes to sell to the Purchaser, as an employee benefit and as an incentive to the Purchaser 10,000 shares (collectively the "Shares" and individually a "Share") of its common stock, $.01 par value (the "Common Stock"), at a price of $2.80 per Share. 2. Purchase of the Shares by the Purchaser. Subject to the terms and conditions hereof, the Purchaser hereby agrees to purchase the Shares from the Company in reliance upon its representations and warranties herein contained, and the Company hereby agrees to sell the Shares to the Purchaser in reliance upon the Purchaser's representations and warranties herein contained, at an aggregate purchase price (the "Purchase Price") of $28,000 in cash. 3. Representations, Warranties, and Agreements of the Company. The Company represents and warrants to, and agrees with, the Purchaser as follows: (a) The Company has been duly incorporated and is validly existing as a corporation in good standing under the laws of the State of Delaware. (b) The Company has duly authorized the execution and delivery of this Agreement and the issuance and delivery of the Shares and this Agreement constitutes a valid and legally binding agreement of the Company enforceable in accordance with its terms, except as such enforceability may be limited by bankruptcy, insolvency, or other laws affecting generally the enforceability of creditors' rights and by limitations on the availability of equitable remedies. The Shares, when issued and 2 delivered in accordance with this Agreement, shall have been duly issued and shall be validly outstanding, fully paid and nonassessable shares of the Common Stock. 4. Representations, Warranties, and Agreements of the Purchaser. The Purchaser hereby represents and warrants to, and agrees with, the Company as follows: (a) The Purchaser understands that by the terms of this Agreement he is purchasing shares of Common Stock issued and delivered by the Company without compliance with the registration requirements of the Securities Act of 1933 (the "Securities Act") or the securities laws of any state, under and in reliance on exemptions from the registration requirements of the Securities Act and such laws, and without the approval, disapproval, or passing on the merits by any regulatory authority; that for purposes of such exemptions, the Company will rely upon the representations, warranties and agreements of the Purchaser contained herein; and that such non-compliance with registration requirements is not permissible unless such representations and warranties are correct and such agreements performed. The Purchaser is an "accredited investor" as such term is defined in Rule 501 under the Securities Act. (b) The Purchaser understands that the Company is under no obligation to effect a registration under the Securities Act of the Shares to be purchased by him hereunder. The Purchaser understands that, under existing rules of the Securities and Exchange Commission (the "Commission"), the Purchaser may be unable to sell any of the Shares except to the extent that the Shares may be sold (A) in a bona fide private placement to a purchaser who shall be subject to the same restrictions on sale or (B) subject to the restrictions contained in Rule 144 under the Securities Act. (c) The Purchaser is acquiring the Shares pursuant to this Agreement for the Purchaser's own account and not with a view to or for sale in connection with the distribution thereof within the meaning of the Securities Act. The Purchaser shall not effect a distribution of any Shares until either (A) the Purchaser has received the opinion of counsel for the Company that registration under the Securities Act is not required or (B) a registration statement under the Securities Act covering such Shares and the disposition thereof has become effective under the Securities Act, and the Purchaser agrees that the certificates evidencing the Shares may bear a restrictive legend to the foregoing effect. (d) As President of the Company's parent NovaCare, Inc., the Purchaser is fully familiar with the business, properties and financial condition of the Company, and acknowledges that he has been afforded access to such additional information concerning the Company as he considers necessary or appropriate to make an informed investment decision, and to all additional information which has considered necessary to verify the accuracy of the information so received. The Purchaser has had the opportunity to ask questions of and receive answers from the Company concerning the terms and conditions of the transactions contemplated by this Agreement 2 3 (e) The Purchaser is a sophisticated investor familiar with the type of risks inherent in the acquisition of restricted securities such as the Common Stock and his financial position is such that he can afford to retain the Shares for an indefinite period of time without realizing any direct or indirect cash return on his investment. (f) The Purchaser is familiar with the provisions of Rule 144 and the limitations upon the availability and applicability of such rule. 5. Restrictions on Transferability of the Shares. The Purchaser hereby agrees that the Purchaser shall not sell, assign, transfer, gift, devise, bequeath, deliver, pledge, hypothecate or otherwise dispose of any of the Shares, except as provided for in this Agreement. Any disposition or purported disposition of Shares in violation of this Agreement shall be null and void and shall not be recorded on the books of the Company. Notwithstanding the foregoing: (a) Disposition of Vested Shares and Shares Which Are Not Vested Shares. Shares which are "vested" in accordance with the following schedule (the "Vested Shares") may be disposed of in the manner set forth in Subsection (b) or (d) of this Section 5.
Cumulative Percentage of Shares Which Are Vested Shares ------------------------------ On or before April 30, 1998 ................ 0% May 1, 1998 to April 30, 1999.............................. 33-1/3% May 1, 1999 to April 30, 2000.............................. 66-2/3% On or after May 1, 2000 .................... 100%
Shares which are not Vested Shares (the "Unvested Shares") may be disposed of only in the manner set forth in Subsection (c) or (d) of this Section 5. (b) Vested Shares. (i) Vested Shares held by the Purchaser may be transferred by the Purchaser provided that the Purchaser first complies with the right to purchase set forth in this Subsection (b). The Company shall have a right to purchase any Vested Shares proposed to be sold by the Purchaser on the terms set forth in this Subsection (b). 3 4 (ii) If the Purchaser wishes to dispose of Vested Shares, the Purchaser shall first obtain a bona fide written offer (the "Offer") for the purchase of the Vested Shares which he or she wishes to dispose of. Such Offer shall be for cash or promissory notes only. Promptly upon receipt of the Offer, the Purchaser shall give notice to the Company (the "Offer Notice") of the Purchaser's intent to dispose of Vested Shares, which Offer Notice shall specify the name of the proposed purchaser, the number of Vested Shares (the "Offered Securities") the Purchaser desires to dispose of and the price and terms of payment of such proposed disposition. Upon receipt of the Offer Notice, the Company shall have the right to purchase all (but not less than all) of the Offered Securities at the price and on the terms of the Offer. Such right must be exercised by the Company by giving notice to that effect to the Purchaser within a period of ten business days after the date of receipt of the Offer Notice (any such notice of the exercise of such right being herein referred to as an "Acceptance Notice"). (iii) In the event of the exercise by the Company of its right to purchase pursuant to this Subsection (b), the Acceptance Notice shall specify the time and date for purchase of the Offered Securities (the "Share closing") which shall be not more than 30 days after the expiration of the ten business day period set forth in clause (b)(ii). The Purchaser shall deliver to the Company at the Share closing, which shall be held at the business headquarters of the Company, the Offered Securities in due and proper form for transfer, against payment of the purchase price of the Company. (iv) If the Company shall fail or decline to agree to purchase the Offered Securities within the ten business day period provided for in clause (b)(ii), then the Purchaser shall have the right and privilege to sell all (but not less than all) the Offered Securities, within 60 days after the expiration of such ten business day period, to the bona fide purchaser named in the Offer Notice, at the price and on terms of payment specified in the Offer. If, for any reason, the Offered Securities are not sold within such 60-day period, the Offered Securities shall again become subject to the terms and conditions of this Agreement. (v) The Company's right to purchase set forth in this Subsection (b) shall terminate upon the occurrence of the closing of the initial sale by the Company to the public of shares of the Common Stock pursuant to a registration statement filed under the Securities Act (other than a registration statement covering securities of the Company to be issued pursuant to an employee benefit plan). (c) Termination of the Purchaser's Employment. (i) If the Purchaser shall cease to be employed by the Company's parent or any other subsidiary or affiliate of the Company's parent (collectively, the "Company Group"), for any reason whatsoever, the Company shall have the right (but not the obligation) to purchase from the Purchaser all or any portion of the Unvested Shares owned by the Purchaser at the time the Purchaser ceases to be employed by the Company, provided that Shares that become vested before or upon such 4 5 termination of Purchaser's employment pursuant to any provision of the Employment Agreement providing for acceleration of vesting upon the occurrence of certain events shall be deemed vested for purposes of this Agreement. Such right to purchase shall be exercisable by written notice to that effect given by the Company to the Purchaser within 30 days after the Purchaser has ceased to be employed by any member of the Company Group, as aforesaid. Upon the giving of such written notice, the Purchaser shall for all purposes cease to be a stockholder of the Company as to the Unvested Shares covered by such notice and shall have no rights against the Company or any other person in respect of such Unvested Shares except the right to receive payment for such Unvested Shares in accordance herewith. Notwithstanding the provisions of Subsection (a) of this Section 5, Unvested Shares not so purchased by the Company shall upon the expiration of such 30-day period become Vested Shares. (ii) At the time and date specified in the notice given by the Company referred to in clause (c)(i), which date shall in no event be more than 15 days after the expiration of the 30-day period for the exercise of the right to purchase set forth therein, the Purchaser shall deliver to the Company, at the business headquarters of the Company, the Unvested Shares to be sold by the Purchaser in due and proper form for transfer, against payment by the Company of the purchase price therefor, as determined in accordance with clause (c)(iii). (iii) The per Share purchase price for the Unvested Shares payable by the Company pursuant to clause (c)(ii) shall be $2.80. The number of Unvested Shares to be purchased and the per Share purchase price pursuant to this clause (c)(iii) shall be appropriately adjusted by the Board of Directors of the Company to reflect any split, reverse split, recapitalization, reorganization, merger, stock dividend, consolidation or other change in the corporate structure or the stock of the Company (d) Disposition to Family Members. Shares held by the Purchaser may be transferred by the Purchaser to or for the benefit of the Purchaser or a member of the Purchaser's immediate family. For the purpose of this Agreement, the term "immediate family" of the Purchaser shall mean the Purchaser's spouse and children (and the direct lineal descendants of the Purchaser's children). It shall be a condition to the validity of any transfer of Shares permitted by the provisions of this Subsection (d) that the transferee shall execute a copy of this Agreement, shall hold such Shares subject to the provisions of this Agreement, and shall make no further transfer of such Shares, except in compliance with the terms and conditions of this Agreement. 6. The Closing. Simultaneously with the execution and delivery of this Agreement, the Purchaser shall cause to be delivered to the Company a check or checks payable to the order of the Company in the amount of the Purchase Price. Promptly after receipt of such check or checks, the Company shall deliver to the Purchaser at the Purchaser's address set forth at the head of this Agreement, a stock certificate registered in the name of the Purchaser and representing the Shares. 5 6 7. Notice. Any notice under this Agreement shall be in writing and delivered personally or sent by certified mail, return receipt requested, addressed, as the case may be, (i) to the Company at its address set forth at the head of this Agreement or such other address as may hereafter be designated by the Company by notice to the Purchaser in the manner provided herein; and (ii) to the Purchaser at the Purchaser's address set forth at the head of this Agreement or such other address as may hereafter be designated by the Purchaser by notice to the Company in the manner provided herein. All notices personally delivered shall be deemed to have been given when delivered and all notices sent by mail shall be deemed to have been given three business days after mailing. 8. Successors. The terms, covenants and conditions of this Agreement shall inure to the benefit of and be binding upon the parties hereto and their respective heirs, legal representatives, successors, permitted transferees and assigns. 9. Applicable Law. This Agreement shall be governed by and construed in accordance with the laws of the Commonwealth of Pennsylvania applicable to agreements made and to be performed entirely within such Commonwealth. 10. Entire Agreement. This Agreement sets forth the entire understanding of the parties hereto, and no modifications of or amendments to this Agreement shall be binding on the parties hereto unless in writing and signed by them. 11. Integration. This Agreement supersedes all prior understandings, negotiations, and agreements relating to the subject matter hereof. 12. Severability. If any provision herein contained shall be held to be illegal or unenforceable, such holding shall not affect the validity or enforceability of the other provisions of this Agreement. 13. Reorganization, Etc. The provisions of this Agreement shall apply mutatis mutandi to any shares or other securities resulting from any stock split or reverse split, stock dividend, reclassification, subdivision, consolidation or reorganization of any shares or other securities of the Company and to any shares or other securities of the Company or of any successor company which may be received by the Purchaser by virtue of his or her ownership of the Shares. 14. Disputes. (a) Arbitration. The parties shall attempt amicably to resolve disagreements by negotiating with each other. In the event that the matter is not amicably resolved through negotiation, any controversy, dispute or disagreement arising out of or relating to this Agreement (a "Controversy") shall be settled exclusively by binding arbitration, which shall be conducted by a single arbitrator in Philadelphia, PA, in accordance with the J-A-M-S/Endispute Streamlined Arbitration Rules and Procedures (the "Rules"). The parties agree that, notwithstanding anything to the contrary contained 6 7 in the Rules, the arbitrator shall not award consequential, exemplary, incidental, punitive or special damages. (b) Procedure. It is agreed that if any party shall desire relief of any nature whatsoever from the other party as a result of any Controversy, such party will initiate such arbitration proceedings within a reasonable time, but in no event more than one (1) year after the facts underlying said Controversy first arise or become known to the party seeking relief (whichever is later). The failure of such party to institute such proceedings within said period shall be deemed a full waiver of any claim for such relief. The parties shall bear equally all costs of said arbitration (other than their own attorney's fees and costs). The parties agree that the decision and award of the Arbitrator shall be final and conclusive upon the parties, in lieu of all other legal, equitable or judicial proceedings between them, and that no appeal or judicial review of the award or decision of the Arbitrator shall be taken, but that such award or decision may be entered as a judgment and enforced in any court having jurisdiction over the party against whom enforcement is sought. * * * 7 8 If you are in agreement with the foregoing, please execute and deliver to the undersigned the enclosed counterpart of this Agreement, whereupon this Agreement shall become a binding agreement between us. Very truly yours, NOVACARE EMPLOYEE SERVICES, INC. By /s/ Loren Holber ___________________________ Accepted and agreed to as aforesaid: /s/ James W. McLane _______________________________ James W. McLane 8 EX-10.(J)(IX) 5 REVOLVING CREDIT FACILITY AGREEMENT EIGHTH AMEND. 1 EXHIBIT 10(j)(ix) NOVACARE, INC. 1016 WEST NINTH AVENUE KING OF PRUSSIA, PA 19406 January 30, 1997 PNC Bank, National Association, as Agent One PNC Plaza Fifth Avenue and Wood Street Pittsburgh, PA 15265 Attn: Marcie Knittel, Vice President RE: Eighth Amendment to Credit Agreement (the "Eighth Amendment") Dear Marcie: We refer to that certain Credit Agreement, dated as of May 27, 1994, as amended (the "Credit Agreement"), by and among NovaCare, Inc. ("NovaCare") and certain of its Subsidiaries, the Banks party thereto and PNC Bank, National Association, as agent for the Banks ("Agent"). Defined terms used herein, not otherwise defined herein, shall have the meanings given to them under the Credit Agreement as amended hereby. The Borrowers and Guarantors, the Banks and the Agent hereby desire to amend the Credit Agreement, as hereinafter provided. The parties hereto in consideration of their mutual covenants and agreements hereinafter set forth, and intending to be legally bound hereby, covenant and agree as follows: AGREEMENT 1. Amendment of Credit Agreement The parties hereto do hereby modify and amend the Credit Agreement as follows: (a) Cover page is hereby amended by deleting in line 1 the number "$150,000,000" and inserting in lieu thereof the number "175,000,000". (b) Recital paragraph 1, page 1, is hereby amended by deleting in line 2 the number "$150,000,000" and inserting in lieu thereof the number "$175,000,000". 2 (c) Upon the effectiveness of this Eighth Amendment and for periods subsequent to such effective date, SunTrust Bank, Central Florida, N.A. and The Bank of New York shall each be a Bank party to the Credit Agreement. 2. Amendment to Schedules. (a) Schedules. Schedule 1.01(B) [List of Banks, Commitments and Closing Fees] to the Agreement is hereby amended and restated in its entirety in the form of such Schedule attached hereto. 3. Conditions of Effectiveness. The effectiveness of this Eighth Amendment is expressly conditioned upon the occurrence and completion of all of the following: (i) the Agent's receipt of counterparts of this Eighth Amendment duly executed by the Borrowers, the Guarantors and the Banks; (ii) the Agent's receipt of a certificate signed by the Secretary or Assistant Secretary of the Borrowers and Guarantors, certifying as to all action taken by the Borrowers and Guarantors to authorize the execution, delivery and performance of this Eighth Amendment; (iii) the Agent's receipt of a Confirmation of Guaranty duly executed by the Guarantors in the form of Exhibit II attached hereto; (iv) an opinion of Peter D. Bewley, General Counsel of the Loan Parties reasonably satisfactory to the Agent regarding this Eighth Amendment; and (v) each Borrower shall have delivered to the Agent on behalf of each Bank a Note in the amount of each Bank's Commitment. This Eighth Amendment shall be dated as of and shall be effective as of the date and year first above written which shall be the date of satisfaction of all conditions precedent to effectiveness as set forth in this Section 3. 4. Consent of All Banks. Pursuant to Section 11.01(a) of the Credit Agreement, this Eighth Amendment shall require the written consent of all of the Banks, all of the Borrowers and all of the Guarantors. 5. Full Force and Effect. Except as expressly modified and amended by this Eighth Amendment, the Credit Agreement and the other Loan Documents are hereby ratified and confirmed and shall remain in full force and effect. -2- 3 6. Costs, Expenses, Disbursements. The Borrowers hereby agree to reimburse the Agent and the Banks on demand for all costs, expenses and disbursements relating to this Eighth Amendment which are payable by the Borrowers as provided in Section 10.05 of the Credit Agreement. 7. Counterparts. This Eighth Amendment may be executed by different parties hereto in any number of separate counterparts, each of which, when so executed and delivered, shall be an original, and all of such counterparts shall together constitute one and the same instrument. 8. Governing Law. This Eighth Amendment shall be deemed to be a contract under the laws of the Commonwealth of Pennsylvania and for all purposes shall be governed by and construed and enforced in accordance with the internal laws of the Commonwealth of Pennsylvania without regard to its conflict of laws principles. -3- 4 [Signature Page 1 of 7 to Eighth Amendment] IN WITNESS WHEREOF, the parties hereto, by their officers thereunto duly authorized, have executed this Eighth Amendment as of the day and year first above written. BORROWERS AND GUARANTORS: ATTEST: NOVACARE, INC., a Delaware corporation, and each of the other BORROWERS listed on Schedule 6.01(c) of the Credit Agreement (which Schedule is attached hereto as Exhibit I) and each of the GUARANTORS listed on Schedule 6.01(c) of the Credit Agreement (which Schedule is attached hereto as Exhibit I), other than those listed below By: /s/ Richard A. McDonald By: /s/ Barry E. Smith ----------------------- ---------------------- [Seal] Barry E. Smith [Name], ---------------- the Vice President ----------------[Title] of each Borrower and Guarantor listed on Schedule 6.01(c) of the Credit Agreement (which Schedule is attached hereto as Exhibit I), other than those listed below, which is a corporation and of each general partner of each Borrower and Guarantor which is a partnership Address for Notices for each of the foregoing Borrowers and Guarantors: 1016 West Ninth Avenue King of Prussia, PA 19406 Telecopier No. (610) 992-3328 Attention: Chief Financial Officer Telephone No. (610) 992-7200 5 [Signature Page 2 of 7 to Eighth Amendment] [INTENTIONALLY BLANK] 6 [Signature Page 3 of 7 to Eighth Amendment] AGENT: PNC BANK, NATIONAL ASSOCIATION, as Agent By:/s/ Marcie D. Knittel -------------------------------- Title: Vice President Address for Notices: One PNC Plaza Fifth Avenue and Wood Street Pittsburgh, PA 15265 Telecopier No. (412) 762-2784 Attention: Regional Healthcare Group Telephone No. (412) 762-8343 BANKS: PNC BANK, NATIONAL ASSOCIATION By: /s/ Marcie D. Knittel ------------------------------ Title: Vice President Address for Notices: One PNC Plaza Fifth Avenue and Wood Street Pittsburgh, PA 15265 Telecopier No. (412) 762-2784 Attention: Regional Healthcare Group Telephone No. (412) 762-8343 7 [Signature Page 4 of 7 to Eighth Amendment] CORESTATES BANK, N.A. By: /s/ Jennifer W. Leibowitz ------------------------------ Name: Jennifer W. Leibowitz Title: Vice President Address for Notices: 1339 Chestnut Street P.O. Box 7618 FC 1-8-3-22 Philadelphia, PA 19101 Telecopier No. (215) 786-7721 Attention: Jennifer W. Leibowitz Assistant Vice President Telephone No. (215) 786-3972 FIRST UNION NATIONAL BANK OF NORTH CAROLINA By: /s/ Joseph H. Towell ------------------------------ Name: Joseph H. Towell Title: Sr. V.P. Address for Notices: One First Union Center 301 S. Giles Street Charlotte, NC 28288-0735 Telecopier No. (704) 374-4092 Attention: James F. Young, Assistant Vice President Telephone No. (704) 383-0507 8 [Signature Page 5 of 7 to Eighth Amendment] FLEET BANK OF MASSACHUSETTS, N.A. By: /s/ Amy E. Fredericks ---------------------------- Name: Amy E. Fredericks Title: Vice President Address for Notices: Health Care and Non Profit Group Fleet Center MA BOF 04A 75 State Street Boston, MA 02109-1810 Telecopier No. (617) 346-1646 Attention: Amy Fredericks Vice President Telephone No. (617) 346-1629 MELLON BANK, N.A. By: /s/ Carol Paige ---------------------------- Name: Carol Paige Title: Vice President Address for Notices: Healthcare Banking Plymouth Meeting/Exec. Campus 610 W. Germantown Pike Suite 200/AIM #19E-0246 Plymouth Meeting, PA 19462 Telecopier No. (610) 941-4136 Attention: Carol Paige Vice President Telephone No. (610) 941-8409 9 [Signature Page 6 of 7 to Eighth Amendment] NATIONSBANK, N.A. By: /s/ Kevin Wagley ----------------------------- Name: Kevin Wagley Title: Vice President Address for Notices: One NationsBank Plaza Fifth Floor Nashville, TN 37239-1697 Telecopier No. (615) 749-4646 Attention: S. Walker Choppin Sr. Vice President Telephone No. (615) 749-3607 THE BANK OF NEW YORK By: /s/ Peter H. Abdill ----------------------------- Name: Peter H. Abdill Title: Vice President Address for Notices: Northeastern Division One Wall Street 22nd Floor New York, NY 10286 Telecopier No. (212) 635-6999 Attention: Peter Abdill Vice President Telephone No. (212) 635-6987 10 [Signature Page 7 of 7 to Eighth Amendment] SUNTRUST BANK, CENTRAL FLORIDA, N.A. By: /s/ Harold Bitler ----------------------------- Name: Harold Bitler Title: First VP Address for Notices: Healthcare Banking Group 0-1106, Tower 10 200 South Orange Avenue Orlando, FL 32801 Telecopier No. (407) 237-2491 Attention: Jeffrey R. Dickson First Vice President Telephone No. (407) 237-4541 STATE OF GEORGIA COUNTY OF FULTON On the 29 day of January, 1997 personally appeared Harold Bitler, as the First Vice President of SunTrust Bank, Central Florida, National Association, and before me executed the attached Eighth Amendment dated as of January 30, 1997 to the Credit Agreement between NovaCare, Inc., with SunTrust Bank, Central Florida, National Association, as Lender. IN WITNESS WHEREOF, I have hereunto set my hand and official seal, in the state and county aforesaid. /s/ Marian C.Maldonato -------------------------------------------- Signature of Notary Public, State of Georgia Notary Public, Fulton County, Georgia My Commission Expires Sept. 10, 1999 Marian C. Maldonato -------------------------------------------- (Print, Type or Stamp Commissioned Name of Notary Public) Personally known X ; -------- OR Produced Identification ---------------- Type of identification produced: ------------ 11 SCHEDULE 1.01(B) COMMITMENTS OF BANKS
Revolving Participation Credit Bank Percentage Commitment ---- ---------- ---------- PNC Bank, National Association 22.857142858 $ 40,000,000 Mellon Bank, N.A. 15.714285714 $ 27,500,000 NationsBank, N.A. 14.285714286 $ 25,000,000 CoreStates Bank, N.A. 11.428571429 $ 20,000,000 SunTrust 10.000000000 $ 17,500,000 Fleet Bank of Massachusetts, N.A. 8.571428571 $ 15,000,000 First Union National Bank of North Carolina 8.571428571 $ 15,000,000 The Bank of New York 8.571428571 $ 15,000,000 TOTAL 100.000000000% $175,000,000 ============== ============
EX-10.(J)(X) 6 REVOLVING CREDIT FACILITY AGREEMENT NINTH AMEND. 1 EXHIBIT 10(j)(x) NOVACARE, INC. 1016 WEST NINTH AVENUE KING OF PRUSSIA, PA 19406 January 30, 1997 PNC Bank, National Association, as Agent One PNC Plaza Fifth Avenue and Wood Street Pittsburgh, PA 15265 Attn: Marcie Knittel, Vice President RE: Amendment No. 9 to Credit Agreement (the "Amendment") Dear Marcie: We refer to that certain Credit Agreement, dated as of May 27, 1994, as amended (the "Credit Agreement"), by and among NovaCare, Inc. ("NovaCare") and certain of its Subsidiaries, the Banks party thereto and PNC Bank, National Association, as agent for the Banks ("Agent"). Defined terms used herein, not otherwise defined herein, shall have the meanings given to them under the Credit Agreement as amended hereby. The Borrowers and Guarantors, the Banks and the Agent hereby desire to amend the Credit Agreement, as hereinafter provided. The parties hereto in consideration of their mutual covenants and agreements hereinafter set forth, and intending to be legally bound hereby, covenant and agree as follows: AGREEMENT 1. Amendment of Credit Agreement. The parties hereto do hereby modify and amend the Credit Agreement as follows: (a) Section 8.02 (d) [Negative Covenants; Liquidations, Mergers, Consolidations, Acquisitions.] is hereby amended by deleting subsection (ii) (g) thereof and inserting in lieu thereof, the following: 2 "(g) the Consideration paid by the Loan Parties for each Permitted Acquisition shall not exceed Thirty Million Dollars ($30,000,000), and after giving effect to such Permitted Acquisition, the Consideration paid by the Loan Parties for all Permitted Acquisitions made during the current fiscal year of the Loan Parties shall not exceed One Hundred Fifty Million Dollars ($150,000,000) (the "Annual Permitted Acquisition Amount") provided that in no event shall the portion of the Annual Permitted Acquisition Amount utilized to make Permitted Acquisitions of physician practices in the specialty of occupational medicine exceed Forty Million Dollars ($40,000,000) in any fiscal year and in no event shall the portion of the Annual Permitted Acquisition Amount utilized to make Permitted Acquisitions of Professional Employment Organizations exceed Forty Five Million Dollars ($45,000,000) during the fiscal year ended June 30, 1997 or Forty Million Dollars ($40,000,000) during any fiscal year thereafter." (b) Section 8.02 (o) [Negative Covenants.; Minimum Fixed Charge Coverage Ratio.] is hereby amended by deleting the words "Closing Date" in the first line of the column entitled "Period" and inserting, in lieu thereof, the words "9/30/1996". 2. Conditions of Effectiveness. The effectiveness of this Amendment is expressly conditioned upon the occurrence and completion of all of the following: (i) the Agent's receipt of counterparts of this Amendment duly executed by the Borrowers, the Guarantors and the Required Banks; (ii) the Agent's receipt of a certificate signed by the Secretary or Assistant Secretary of the Borrowers and Guarantors, certifying as to all action taken by the Borrowers and Guarantors to authorize the execution, delivery and performance of this Amendment; and (iii) an opinion of Peter D. Bewley, General Counsel of the Loan Parties reasonably satisfactory to the Agent regarding this Amendment. Further, the representations and warranties of the Loan Parties contained in Article VI of the Credit Agreement shall be true and accurate on the date hereof with the same effect as though such representations and warranties had been made on and as of such date (except representations and warranties which relate solely to an earlier date or time, which representations and warranties shall be true and correct on and as of the specific dates or times referred to therein), the Loan Parties shall have performed and complied with all covenants and conditions hereof; no Event of Default or Potential Default under the Credit Agreement shall have occurred and be continuing or shall exist and there shall be delivered to the Agent for the benefit of each Bank a certificate of an Authorized Officer of the Loan Parties dated as of the date hereof certifying as to each of the foregoing. -2- 3 This Amendment shall be dated as of and shall be effective as of the date and year first above written which shall be the date of satisfaction of all conditions precedent to effectiveness as set forth in this Section 2. 3. Full Force and Effect. Except as expressly modified and amended by this Amendment, the Credit Agreement and the other Loan Documents are hereby ratified and confirmed and shall remain in full force and effect. 4. Costs, Expenses, Disbursements. The Borrowers hereby agree to reimburse the Agent and the Banks on demand for all costs, expenses and disbursements relating to this Amendment which are payable by the Borrowers as provided in Section 10.05 of the Credit Agreement. 5. Counterparts. This Amendment may be executed by different parties hereto in any number of separate counterparts, each of which, when so executed and delivered, shall be an original, and all of such counterparts shall together constitute one and the same instrument. 6. Governing Law. This Amendment shall be deemed to be a contract under the laws of the Commonwealth of Pennsylvania and for all purposes shall be governed by and construed and enforced in accordance with the internal laws of the Commonwealth of Pennsylvania without regard to its conflict of laws principles. -3- 4 [Signature Page 1 of 6 to Ninth Amendment] IN WITNESS WHEREOF, the parties hereto, by their officers thereunto duly authorized, have executed this Amendment as of the day and year first above written. BORROWERS AND GUARANTORS: ATTEST: NOVACARE, INC., a Delaware corporation, and each of the other BORROWERS listed on Schedule 6.01(c) of the Credit Agreement (which Schedule is attached hereto as Exhibit I) and each of the GUARANTORS listed on Schedule 6.01(c) of the Credit Agreement (which Schedule is attached hereto as Exhibit I), other than those listed below By: /s/ Peter D. Bewley By: /s/ Robert E. Healy, Jr. ---------------------- ----------------------------- Robert E. Healy, Jr. [Name], [Seal] the Senior Vice President [Title] of each Borrower and Guarantor listed on Schedule 6.01(c) of the Credit Agreement (which Schedule is attached hereto as Exhibit I), other than those listed below, which is a corporation and of each general partner of each Borrower and Guarantor which is a partnership Address for Notices for each of the foregoing Borrowers and Guarantors: 1016 West Ninth Avenue King of Prussia, PA 19406 Telecopier No. (610) 992-3328 Attention: Chief Financial Officer Telephone No. (610) 992-7200 5 [Signature Page 2 of 6 to Ninth Amendment] AGENT: PNC BANK, NATIONAL ASSOCIATION, as Agent By: /s/ Marcie D. Knittel ----------------------------- Title: Vice President Address for Notices: One PNC Plaza Fifth Avenue and Wood Street Pittsburgh, PA 15265 Telecopier No. (412) 762-2784 Attention: Regional Healthcare Group Telephone No. (412) 762-8343 BANKS: PNC BANK, NATIONAL ASSOCIATION By: /s/ Marcie D. Knittel ----------------------------- Title: Vice President Address for Notices: One PNC Plaza Fifth Avenue and Wood Street Pittsburgh, PA 15265 Telecopier No. (412) 762-2784 Attention: Regional Healthcare Group Telephone No. (412) 762-8343 6 [Signature Page 3 of 6 to Ninth Amendment] CORESTATES BANK, N.A. /s/ Jennifer W. Leibowitz By:______________________________ Jennifer W. Leibowitz Name:____________________________ Vice President Title:___________________________ Address for Notices: 1339 Chestnut Street P.O. Box 7618 FC 1-8-3-22 Philadelphia, PA 19101 Telecopier No. (215) 786-7721 Attention: Jennifer W. Leibowitz Assistant Vice President Telephone No. (215) 786-3972 FIRST UNION NATIONAL BANK OF NORTH CAROLINA /s/ Joseph H. Towell By:______________________________ Joseph H. Towell Name:____________________________ A.V.P. Title:___________________________ Address for Notices: One First Union Center 301 S. Giles Street Charlotte, NC 28288-0735 Telecopier No. (704) 374-4092 Attention: James F. Young, Assistant Vice President Telephone No. (704) 383-0507 7 [Signature Page 4 of 6 to Ninth Amendment] FLEET BANK OF MASSACHUSETTS, N.A. By: /s/ Amy E. Fredericks ----------------------------- Name: Amy E. Fredericks Title: Vice President Address for Notices: Health Care and Non Profit Group Fleet Center MA BOF 04A 75 State Street Boston, MA 02109-1810 Telecopier No. (617) 346-1646 Attention: Amy Fredericks Vice President Telephone No. (617) 346-1629 MELLON BANK, N.A. By: /s/ Carol Paige ----------------------------- Name: Carol Paige Title: Vice President Address for Notices: Healthcare Banking Plymouth Meeting/Exec. Campus 610 W. Germantown Pike Suite 200/AIM #19E-0246 Plymouth Meeting, PA 19462 Telecopier No. (610) 941-4136 Attention: Carol Paige Vice President Telephone No. (610) 941-8409 8 [Signature Page 5 of 6 to Ninth Amendment] NATIONSBANK, N.A. By: /s/ Kevin Wagley ----------------------------------- Name: Kevin Wagley Title: Vice President Address for Notices: One NationsBank Plaza Fifth Floor Nashville, TN 37239-1697 Telecopier No. (615) 749-4646 Attention: S. Walker Choppin Sr. Vice President Telephone No. (615) 749-3607 THE BANK OF NEW YORK By: /s/ Walter C. Parelli ----------------------------------- Name: Walter C. Parelli Title: Assistant Vice President Address for Notices: Northeastern Division One Wall Street 22nd Floor New York, NY 10286 Telecopier No. (212) 635-6999 Attention: Peter Abdill Vice President Telephone No. (212) 635-6987 9 [Signature Page 6 of 6 to Ninth Amendment] SUNTRUST BANK, CENTRAL FLORIDA, N.A. By: /s/ Harold Bitler ----------------------------- Name: Harold Bitler Title: First V.P. Address for Notices: Healthcare Banking Group 0-1106, Tower 10 200 South Orange Avenue Orlando, FL 32801 Telecopier No. (407) 237-2491 Attention: Jeffrey R. Dickson First Vice President Telephone No. (407) 237-4541 STATE OF GEORGIA COUNTY OF FULTON On the 29th day of January, 1997 personally appeared Harold Bitler, as the First Vice President of SunTrust Bank, Central Florida, National Association, and before me executed the attached Ninth Amendment dated as of _____________, 1997 to the Credit Agreement between NovaCare, Inc., with SunTrust Bank, Central Florida, National Association, as Lender. IN WITNESS WHEREOF, I have hereunto set my hand and official seal, in the state and county aforesaid. /s/ Marian C. Maldonads ------------------------------------------------ Signature of Notary Public, State of Georgia Notary Public, Fulton County, Georgia My commission expires Sept. 10, 1999 Marian C. Maldonads ------------------------------------------------ (Print, Type or Stamp Commissioned Name of Notary Public) Personally known /x/; ---- OR Produced Identification --------------------- Type of identification produced: ---------------- ------------------------------------------------ EX-10.(J)(XI) 7 REVOLVING CREDIT FACILITY AGREEMENT TENTH AMEND. 1 EXHIBIT 10 (j)(xi) NOVACARE, INC. 1016 WEST NINTH AVENUE KING OF PRUSSIA, PA 19406 Dated as of March 31, 1997 PNC Bank, National Association, as Agent One PNC Plaza Fifth Avenue and Wood Street Pittsburgh, PA 15265 Attn: Marcie Knittel, Vice President RE: Amendment No. 10, Waiver and Consent to Credit Agreement (the "Amendment") Dear Marcie: We refer to that certain Credit Agreement, dated as of May 27, 1994, as amended (the "Credit Agreement"), by and among NovaCare, Inc. ("NovaCare") and certain of its Subsidiaries, the Banks party thereto and PNC Bank, National Association, as agent for the Banks ("Agent"). Defined terms used herein, not otherwise defined herein, shall have the meanings given to them under the Credit Agreement as amended hereby. The Borrowers and Guarantors, the Banks and the Agent hereby desire to amend the Credit Agreement, as hereinafter provided. The parties hereto in consideration of their mutual covenants and agreements hereinafter set forth, and intending to be legally bound hereby, covenant and agree as follows: AGREEMENT PART I: AMENDMENT AND WAIVER 1. Amendment to Credit Agreement. The parties hereto hereby agree that subject to the prior satisfaction of all conditions precedent to the effectiveness of this Amendment set forth in Part I, Section 4, the Credit Agreement shall be automatically amended, as follows: 2 (a) Section 8.02 (d) [LIQUIDATIONS, MERGERS, CONSOLIDATIONS, ACQUISITIONS.], shall be amended by adding the following sentence after the last sentence thereof: "Notwithstanding anything herein or in any other Loan Document to the contrary, for periods on and after March 31, 1997 neither NovaCare nor any other Loan Party nor any Subsidiary of any Loan Party shall at any time become a party to any merger or consolidation, or acquire by purchase, lease or otherwise all or substantially all of the assets or capital stock or other ownership interests of any other entity or Person which engages in the business of a Professional Employment Organization, other than the continued ownership of NovaCare's equity interest of common stock of NovaCare Employee Services, Inc., a Delaware corporation, such equity interest to be in an amount which at no time shall exceed the amount of such interest as of March 31, 1997." (b) Section 8.02(i) [LOANS AND INVESTMENTS], clause (iv) shall be deleted in its entirety, and the following clause (iv) shall be inserted in lieu thereof: "(iv) Permitted Intercompany Indebtedness, and Investments by the Loan Parties in other Loan Parties; provided, however, that for periods on and after March 31, 1997 the Investments by the Loan Parties in other Loan Parties which are engaged in the business of a Professional Employment Organization shall be limited solely to the Investment by NovaCare in NovaCare Employee Services, Inc., a Delaware corporation, such Investment to be in an amount which at no time shall exceed the amount of such Investment as of March 31, 1997; and" (c) Section 8.02(n) [FUNDED DEBT TO CASH FLOW FROM OPERATIONS] is hereby amended and restated in its entirety to read as follows: "(n) Funded Debt to Cash Flow From Operations. The Loan Parties shall not permit the ratio of Consolidated Funded Debt to Consolidated Cash Flow from Operations, calculated as of the end of each fiscal quarter for the four fiscal quarters then ended, to exceed the ratio set forth below during the period specified below:
RATIO OF CONSOLIDATED FUNDED DEBT TO CONSOLIDATED PERIOD CASH FLOW FROM OPERATIONS ------ ------------------------- Closing Date through 6/30/1995 3.00 to 1.00 7/1/1995 through 12/31/1995 2.75 to 1.00 1/1/1996 through 6/30/1996 2.50 to 1.00 7/1/1996 through 12/31/1996 3.00 to 1.00 1/1/1997 through 6/30/1997 2.75 to 1.00 7/1/1997 and thereafter 2.50 to 1.00"
-2- 3 2. Background; Certain Representations, Warranties and Covenants of Loan Parties. NovaCare advises the Banks that during the fiscal quarter ended March 31, 1997, the Loan Parties entered into acquisition transactions and during the fiscal quarter ended June 30, 1997, the Loan Parties anticipate entering into acquisition transactions, in all such cases the aggregate Consideration with respect to which exceeds the $150,000,000 limitation for Consideration paid by the Loan Parties for Permitted Acquisitions in any fiscal year, as set forth in Section 8.02(d)(ii)(g) of the Credit Agreement. The Loan Parties represent and warrant that Part A of Exhibit 1 hereto sets forth a complete and accurate list of each acquisition completed during the fiscal quarter ended March 31, 1997, providing adequate detail of the following for each acquisition: (i) the name of the acquired entity; (ii) whether such acquired entity has joined the Credit Agreement as a Borrower or a Guarantor; (iii) the line of (i) business of the acquired entity; and (iv) the Consideration paid by the Loan Parties for the Permitted Acquisition. The Loan Parties represent that all of the equity interests of each acquired entity or of the entity which acquired such assets have been pledged to the Agent for the benefit of the Banks on a first priority perfected basis. The Loan Parties represent and warrant that Part B of Exhibit 1 hereto sets forth a complete and accurate list of each acquisition expected to be completed during the fiscal quarter ended June 30, 1997, providing adequate detail of the following for each acquisition: (i) the name of the entity to be acquired; (ii) whether such entity will join the Credit Agreement as a Borrower or a Guarantor; (iii) the line of business of the entity to be acquired; and (iv) a good faith estimate of the expected Consideration to be paid by the Loan Parties for the entity or such assets. The Banks acknowledge that the Consideration set forth on Part B of Exhibit 1, is subject to final negotiation of the terms of each transaction and that, without prior approval of the Banks, the Loan Parties may increase the aggregate Consideration for each transaction by not more than 25% of the original estimated Consideration for such transactions as set forth on Part B of Exhibit 1. 3. Waiver Relating to Liquidations, Mergers, Consolidations, Acquisitions. The Banks hereby waive the aggregate limitation of $150,000,000 of Permitted Acquisitions set forth in Section 8.02(d), clause (ii)(g) [Liquidations, Mergers, Consolidations, Acquisitions] made by the Loan Parties in the fiscal year ended June 30, 1997, to permit the Loan Parties to consummate certain acquisitions listed on Exhibit 1 hereto made during the fiscal quarter ended March 31, 1997 or to be made during the fiscal quarter ending June 30, 1997, provided that such acquisitions are made during the time periods and for the Consideration listed on Exhibit 1 and so long as each Permitted Acquisition otherwise complies with Section 8.02(d) of the Credit Agreement (including without limitation that all equity interests of the entity acquired or which is acquiring assets have been pledged to the Agent for the benefit of the Banks on a first priority, perfected basis). The foregoing waiver is applicable only to the fiscal quarters ended March 31 and June 30, 1997, and to the extent that the acquisitions specified on Exhibit 1 are not completed on or before June 30, 1997, such acquisitions must be permitted by the provisions of Section 8.02(d) and the other provisions of the Credit Agreement. To the extent that the Loan Parties desire to substitute a potential acquisition listed on Part B of Exhibit I for a -3- 4 different acquisition, or desire to amend Exhibit 1 in any other manner, the prior consent of the Required Banks, which shall not be unreasonably withheld, shall be required. Within five (5) Business Days following receipt by the Banks from NovaCare of a request to amend Part B of Exhibit 1, any Bank objecting to the proposed amendment shall promptly notify NovaCare and the Agent of such objection. Any Bank not objecting to a proposed amendment within such time period shall be deemed to have consented to such proposed amendment. 4. Conditions of Effectiveness. The effectiveness of the Amendment and Waiver set forth in this Part I, Sections 1, 2 and 3 is expressly conditioned upon the occurrence and completion of all of the following to the satisfaction of the Agent, in its sole discretion: (i) the Agent's receipt of counterparts of this Amendment duly executed by the Borrowers, the Guarantors and all of the Banks; and (ii) the Agent's receipt of a certificate signed by the President, Chief Executive Officer or Chief Financial Officer of the Borrowers and Guarantors, certifying as to all action taken by the Borrowers and Guarantors to authorize the execution, delivery and performance of this Amendment and that all conditions to the effectiveness of this Amendment have been met. Further, the representations and warranties of the Loan Parties contained in Article VI of the Credit Agreement shall be true and accurate on the date hereof with the same effect as though such representations and warranties had been made on and as of such date (except representations and warranties which relate solely to an earlier date or time, which representations and warranties shall be true and correct on and as of the specific dates or times referred to therein), the Loan Parties shall have performed and complied with all covenants and conditions contained herein and in the Loan Documents; no Event of Default or Potential Default under the Credit Agreement shall have occurred and be continuing or shall exist; the information set forth on Parts A and B of Exhibit 1 hereto shall be true and correct; and there shall be delivered to the Agent for the benefit of each Bank a certificate of the President, Chief Executive Officer or Chief Financial Officer of the Loan Parties dated as of the date hereof certifying as to each of the foregoing. PART II: AMENDMENT AND CONSENT REGARDING SPIN-OFF 1. Background; Certain Representations, Warranties and Covenants of Loan Parties. NovaCare currently owns at least a 90% interest in a certain Professional Employment Organization known as NovaCare Employee Services, Inc., a Delaware corporation (the "Spin-Off Entity"). NovaCare plans to spin-off a percentage of its ownership interest in the Spin-Off Entity by either directly selling a portion of its ownership interest in the Spin-Off Entity or by having the Spin-Off Entity issue additional shares of capital stock through an initial public offering of stock (the "Spin-Off"). The Spin-Off will require the consent of the all of the Banks. NovaCare desires that after the Spin-Off, the Spin-Off Entity be classified as an Excluded Entity. NovaCare covenants that it shall consummate the Spin-Off only if: (i) the aggregate proceeds to NovaCare or the Spin-Off Entity (in either case, net of all reasonable and customary transaction fees and costs and net of federal, state and local income taxes in connection with the Spin-Off) shall be in an amount at least equal to the amount necessary to repay all indebtedness of the Spin- -4- 5 Off Entity to NovaCare, including all accrued interest thereon, as of the date of consummation of the Spin-Off; (ii) a portion of the proceeds of the Spin-Off shall be used, on the date of consummation of the Spin-Off, by the Spin-Off Entity to repay all of the outstanding Indebtedness of the Spin-Off Entity to NovaCare, together with accrued interest thereon, which Indebtedness as of March 31, 1997 had an outstanding principal balance of $26 million; (iii) the Spin-Off shall occur on or before September 30, 1997, and after giving effect to the Spin-Off, NovaCare shall own at least 70% of all of the issued and outstanding equity interests of the Spin-Off Entity; and (iv) at least ten (10) days prior to consummation of the Spin-Off, NovaCare shall have delivered to the Agent copies of all documents in connection with the Spin-Off (the "Spin-Off Documents") which shall be in form and substance satisfactory to the Agent. The Loan Parties represent and warrant that after giving effect to the Spin-Off, no Event of Default or Potential Default shall exist or be continuing. 2. Consent of All Banks; Release of Certain Collateral. (a) The consent of the Banks, as hereinafter provided, is subject to the terms and conditions of this Amendment, including without limitation the accuracy of all representations and warranties of the Loan Parties with respect to the Spin-Off and the prior satisfaction of all covenants and all conditions precedent set forth in Part II, Section 4 hereof, and subject to the foregoing, the Banks hereby consent solely to either: (i) the spin-off of a portion of NovaCare's stock in the Spin-Off Entity as described above or (ii) the issuance by the Spin-Off Entity of additional shares of capital stock through an initial public offering of stock. For the limited purpose, solely of permitting the transactions described in the preceding sentence, the Banks hereby waive the limitations on sales set forth in Section 8.02(e)(iv) of the Credit Agreement. (b) Effective upon the consummation of the Spin-Off and satisfaction of all conditions precedent set forth in Part II, Section 4 hereof, the Banks consent to the release of their Lien upon the Stock of the Spin-Off Entity owned by NovaCare and authorize the Agent to take the actions required to so release such Lien. 3. Amendment to Credit Agreement - Effective Upon Consummation of Spin-Off. The parties hereto hereby agree that subject to the prior satisfaction of all conditions precedent as set forth in Part II, Section 4, effective upon the consummation of the Spin-Off, the Credit Agreement shall be automatically amended, as follows: (a) Section 1.01 [CERTAIN DEFINITIONS] shall be amended by deleting, in its entirety the definition of "Consolidated Cash Flow from Operations" and inserting in lieu thereof, the following: "Consolidated Cash Flow from Operations for any period of determination shall mean (i) the sum of net income, depreciation, amortization, other non-cash charges, if any, deducted in the determination of net income, interest expense and income tax expense, minus (ii) non-cash credits, if any, included in the determination of net income, in each case of NovaCare and its Subsidiaries for such period determined and consolidated in accordance with GAAP but without regard to net income and the other items described in clauses (i) and (ii) of this sentence -5- 6 attributable to NovaCare PEO (for periods on and after the Spin-Off Consummation) and without regard to net income and the other items described in clauses (i) and (ii) of this sentence attributable to Restricted Excluded Entities and; provided that, if a Loan Party shall have made one or more Permitted Acquisitions during such period, Consolidated Cash Flow from Operations shall be adjusted on a pro forma basis to give effect to all Permitted Acquisitions as if they had occurred at the beginning of such period; and provided further that if any Loan Party shall have effected one or more Permitted Asset Transfers during such period, Consolidated Cash Flow from Operations shall be adjusted on a pro forma basis to give effect to all such Permitted Asset Transfers as if they had occurred at the beginning of such period. The pro forma adjustments described in the previous sentence shall be made based upon historical financial statements for the four (4) fiscal quarters prior to the date of such Permitted Acquisition or Permitted Asset Transfer, as the case may be, which historical financial statements shall be reasonably satisfactory to the Agent." (b) Section 1.01 [CERTAIN DEFINITIONS] shall be amended by deleting, in its entirety the definition of "Consolidated Earnings Available for Fixed Charges" and inserting in lieu thereof, the following: "Consolidated Earnings Available for Fixed Charges shall mean: (A) for any period of determination from the Closing Date through, but not including, the Sixth Amendment Effective Date, the sum of net income, interest expense, income tax expense and expenses under operating leases, in each case of NovaCare and its Subsidiaries for such period determined and consolidated in accordance with GAAP, but without regard to net income, interest expense, income tax expense and expenses under operating leases attributable to Restricted Excluded Entities; and (B) for any period of determination from the Sixth Amendment Effective Date and thereafter, the sum of net income (excluding non-cash credits, if any, included in the determination of net income), interest expense, income tax expense, depreciation, amortization, other non-cash charges, if any, deducted in the determination of net income and expenses under operating leases, in each case of NovaCare and its Subsidiaries for such period determined and consolidated in accordance with GAAP, but without regard to net income, interest expense, income tax expense, depreciation, amortization, other non-cash charges and expenses under operating leases attributable to NovaCare PEO (for periods on and after the Spin-Off Consummation) and without regard to such items attributable to Restricted Excluded Entities. If a Loan Party shall have made one or more Permitted Acquisitions during any such period, Consolidated Earnings Available for Fixed Charges shall be adjusted on a pro forma basis to give effect to all Permitted Acquisitions as if they had occurred at the beginning of such period; and provided further that if any Loan Party shall have effected one or more Permitted Asset Transfers during such period, Consolidated Earnings Available for Fixed Charges shall be adjusted on a pro forma basis to give effect to all such Permitted Asset Transfers as if they had occurred at the beginning of such period. The pro forma adjustments described in the previous sentence shall be made based upon historical financial statements for the four (4) -6- 7 fiscal quarters prior to the date of such Permitted Acquisition or Permitted Asset Transfer, as the case may be, which historical financial statements shall be reasonably satisfactory to the Agent." (c) Section 1.01 [CERTAIN DEFINITIONS] shall be amended by deleting, in its entirety the definition of "Consolidated Fixed Charges" and inserting in lieu thereof, the following: "Consolidated Fixed Charges shall mean: (A) for any period of determination from the Closing Date through, but not including, the Sixth Amendment Effective Date, the sum of interest expense plus expenses under operating leases, in each case of NovaCare and its Subsidiaries for such period determined and consolidated in accordance with GAAP; (B) for any period of determination from the Sixth Amendment Effective Date through and including the Spin-Off Consummation, the sum of interest expense, expenses under operating leases, income tax expense, current maturities of long term Indebtedness, and current principal payments under capitalized leases (for the twelve (12) month period following the date of determination), in each case of NovaCare and its Subsidiaries for such period determined and consolidated in accordance with GAAP; and (C) for any period of determination after the Spin-Off Consummation, the sum of interest expense, expenses under operating leases, income tax expense, current maturities of long term Indebtedness, and current principal payments under capitalized leases (for the twelve (12) month period following the date of determination), in each case of NovaCare and its Subsidiaries (other than NovaCare PEO) for such period determined and consolidated in accordance with GAAP. If a Loan Party shall have made one or more Permitted Acquisitions during any such period, Consolidated Fixed Charges shall be adjusted on a pro forma basis to give effect to all Permitted Acquisitions as if they had occurred at the beginning of such period; and provided further that if any Loan Party shall have effected one or more Permitted Asset Transfers during such period, Consolidated Fixed Charges shall be adjusted on a pro forma basis to give effect to all such Permitted Asset Transfers as if they had occurred at the beginning of such period. The pro forma adjustments described in the previous sentence shall be made based upon historical financial statements for the four (4) fiscal quarters prior to the date of such Permitted Acquisition or Permitted Asset Transfer, as the case may be, which historical financial statements shall be reasonably satisfactory to the Agent." (d) Section 1.01 [CERTAIN DEFINITIONS] shall be amended by deleting, in its entirety the definition of "Consolidated Funded Debt" and inserting in lieu thereof, the following: "Consolidated Funded Debt shall mean (i) as of any date of determination through but not including the Spin-Off Consummation, any Indebtedness of NovaCare and its Subsidiaries to persons other than NovaCare and its Subsidiaries, determined and consolidated in accordance with GAAP, and (ii) as of any date of determination on and after the Spin-Off Consummation, any Indebtedness of NovaCare and its Subsidiaries (other than NovaCare PEO), -7- 8 to persons other than NovaCare and its Subsidiaries determined and consolidated in accordance with GAAP. Any items which are included in more than one clause of the definition of Indebtedness shall not be counted more than one time in computing the amount of Consolidated Funded Debt." (e) Section 1.01 [CERTAIN DEFINITIONS] shall be amended by deleting, in its entirety the definition of "Consolidated Net Income" and inserting in lieu thereof, the following: "Consolidated Net Income shall mean (i) for any period of determination for periods prior to the Spin-Off Consummation, the net income of NovaCare and its Subsidiaries for such period determined and consolidated in accordance with GAAP, and (ii) for any period of determination for periods on and after the Spin-Off Consummation, the net income of NovaCare and its Subsidiaries (other than NovaCare PEO) for such period determined and consolidated in accordance with GAAP, except that in the case of amounts under either the forgoing clause (i) or (ii), there shall be excluded from such net income any increases or decreases in income or expenses resulting from changes in GAAP on and after the Closing Date." (f) Section 1.01 [CERTAIN DEFINITIONS] shall be amended by deleting, in its entirety the definition of "Consolidated Net Worth" and inserting in lieu thereof, the following: "Consolidated Net Worth shall mean (i) as of any date of determination for periods prior to the Spin-Off Consummation, total stockholders' equity of NovaCare and its Subsidiaries as of such date determined and consolidated in accordance with GAAP, and (ii) as of any date of determination for periods on and after the Spin-Off Consummation, total stockholders' equity of NovaCare and its Subsidiaries (other than NovaCare PEO) as of such date determined and consolidated in accordance with GAAP." (g) Section 1.01 [CERTAIN DEFINITIONS] shall be amended by deleting, in its entirety the definition of "Excluded Entities" and inserting in lieu thereof, the following: "Excluded Entities shall mean collectively (i) any Minority Subsidiary or Unaffiliated Managed Company in which a Loan Party has made a Restricted Investment permitted by Section 8.02(i)(v); (ii) the Excluded Qualifying Subsidiaries; and (iii) effective upon the Spin-Off Consummation, NovaCare PEO; and Excluded Entity shall mean separately any of the Excluded Entities." (h) Section 1.01 [CERTAIN DEFINITIONS] shall be amended by deleting in its entirety the definition of "Intercompany Indebtedness" and inserting in lieu thereof, the following: "Intercompany Indebtedness shall mean, for periods prior to the Spin-Off Consummation, all Indebtedness of NovaCare or any of its Subsidiaries, as maker, to NovaCare or any other Subsidiary, as holder, and for periods on or after the Spin-Off Consummation, all Indebtedness of NovaCare or any of its Subsidiaries (other than NovaCare PEO), as maker, to NovaCare or any other Subsidiary, as holder. It is expressly agreed that for periods on or after the Spin-Off Consummation, neither NovaCare nor any Subsidiary of NovaCare shall make any loans or advances to NovaCare PEO." -8- 9 (i) Section 1.01 [CERTAIN DEFINITIONS] shall be amended by deleting clause (C) of the definition of "Minimum Net Worth Requirement" and inserting in lieu thereof, the following new clause (C): "(C) for any period of determination from July 1, 1996 and thereafter, the sum of the amounts under the following clauses (i), (ii), (iii) and (iv) reduced by the amount under the following clause (v): (i) the amount determined under the preceding clause (B) as of June 30, 1996, plus (ii) seventy-five percent (75%) of Consolidated Net Income of NovaCare and its Subsidiaries (other than, for periods on and after the Spin-Off Consummation, the portion of Consolidated Net Income attributable to NovaCare PEO) for each fiscal quarter in which net income was earned (as opposed to a net loss), plus (iii) to the extent not included in Consolidated Net Income in the preceding clause (ii), one hundred percent (100%) of federal and state income tax refunds (collectively the "Tax Refunds") received by NovaCare or a Subsidiary of NovaCare (other than, for periods on and after the Spin-Off Consummation, federal and state tax refunds attributable to NovaCare PEO) during the period of determination relating to the sale by them of their rehabilitation hospitals during the fiscal year ended June 30, 1995, plus (iv) the proceeds received by NovaCare in connection with the sale of shares of its capital stock after deducting any expenses associated with any sale including proceeds from conversion of the Subordinated Debentures, during the period from July 1, 1996 through (and including) the date of determination, minus (v) the cash purchase price of common stock of NovaCare repurchased by NovaCare during the period of determination, up to an aggregate maximum amount for the repurchase of such common stock of $70,000,000 plus the portion of the Tax Refunds used to repurchase such common stock, for all periods after July 1, 1995." (j) Section 1.01 [CERTAIN DEFINITIONS] shall be amended by inserting after the definition of Notes, the following new definition of "NovaCare PEO": "NovaCare PEO shall mean NovaCare Employee Services, Inc., a corporation organized and existing under the laws of the State of Delaware." (k) Section 1.01 [CERTAIN DEFINITIONS] shall be amended by deleting the definition of "Permitted Investment in Excluded Entities" in its entirety and inserting, in lieu thereof, the following: "Permitted Investment in Excluded Entities shall mean Restricted Investments in Excluded Entities which do not exceed in the aggregate $50,000,000 for all Excluded Entities or the following amount as to any individual Excluded Entity: (i) $5,000,000, in the case of a Restricted Investment in an Excluded Entity which is a Minority Subsidiary; (ii) $10,000,000, in the case of a Restricted Investment in an Excluded Entity which is a Subsidiary; (iii) $1,000,000, in the case of a Restricted Investment in either an Unaffiliated Managed Company or an entity which is neither a Subsidiary nor a Minority Subsidiary, and (iv) for periods on and after the Spin-Off Consummation, $0, in the case of any Restricted Investment in NovaCare PEO. In addition, the aggregate Restricted Investments in Excluded Entities of the type described in clause (iii) of the preceding sentence shall not exceed $5,000,000. Notwithstanding anything in this Agreement to the contrary, for periods on and after the Spin-Off -9- 10 Consummation, no Restricted Investments shall be made by NovaCare or any Subsidiary of NovaCare in NovaCare PEO." (l) Section 1.01 [CERTAIN DEFINITIONS] shall be amended by deleting the definition of "Permitted Line of Business" in its entirety and inserting, in lieu thereof, the following: "Permitted Line of Business shall mean, for the period commencing on the Closing Date through the Sixth Amendment Effective Date, the Existing Lines of Business; for the period commencing on the Sixth Amendment Effective Date through but not including the date of the Spin-Off Consummation, the business substantially engaged in by NovaCare and its Subsidiaries on the Sixth Amendment Effective Date, rehabilitation and subacute care management and consulting businesses, the ownership and operation of physician practice groups specializing in occupational medicine and the ownership and operation of Professional Employment Organizations; and for periods from and after the Spin-Off Consummation, the business substantially engaged in by NovaCare and its Subsidiaries on the Sixth Amendment Effective Date, rehabilitation and subacute care management and consulting businesses and the ownership and operation of physician practice groups specializing in occupational medicine." (m) Section 1.01 [CERTAIN DEFINITIONS] shall be amended to include the following new definitions of "Spin-Off" and "Spin-Off Consummation," which shall be inserted between the definition of "Solvent" and the definition of "Subordinated Debentures," as follows: "Spin-Off shall mean that certain transaction pursuant to which the following shall have occurred: (i) NovaCare shall have either completed a spin-off of a percentage of its ownership interests in, or, caused the issuance, through an initial public offering of stock, of additional shares of capital stock of NovaCare PEO and as a result of such transaction, NovaCare, after giving effect thereto, owned at least 70% of all of the issued and outstanding equity interests of NovaCare PEO, (ii) the aggregate proceeds to NovaCare or NovaCare PEO (in either case, net of all reasonable and customary transaction fees and costs and all federal, state and local income taxes in connection therewith) were at least equal to the amount necessary to repay all indebtedness of NovaCare PEO to NovaCare, including all accrued interest thereon, as of the Spin-Off Consummation, and (iii) a portion of such proceeds were used to repay all outstanding Indebtedness together with accrued interest thereon, of NovaCare PEO to NovaCare. Spin-Off Consummation shall mean the date of the consummation of the Spin-Off in accordance with and subject to the satisfaction of all of the terms and conditions to the effectiveness of the Tenth Amendment." (n) Section 1.01 [CERTAIN DEFINITIONS] shall be amended to include the following new definition of "Tenth Amendment" which shall be inserted between the definition of "Subsidiary Shares" and the definition of "Termination Date" as follows: "Tenth Amendment shall mean that certain tenth amendment to this Agreement which is dated as of March 31, 1997 and which is effective as provided therein." -10- 11 (o) Section 2.08 [USE OF PROCEEDS], shall be amended and restated in its entirety to read as follows: "2.08 Use of Proceeds. The proceeds of the Revolving Credit Loans shall be used by the Borrowers only for: (i) Permitted Acquisitions and the refinancing of Indebtedness assumed in connection therewith , (ii) the development of health care related businesses and facilities and for periods prior to the Spin-Off Consummation, Professional Employment Organizations, each as permitted under this Agreement, and (iii) general corporate purposes, provided, however, that no portion of the Revolving Credit Loans shall be used directly or indirectly for the purpose of repaying or redeeming the Subordinated Debentures." (p)(i) Section 8.01 (m) [CERTIFICATE OF BORROWERS; OTHER REPORTS AND INFORMATION] is hereby amended by adding the following sentence at the end of clause (i) [QUARTERLY FINANCIAL STATEMENTS]: "Notwithstanding anything contained herein to the contrary, for periods on and after the Spin-Off Consummation, the quarterly financial statements of NovaCare and its consolidated Subsidiaries required to be prepared and delivered in accordance with this Section 8.01 (m)(i) shall be prepared on a consolidated basis in accordance with GAAP but without regard to NovaCare PEO." (p)(ii) Section 8.01(m) [CERTIFICATE OF BORROWERS; OTHER REPORTS AND INFORMATION] shall also be amended by adding the following sentence at the end of clause (ii) [ANNUAL FINANCIAL STATEMENTS]: "Notwithstanding anything contained herein to the contrary, for periods on and after the Spin-Off Consummation, the annual financial statements of NovaCare and its consolidated Subsidiaries required to be prepared and delivered in accordance with this Section 8.01 (m)(ii) shall be prepared on a consolidated basis in accordance with GAAP but without regard to NovaCare PEO." (q) Section 8.02(a) [INDEBTEDNESS.] is hereby amended by deleting clause (vii) in its entirety and inserting the following new clause (vii), in lieu thereof: "(vii) Permitted Intercompany Indebtedness, provided, however, that for periods on or after the Spin-Off Consummation, neither NovaCare nor any Subsidiary of NovaCare shall make any loans or advances to NovaCare PEO." (r) Section 8.02 (d) [LIQUIDATIONS, MERGERS, CONSOLIDATIONS, ACQUISITIONS.], shall be amended and restated in its entirety to read as follows: "(d) Liquidations, Mergers, Consolidations, Acquisitions. Each of the Loan Parties shall not, and shall not permit any of its Subsidiaries (other than NovaCare PEO for any period after the Spin-Off Consummation) to, dissolve, liquidate or wind-up its affairs, or become a party to any merger or consolidation, or acquire by purchase, lease or otherwise all or -11- 12 substantially all of the assets or capital stock or other ownership interests of any other person, provided that (i) any wholly-owned Subsidiary of NovaCare may consolidate or merge into another Loan Party which is wholly-owned by one or more of the other Loan Parties, and (ii) any Loan Party may acquire, whether by purchase or by merger, (A) all of the ownership interests of another Person or (B) substantially all of the assets of another Person or of a business or division of another Person (each a "Permitted Acquisition"), provided that each of the following requirements is met: (a) such Person shall be a corporation, limited liability company or other entity with respect to applicable state law provided that the owners of all stock or other ownership interests in such entity shall not be liable for any obligations of such entity or for the claims of any creditors thereof, (b) if the Loan Parties are acquiring the ownership interests in such Person, such Person shall join this Agreement as a Borrower or a Guarantor pursuant to Section 11.18 hereof and the owners of such acquired Person shall grant Liens in the stock or other ownership interests in such Person and otherwise comply with Section 11.18 on or before the date of such Permitted Acquisition, (c) the board of directors or other equivalent governing body of such Person shall have approved such Permitted Acquisition, (d) the business acquired, or the business conducted by the Person whose ownership interests are being acquired, as applicable, shall be a Permitted Line of Business, (e) no Potential Default or Event of Default shall exist immediately prior to and after giving effect to such Permitted Acquisition, (f) after giving effect to such Permitted Acquisition there shall be Available Revolving Credit Commitments of at least Five Million Dollars ($5,000,000), and (g) the Consideration paid by the Loan Parties for each Permitted Acquisition shall not exceed Thirty Million Dollars ($30,000,000), and after giving effect to such Permitted Acquisition, the Consideration paid by the Loan Parties for all Permitted Acquisitions made during the current fiscal year of the Loan Parties shall not exceed One Hundred Fifty Million Dollars ($150,000,000) (the "Annual Permitted Acquisition Amount") provided that in no event shall the portion of the Annual Permitted Acquisition Amount utilized to make Permitted Acquisitions of physician practices in the specialty of occupational medicine exceed Forty Million Dollars ($40,000,000) in any fiscal year and in no event shall the portion of the Annual Permitted Acquisition Amount utilized to make Permitted Acquisitions of Professional Employment Organizations in any fiscal year prior to the fiscal year during which the Spin-Off -12- 13 Consummation occurs exceed Forty Five Million Dollars ($45,000,000). Notwithstanding anything in this Agreement to the contrary, for periods on or after the Spin-Off Consummation, no portion of the Annual Permitted Acquisition Amount shall be utilized to make Permitted Acquisitions of Professional Employment Organizations." (s) Section 8.02 (e) [DISPOSITIONS OF ASSETS OR SUBSIDIARIES.], shall be amended and restated in its entirety to read as follows: "(e) Dispositions of Assets or Subsidiaries. Each Loan Party shall not sell, convey, assign, lease, abandon or otherwise transfer or dispose of, voluntarily or involuntarily, any of its properties or assets, tangible or intangible (including but not limited to sale, assignment, discount or other disposition of accounts, contract rights, chattel paper, equipment or general intangibles with or without recourse or of capital stock, shares of beneficial interest or partnership interests of a Subsidiary), except transactions involving (i) any sale, abandonment, transfer or lease of assets in the ordinary course of business which are no longer necessary or required in the conduct of such Loan Party's business; (ii) any sale, transfer, abandonment or lease of assets by any Loan Party which is a wholly owned Subsidiary of NovaCare to NovaCare or any other Loan Party which is a wholly owned Subsidiary of NovaCare; (iii) any sale, abandonment, transfer or lease of assets in the ordinary course of business which are replaced by substitute assets; or (iv) a sale of assets provided that the sum of the Sale Price received from such sale and from all prior sales permitted under this clause (iv) (but without regard to the Sale Price received in connection with the Spin-Off) does not exceed 5% of Consolidated Net Worth as of the end of the fiscal quarter of NovaCare preceding the date of such sale and provided that the Loan Parties deliver to the Banks evidence of compliance with this clause (iv) before making such sale." (t)(i) Section 8.02(i) [LOANS AND INVESTMENTS], clause (iv) shall be deleted in its entirety, and the following clause (iv) shall be inserted in lieu thereof: "(iv) Permitted Intercompany Indebtedness, and Investments by the Loan Parties in other Loan Parties; provided, however, that for periods on or after the Spin-Off Consummation, neither NovaCare nor any Subsidiary of NovaCare shall make any loans or advances to or investments in NovaCare PEO; and" (t)(ii) Section 8.02 (i) [LOANS AND INVESTMENTS], shall also be amended by adding the following sentence after the last sentence of clause (v) thereof: "Notwithstanding anything contained in this Section 8.02(i) to the contrary, neither NovaCare nor any other Loan Party shall at any time on or after the Spin-Off Consummation make any loan or advance to, purchase, acquire or own any stock, bonds, notes or securities of, or any other investment or interest in, or make any capital contribution to, or agree, become or remain liable to do any of the foregoing with respect to NovaCare PEO, other than the continued ownership of NovaCare's equity interest of common stock of NovaCare PEO as owned as of the Spin-Off Consummation." -13- 14 (u) Section 8.02(k) [MINIMUM CURRENT RATIO], shall be amended by adding the following sentence after the table set forth in such Section: "For periods on and after the Spin-Off Consummation, for purposes solely of this Section 8.02(k), NovaCare PEO shall not be deemed to be a Subsidiary of NovaCare for purposes of calculating the ratio set forth above, and the current assets and current liabilities of NovaCare PEO shall be excluded from calculation of such ratio." (v) Section 11.18 [JOINDER OF LOAN PARTIES.], clause (i) shall be amended by adding the following sentence after the last sentence thereof; "Notwithstanding the provisions of this Section 11.18(i) to the contrary, for periods after the Spin-Off Consummation, NovaCare PEO shall not be required to join this Agreement as a Guarantor or Borrower, and further, following the Spin-Off Consummation, any equity interests of NovaCare PEO owned by NovaCare or any Subsidiary of NovaCare shall not be required to be pledged to the Agent for the benefit of the Banks." (w) Schedule 1.01(E) [EXCLUDED ENTITIES] to the Credit Agreement shall be amended and restated in its entirety in the form of such Schedule attached hereto, for the purpose of including the Spin-Off Entity as an Excluded Entity. (x) Exhibit 8.01(m)(iii) [COMPLIANCE CERTIFICATE] to the Credit Agreement shall be amended and restated in its entirety in the form of such Exhibit attached hereto. 4. Conditions of Effectiveness. The effectiveness of the Amendment and Consent set forth in this Part II, Sections 1, 2 and 3 is expressly conditioned upon the occurrence and completion of all of the following to the satisfaction of the Agent, in its sole discretion: (i) the Agent's receipt of counterparts of this Amendment duly executed by the Borrowers, the Guarantors and all of the Banks; (ii) NovaCare's and/or the Spin-Off Entity's receipt, in the aggregate, of proceeds as a result of the Spin-Off, net of all reasonable and customary transaction fees and costs and net of federal, state and local income taxes in connection with the Spin-Off in an amount at least equal to the amount necessary to repay all indebtedness of the Spin-Off Entity to NovaCare, including all accrued interest thereon, as of the date of consummation of the Spin-Off; (iii) a portion of the proceeds of the Spin-Off shall be used, on the date of the consummation of the Spin-Off, by the Spin-Off Entity to repay all of the outstanding Indebtedness of the Spin-Off Entity to NovaCare, together with accrued interest thereon; (iv) the Spin-Off shall have occurred on or before September 30, 1997; (v) after giving effect to the Spin-Off, NovaCare shall own at least 70% of all of the issued and outstanding equity interests of the Spin-Off Entity; (vi) NovaCare shall have delivered to the Agent copies of all Spin-Off Documents prior to the consummation of the Spin-Off, which shall all be in form and substance satisfactory to the Agent, the Spin-Off shall have been consummated in accordance with the Spin-Off Documents and the President, Chief Executive Officer or Chief Financial Officer of NovaCare shall have delivered to the Agent a Certificate certifying the consummation of the Spin-Off in accordance with the Spin-Off Documents and attaching a true and complete copy of the Spin-Off Documents, as certified by such officer; (vii) the Agent's receipt of a certificate signed by the President, Chief Executive Officer or Chief Financial Officer -14- 15 of the Borrowers and Guarantors, certifying as to all action taken by the Borrowers and Guarantors to authorize the execution, delivery and performance of the Spin-Off and this Amendment and that all conditions to the effectiveness of this Amendment have been met; and (viii) the Agent's receipt of an opinion of Peter D. Bewley, General Counsel of the Loan Parties reasonably satisfactory to the Agent [including without limitation customary opinions regarding with respect to the Spin-Off the compliance with all securities laws, including 10b(5) and a Prior Security Interest of remaining stock by NovaCare after the Spin-Off.] Further, the representations and warranties of the Loan Parties contained in Article VI of the Credit Agreement shall be true and accurate on the date hereof with the same effect as though such representations and warranties had been made on and as of such date (except representations and warranties which relate solely to an earlier date or time, which representations and warranties shall be true and correct on and as of the specific dates or times referred to therein), the Loan Parties shall have performed and complied with all covenants and conditions contained herein and in the Loan Documents; no Event of Default or Potential Default under the Credit Agreement shall have occurred and be continuing or shall exist and there shall be delivered to the Agent for the benefit of each Bank a certificate of the President, Chief Executive Officer or Chief Financial Officer of the Loan Parties dated as of the date hereof certifying as to each of the foregoing. PART III: MISCELLANEOUS 1. Effective Date of Waiver. This Amendment shall be dated as of the date and year first above written, provided, however that the provisions of Part I hereof shall be effective only upon the satisfaction of all Conditions of Effectiveness set forth in Part I, Section 4 hereof and provided further that the provisions of Part II hereof shall be effective only upon the satisfaction of all Conditions of Effectiveness set forth in Part II, Section 4 hereof. 2. Full Force and Effect. Except as expressly modified and amended by this Amendment, the Credit Agreement and the other Loan Documents are hereby ratified and confirmed and shall remain in full force and effect. 3. Costs, Expenses, Disbursements. The Borrowers hereby agree to reimburse the Agent and the Banks on demand for all costs, expenses and disbursements relating to this Amendment which are payable by the Borrowers as provided in Section 10.05 of the Credit Agreement. 4. Counterparts. This Amendment may be executed by different parties hereto in any number of separate counterparts, each of which, when so executed and delivered, shall be an original, and all of such counterparts shall together constitute one and the same instrument. -15- 16 5. Governing Law. This Amendment shall be deemed to be a contract under the laws of the Commonwealth of Pennsylvania and for all purposes shall be governed by and construed and enforced in accordance with the internal laws of the Commonwealth of Pennsylvania without regard to its conflict of laws principles. -16- 17 [Signature Page 1 of 6 to Tenth Amendment, Waiver and Consent] IN WITNESS WHEREOF, the parties hereto, by their officers thereunto duly authorized, have executed this Amendment as of the day and year first above written. BORROWERS AND GUARANTORS: ATTEST: NOVACARE, INC., a Delaware corporation, and each of the other BORROWERS listed on Schedule 6.01(c) of the Credit Agreement (which Schedule is attached hereto as Exhibit I) and each of the GUARANTORS listed on Schedule 6.01(c) of the Credit Agreement (which Schedule is attached hereto as Exhibit I), other than those listed below By: /s/ Peter D. Bewley By: /s/ Richard A. McDonald ---------------------------- --------------------------------- Richard A. McDonald -------------------------------[Name], [Seal] the Vice President ---------------------------[Title] of each Borrower and Guarantor listed on Schedule 6.01(c) of the Credit Agreement (which Schedule is attached hereto as Exhibit I), other than those listed below, which is a corporation and of each general partner of each Borrower and Guarantor which is a partnership Address for Notices for each of the foregoing Borrowers and Guarantors: 1016 West Ninth Avenue King of Prussia, PA 19406 Telecopier No. (610) 992-3328 Attention: Chief Financial Officer Telephone No. (610) 992-7200 18 [Signature Page 2 of 6 to Tenth Amendment, Waiver and Consent] AGENT: PNC BANK, NATIONAL ASSOCIATION, as Agent By: /s/ Marcie D. Knittel --------------------------------- Title: Vice President Address for Notices: One PNC Plaza Fifth Avenue and Wood Street Pittsburgh, PA 15265 Telecopier No. (412) 762-2784 Attention: Regional Healthcare Group Telephone No. (412) 762-8343 BANKS: PNC BANK, NATIONAL ASSOCIATION By: /s/ Marcie D. Knittel ---------------------------- Title: Vice President Address for Notices: One PNC Plaza Fifth Avenue and Wood Street Pittsburgh, PA 15265 Telecopier No. (412) 762-2784 Attention: Regional Healthcare Group Telephone No. (412) 762-8343 19 [Signature Page 3 of 6 to Tenth Amendment, Waiver and Consent] CORESTATES BANK, N.A. By: /s/ Jennifer W. Leibowitz _____________________________________ Name: Jennifer W. Leibowitz Title: Vice President Address for Notices: 1339 Chestnut Street P.O. Box 7618 FC 1-8-3-22 Philadelphia, PA 19101 Telecopier No. (215) 973-2738 Attention: Jennifer W. Leibowitz Assistant Vice President Telephone No. (215) 786-3972 FIRST UNION NATIONAL BANK OF NORTH CAROLINA By: /s/ Ann M. Dodd _____________________________________ Name: Ann M. Dodd Title: Senior Vice President Address for Notices: One First Union Center 301 S. Giles Street Charlotte, NC 28288-0735 Telecopier No. (704) 383-9144 Attention: Terence Moore Assistant Vice President Telephone No. (704) 383-5212 20 [Signature Page 4 of 6 to Tenth Amendment, Waiver and Consent] FLEET NATIONAL BANK By: /s/ Maryann S. Smith -------------------------------- Name: Maryann S. Smith Title: Vice President Address for Notices: Health Care and Non Profit Group Fleet Center MA BOF 04A 75 State Street Boston, MA 02109-1810 Telecopier No. (617) 346-0610 Attention: Maryann S. Smith Vice President Telephone No. (617) 346-1594 MELLON BANK, N.A. By: /s/ Colleen M. Cunniffer -------------------------------- Name: Colleen M. Cunniffer Title: Address for Notices: Healthcare Banking Plymouth Meeting/Exec. Campus 610 W. Germantown Pike Suite 200/AIM #19E-0246 Plymouth Meeting, PA 19462 Telecopier No. (610) 941-4136 Attention: Colleen M. Cunniffer Vice President Telephone No. 610-941-8426 21 [Signature Page 5 of 6 to Tenth Amendment, Waiver and Consent] NATIONSBANK, N.A. By: /s/ Kevin Wagley ------------------------------------ Name: Kevin Wagley Title: Vice President Address for Notices: One NationsBank Plaza Fifth Floor Nashville, TN 37239-1697 Telecopier No. (615) 749-4646 Attention: S. Walker Choppin Sr. Vice President Telephone No. (615) 749-3607 THE BANK OF NEW YORK By: /s/ Peter H. Abdill ----------------------------------- Name: Peter H. Abdill Title: Vice President Address for Notices: Northeastern Division One Wall Street 22nd Floor New York, NY 10286 Telecopier No. (212) 635-6999 Attention: Peter Abdill Vice President Telephone No. (212) 635-6987 22 [Signature Page 6 of 6 to Tenth Amendment, Waiver and Consent] SUNTRUST BANK, CENTRAL FLORIDA, N.A. By: /s/ Jorge Arrieta ------------------------------------ Name: Jorge Arrieta Title: Vice President Address for Notices: Healthcare Banking Group 0-1106, Tower 10 200 South Orange Avenue Orlando, FL 32801 Telecopier No. (407) 237-2491 Attention: Jeffrey R. Dickson First Vice President Telephone No. (407) 237-4541 23 STATE OF GEORGIA COUNTY OF FULTON On the 25th day of April, 1997 personally appeared Jorge Arrieta, as the Vice President of SunTrust Bank, Central Florida, National Association, and before me executed the attached Tenth Amendment Waiver and Consent dated as of _____________, 1997 to the Credit Agreement between NovaCare, Inc., with SunTrust Bank, Central Florida, National Association, as Lender. IN WITNESS WHEREOF, I have hereunto set my hand and official seal, in the state and county aforesaid. /s/ _______________________________________________ Signature of Notary Public, State of Georgia Notary Public, Clayton County, Georgia My Commission Expires November 1, 1998 (Print, Type or Stamp Commissioned Name of Notary Public) Personally known X ; ____ OR Produced Identification ____________________ Type of identification produced:_______________ _______________________________________________ 24 EXHIBIT 1 PART A - Acquisitions made during fiscal quarter ended March 31, 1997 (See attached) PART B - Acquisitions to be made during fiscal quarter ended June 30, 1997 (See attached) EX-10.(J)(XII) 8 REVOLVING CREDIT FACILITY AGREEMENT ELEVENTH AMEND 1 EXHIBIT 10(j)(xii) NOVACARE, INC. 1016 WEST NINTH AVENUE KING OF PRUSSIA, PA 19406 June 27, 1997 PNC Bank, National Association, as Agent One PNC Plaza Fifth Avenue and Wood Street Pittsburgh, PA 15265 Attn: Marcie Knittel, Vice President RE: Eleventh Amendment to Credit Agreement (the "Eleventh Amendment") Dear Marcie: We refer to that certain Credit Agreement, dated as of May 27, 1994, as amended (the "Credit Agreement"), by and among NovaCare, Inc. ("NovaCare") and certain of its Subsidiaries, the Banks party thereto and PNC Bank, National Association, as agent for the Banks ("Agent"). Defined terms used herein, not otherwise defined herein, shall have the meanings given to them under the Credit Agreement as amended hereby. The Borrowers and Guarantors, the Banks and the Agent hereby desire to amend the Credit Agreement, as hereinafter provided. The parties hereto in consideration of their mutual covenants and agreements hereinafter set forth, and intending to be legally bound hereby, covenant and agree as follows: AGREEMENT 1. Amendment of Credit Agreement The parties hereto do hereby modify and amend the Credit Agreement as follows: (a) Cover page is hereby amended by deleting in line 1 the number "$175,000,000" and inserting in lieu thereof the number "190,000,000". (b) Recital paragraph 1, page 1, is hereby amended by deleting in line 3 the number "$175,000,000" and inserting in lieu thereof the number "$190,000,000". 2 (c) Upon the effectiveness of this Eleventh Amendment and for periods subsequent to such effective date, Bank One, Kentucky, NA ("Bank One") shall be a Bank party to the Credit Agreement. 2. Amendment to Schedules. (a) Schedules. Schedule 1.01(B) [List of Banks, Commitments and Closing Fees] and Schedule 6.01(c) [Subsidiaries] to the Agreement are hereby amended and restated in their entirety in the form of such Schedules attached hereto as Exhibit I and Exhibit II respectively. 3. Conditions of Effectiveness. The effectiveness of this Eleventh Amendment is expressly conditioned upon the occurrence and completion of all of the following: (i) the Agent's receipt of counterparts of this Eleventh Amendment duly executed by the Borrowers, the Guarantors and the Banks; (ii) the Agent's receipt of a certificate signed by the Secretary or Assistant Secretary of the Borrowers and Guarantors, certifying as to all action taken by the Borrowers and Guarantors to authorize the execution, delivery and performance of this Eleventh Amendment; (iii) the Agent's receipt of a Confirmation of Guaranty duly executed by the Guarantors in the form of Exhibit III attached hereto; (iv) an opinion of Peter D. Bewley, General Counsel of the Loan Parties reasonably satisfactory to the Agent regarding this Eleventh Amendment; and (iv) each Borrower shall have delivered to the Agent on behalf of Bank One a Note in the amount of Bank One's Commitment. This Eleventh Amendment shall be dated as of and shall be effective as of the date and year first above written which shall be the date of satisfaction of all conditions precedent to effectiveness as set forth in this Section 3. 4. Consent of All Banks. Pursuant to Section 11.01(b) of the Credit Agreement, this Eleventh Amendment shall require the written consent of all of the Banks. 5. Full Force and Effect. Except as expressly modified and amended by this Eleventh Amendment, the Credit Agreement and the other Loan Documents are hereby ratified and confirmed and shall remain in full force and effect. -2- 3 6. Costs, Expenses, Disbursements. The Borrowers hereby agree to reimburse the Agent and the Banks on demand for all costs, expenses and disbursements relating to this Eleventh Amendment which are payable by the Borrowers as provided in Section 10.05 of the Credit Agreement. 7. Counterparts. This Eleventh Amendment may be executed by different parties hereto in any number of separate counterparts, each of which, when so executed and delivered, shall be an original, and all of such counterparts shall together constitute one and the same instrument. 8. Governing Law. This Eleventh Amendment shall be deemed to be a contract under the laws of the Commonwealth of Pennsylvania and for all purposes shall be governed by and construed and enforced in accordance with the internal laws of the Commonwealth of Pennsylvania without regard to its conflict of laws principles. [INTENTIONALLY BLANK] -3- 4 [Signature Page 1 of 6 to Eleventh Amendment, Waiver and Consent] IN WITNESS WHEREOF, the parties hereto, by their officers thereunto duly authorized, have executed this Amendment as of the day and year first above written. BORROWERS AND GUARANTORS: ATTEST: NOVACARE, INC., a Delaware corporation, and each of the other BORROWERS listed on Schedule 6.01(c) of the Credit Agreement (which Schedule is attached hereto as Exhibit II) and each of the GUARANTORS listed on Schedule 6.01(c) of the Credit Agreement (which Schedule is attached hereto as Exhibit II), other than those listed below By: /s/ Peter D. Bewley By: /s/ Richard A. McDonald --------------------------- ------------------------------ Richard A. McDonald [Name], ------------------------------ [Seal] the Vice President [Title] ------------------------------ of each Borrower and Guarantor listed on Schedule 6.01(c) of the Credit Agreement (which Schedule is attached hereto as Exhibit II), other than those listed below, which is a corporation and of each general partner of each Borrower and Guarantor which is a partnership Address for Notices for each of the foregoing Borrowers and Guarantors: 1016 West Ninth Avenue King of Prussia, PA 19406 Telecopier No. (610) 992-3328 Attention: Chief Financial Officer Telephone No. (610) 992-7200 5 [Signature Page 2 of 6 to Eleventh Amendment, Waiver and Consent] AGENT: PNC BANK, NATIONAL ASSOCIATION, as Agent By: /s/ Marcie D. Knittel _____________________________________ Title: V.P. Address for Notices: One PNC Plaza Fifth Avenue and Wood Street Pittsburgh, PA 15265 Telecopier No. (412) 762-2784 Attention: Regional Healthcare Group Telephone No. (412) 762-8343 BANKS: PNC BANK, NATIONAL ASSOCIATION By: /s/ Marcie D. Knittel _____________________________________ Title: V.P. Address for Notices: One PNC Plaza Fifth Avenue and Wood Street Pittsburgh, PA 15265 Telecopier No. (412) 762-2784 Attention: Regional Healthcare Group Telephone No. (412) 762-8343 6 [Signature Page 3 of 6 to Eleventh Amendment, Waiver and Consent] CORESTATES BANK, N.A. By: /s/ Lisa S. Rothenberger ___________________________________ Name: Lisa S. Rothenberger Title: Commercial Officer Address for Notices: 1339 Chestnut Street P.O. Box 7618 FC 1-8-3-22 Philadelphia, PA 19101 Telecopier No. (215) 973-2738 Attention: Jennifer W. Leibowitz Assistant Vice President Telephone No. (215) 786-3972 FIRST UNION NATIONAL BANK OF NORTH CAROLINA By: /s/ Joseph H. Towell _____________________________________ Name: Joseph H. Towell Title: Senior Vice President Address for Notices: One First Union Center 301 S. Giles Street Charlotte, NC 28288-0735 Telecopier No. (704) 383-9144 Attention: Terence Moore Assistant Vice President Telephone No. (704) 383-5212 7 [Signature Page 4 of 6 to Eleventh Amendment, Waiver and Consent] FLEET NATIONAL BANK By: /s/ Maryann S. Smith ------------------------------------- Name: Maryann S. Smith Title: Vice President Address for Notices: Health Care and Non Profit Group Fleet Center MA BOF 04A 75 State Street Boston, MA 02109-1810 Telecopier No. (617) 346-0610 Attention: Maryann S. Smith Vice President Telephone No. (617) 346-1594 MELLON BANK, N.A. By: /s/ Colleen Cunniffee ------------------------------------- Name: Colleen Cunniffee Title: Banking Officer Address for Notices: Healthcare Banking Plymouth Meeting/Exec. Campus 610 W. Germantown Pike Suite 200/AIM #19E-0246 Plymouth Meeting, PA 19462 Telecopier No. (610) 941-4136 Attention: Colleen Cunniffee Banking Officer Telephone No. (610) 941-8426 8 [Signature Page 5 of 6 to Eleventh Amendment, Waiver and Consent] NATIONSBANK, N.A. By: /s/ Kevin Wagley ------------------------------------- Name: Kevin Wagley Title: Vice President Address for Notices: Healthcare Finance Group One NationsBank Plaza Fifth Floor Nashville, TN 37239-1697 Telecopier No. (615) 749-4640 Attention: Kevin Wagley Vice President Telephone No. (615) 749-3802 THE BANK OF NEW YORK By: /s/ Peter H. Abdill ------------------------------------- Name: Peter H. Abdill Title: Vice President Address for Notices: Northeastern Division One Wall Street 22nd Floor New York, NY 10286 Telecopier No. (212) 635-6999 Attention: Peter Abdill Vice President Telephone No. (212) 635-6987 9 [Signature Page 6 of 6 to Eleventh Amendment, Waiver and Consent] SUNTRUST BANK, CENTRAL FLORIDA, N.A. By: /s/ Ronald K. Rueve ------------------------------------ Name: Ronald K. Rueve Title: Vice President Address for Notices: Healthcare Banking Group 0-1106, Tower 10 200 South Orange Avenue Orlando, FL 32801 Telecopier No. (407) 237-2491 Attention: Jeffrey R. Dickson First Vice President Telephone No. (407) 237-4541 BANK ONE, KENTUCKY, NA By: /s/ Todd D. Munson ------------------------------------ Name: Todd D. Munson Title: Sr. V.P. Address for Notices: Internal Zip KY1-2216 416 West Jefferson Street Louisville, KY 40202 Telecopier No. (502) 566-2367 Attention: Todd Munson Sr. Vice President Telephone No. (502) 566-2640 10 STATE OF GEORGIA COUNTY OF FULTON On the _____ day of ___________, 1997 personally appeared ___________________, as the __________ President of SunTrust Bank, Central Florida, National Association, and before me executed the attached Eleventh Amendment Waiver and Consent dated as of _____________, 1997 to the Credit Agreement between NovaCare, Inc., with SunTrust Bank, Central Florida, National Association, as Lender. IN WITNESS WHEREOF, I have hereunto set my hand and official seal, in the state and county aforesaid. /s/ Tonya Adams Signature of Notary Public, State of Notary Public, Coweta County, Georgia My Commission Expires May 6, 2001 Tonya Adams Personally known X; --- OR Produced Identification Type of identification produced:________________ ________________________________________________ 11 [EXHIBIT I TO ELEVENTH AMENDMENT] SCHEDULE 1.01(B) COMMITMENTS OF BANKS
Revolving Participation Credit Bank Percentage Commitment ---- ---------- ---------- PNC Bank, National Association 21.052631578 $ 40,000,000 Mellon Bank, N.A. 14.473684211 $ 27,500,000 NationsBank, N.A. 13.157894737 $ 25,000,000 CoreStates Bank, N.A. 10.526315790 $ 20,000,000 SunTrust Bank, Central Florida, N.A. 9.210526316 $ 17,500,000 Fleet National Bank 7.894736842 $ 15,000,000 First Union National Bank of North Carolina 7.894736842 $ 15,000,000 The Bank of New York 7.894736842 $ 15,000,000 Bank One, Kentucky, NA 7.894736842 $ 15,000,000 TOTAL 100.000000000% $190,000,000 ============== ============
EX-10.(K) 9 SUPPLEMENTAL BENEFITS PLAN AS AMENDED TO DATE 1 EXHIBIT 10(k) NCES/NOVACARE, INC. SUPPLEMENTAL BENEFITS PLAN This is the NCES/NOVACARE, INC. SUPPLEMENTAL BENEFITS PLAN (formerly known as the NovaCare, Inc. Supplemental Benefits Plan), as amended and restated effective July 1, 1997, maintained by NovaCare Employee Services, Inc. ("NCES"), NovaCare, Inc., a Delaware corporation ("NovaCare"), and certain of their affiliates which have adopted the Plan for their eligible senior executives constituting a select group of management or highly compensated employees. 2 TABLE OF CONTENTS Section Page SECTION 1 DEFINITIONS .................................................. 1 SECTION 2 PARTICIPATION IN THE PLAN .................................... 5 2.1 Commencement of Participation .............................. 5 2.2 Procedure For and Effect of Admission ...................... 6 2.3 Cessation of Participation ................................. 6 2.4 Transfer of Employee ....................................... 6 2.5 Cessation of Employer's Affiliate Status ................... 7 SECTION 3 PLAN CONTRIBUTIONS ........................................... 7 3.1 Deferral Contributions ..................................... 7 3.2 Rules Governing Deferral Contributions ..................... 8 3.3 Fixed Matching Contributions ............................... 8 3.4 Performance Matching Contributions ......................... 8 3.5 Vesting .................................................... 8 SECTION 4 PARTICIPANT ACCOUNTS ......................................... 10 4.1 Establishment of Accounts .................................. 10 4.2 Benefit Allocation ......................................... 10 4.3 Irrevocable Allocation ..................................... 10 4.4 Adjustment of Accounts ..................................... 10 4.5 Suballocation Within the Education Account ................. 11 4.6 Investment Obligation of the Employer ...................... 11 SECTION 5 BENEFITS ..................................................... 11 5.1 Employer Provided Insurance Benefits ....................... 11 5.2 Retirement Account ......................................... 12 5.3 Education Account .......................................... 14 5.4 Fixed Period Account ....................................... 15 5.5 Tax Withholding ............................................ 15 -i- 3 SECTION 6 ADMINISTRATION ............................................... 15 6.1 Appointment of Administrator ............................... 15 6.2 Administrator's Responsibilities ........................... 15 6.3 Records and Accounts ....................................... 16 6.4 Administrator's Specific Powers and Duties ................. 16 6.5 Employer's Responsibility to Administrator ................. 16 6.6 Liability .................................................. 16 6.7 Payment of Expenses ........................................ 17 6.8 Indemnity of Administrator ................................. 17 SECTION 7 CLAIMS PROCEDURE ............................................. 17 7.1 Claim ...................................................... 17 7.2 Review Procedure ........................................... 17 7.3 Final Decision ............................................. 18 SECTION 8 AMENDMENT AND TERMINATION .................................... 18 8.1 Plan Amendment ............................................. 18 8.2 No Premature Distribution .................................. 18 8.3 Termination of the Plan .................................... 18 SECTION 9 MISCELLANEOUS ................................................ 18 9.1 Supplemental Benefits ...................................... 18 9.2 Governing Law; Jurisdiction ................................ 19 9.3 No Assignment Permitted .................................... 19 9.4 Binding Terms .............................................. 19 9.5 Spendthrift Provision ...................................... 19 9.6 Headings ................................................... 19 9.7 Rule of Interpretation ..................................... 19 -ii- 4 SECTION 1 DEFINITIONS 1.1 Account means the recordkeeping source under which Plan benefits are calculated. The specific Accounts under the Plan are listed in Section 4.1. 1.2 Administrator means the individual or committee appointed to administer the Plan pursuant to Section 6. 1.3 Agreement means the trust agreement between the Employer and one or more trustees establishing a grantor trust to assist the Employer in fulfilling its obligations under the Plan. 1.4 Base Pay means an Eligible Employee's base salary, Deferral Contributions and any pretax elective deferrals to any Employer-sponsored plan that includes either a qualified cash or deferred arrangement under section 401(k) of the Code or a cafeteria plan under section 125 of the Code. 1.5 Beneficiary means the person, persons, trust or other entity that a Participant designates by written revocable designation filed with the Administrator to receive Plan benefits in the event of the Participant's death before all amounts due him under the Plan have been fully paid. A Participant may designate a different Beneficiary with respect to each Account established for him. 1.6 Boards means the Boards of Directors of NovaCare and NCES, or any person or persons designated by the Boards of Directors. 1.7 Bonus means any cash remuneration paid to an Eligible Employee as an incentive award pursuant to the bonus plan applicable to the Eligible Employee. Bonus may consist of Annual Bonus and/or Quarterly Bonus components. Annual Bonus means an incentive award based on performance criteria applicable to an entire fiscal year of the applicable Employer. Quarterly Bonus means an incentive award based on performance criteria applicable to the first, second, third or fourth quarter, on a stand-alone basis, of the fiscal year of the applicable Employer. 1.8 Change in Control means (other than an initial public offering) the occurrence of any of the following: A. the acquisition by any party or parties of the beneficial ownership of 20% or more of the outstanding voting shares of the Company; B. the occurrence of a transaction requiring shareholders' approval for the acquisition of the Company through purchase of stock or assets, or by merger or otherwise; or 5 C. the election during any 24-month period of 20%, or more, of the members of either of the Boards, without the approval of a majority of the members of such Board as constituted at the beginning of the period. 1.9 Code means the Internal Revenue Code of 1986, as amended. 1.10 Company means either NovaCare or NCES as the context requires. 1.11 Deferral Agreement means a written agreement between a Participant and the Employer whereby a Participant agrees to defer a portion of his Base Pay and/or Bonus and the Employer agrees to provide Plan benefits. 1.12 Deferral Contribution means a Participant's elective deferral contribution described in Section 3.1 1.13 Determination Date means March 31 and September 30 of each calendar year or such other date as the Administrator shall designate and, for each Participant, the date of his death, Retirement, termination of employment due to Disability or other termination of employment. 1.14 Disability means an illness or injury that meets the definition and provisions described in the Individual Long Term Disability Contract covering the Participants. 1.15 Effective Date means September 1, 1991. The effective date of this amendment and restatement is July 1, 1997. 1.16 Eligibility Dates. A. Eligibility Date, for making Elective Deferrals, means (i) the first day of the first payroll period of any month that begins at least 30 days, but no more than 120 days, after the date an individual first becomes an Eligible Employee, provided that the Eligible Employee must properly submit all necessary forms at least 15 days before such Eligibility Date and (ii) any other date following an Enrollment Period established by the Administrator; B. Eligibility Date, for receiving Fixed and, if any, Performance Matching Contributions, means the January 1 or July 1 following the Eligibility Date upon which the Participant begins to make Elective Deferrals; and -2- 6 C. Eligibility Date, for coverage for insurance benefits, means the January 1 or July 1 following the later of the initial date of hire of an individual who is an Eligible Employee as of that date, or the date an individual who is an employee of the Employer becomes an Eligible Employee. 1.17 Eligible Dependent means an individual who is a child, stepchild, grandchild, niece or nephew, or who otherwise qualifies as a dependent of a Participant for purposes of the Code, who is living at any time during the Enrollment Period, and who is either (i) younger than age 14 or (ii) younger than age 18 but for whom a subaccount was initially established pursuant to Section 4.5 prior to his reaching age 14. 1.18 Eligible Employee means each employee of the Employer who (i) has a Salary Grade of 33 or higher, (ii) is designated by the Administrator as an employee who would have a Salary Grade of 33 or higher (an "Equivalent Salary Grade") if the employee had a Salary Grade, (iii) was demoted during the preceding 12-month period into a lower-graded position from a position with a Salary Grade or Equivalent Salary Grade of 33 or higher, or (iv) was a Participant on July 1, 1994; provided that Eligible Employee shall not include any employee of NCES or any of its affiliates who also maintains an employee-employer relationship with a co-employer other than NovaCare or any of its affiliates. 1.19 Employer means NovaCare, NCES and each of their respective affiliates which have adopted the Plan for their eligible senior executives and joined in the Trust. 1.20 Enrollment Period means the election period established by the Administrator which ends prior to the first day of a Plan Year. 1.21 EPS Budget means, for any Plan Year up to and including the Plan Year beginning July 1, 1995 and ending June 30, 1996, the average of the percentages of the EPS Budgets achieved by NovaCare for that year and the four immediately preceding Plan Years. For the Plan Year beginning July 1, 1996, EPS Budget means the EPS Budget achieved by NovaCare for that year. For any Plan Year beginning on or after July 1, 1997, EPS Budget means the EPS Budget achieved by the applicable Company for that year. 1.22 Fixed Matching Contribution means the Employer contributions described in Section 3.3. 1.23 Group I Eligible Employee means each Eligible Employee who has a Salary Grade or Equivalent Salary Grade of 35 or higher, or who had such a Salary Grade or Equivalent Salary Grade immediately prior to a demotion which became effective during the previous 12-month period. -3- 7 1.24 Group II Eligible Employee means each Eligible Employee who has a Salary Grade or Equivalent Salary Grade of 33 or 34, or who had such a Salary Grade or Equivalent Salary Grade immediately prior to a demotion which became effective during the previous 12-month period. 1.25 Investment Fund or Fund means the investments referenced in Section 4.4 that serve as a means to measure value increases or decreases with respect to a Participant's Accounts. 1.26 Involuntary Termination means, solely for purposes of the Plan and the Agreement, the occurrence of any of the following: A. a termination of the Participant's employment by the Employer other than for serious, willful misconduct in respect of the employee's obligations to the Employer, which misconduct shall include but not be limited to conviction of a felony, or perpetration of a common law fraud which has or is likely to result in material economic damage to the Employer; or B. a termination of the Participant's employment by the Participant following: (1) a change by the Employer of the Participant's functions, duties or responsibilities which causes the Participant's position with the Employer to become of less dignity, responsibility, importance, scope or Salary Grade; (2) a reassignment by the Employer of the Participant to another geographic location more than 50 miles from the Participant's current place of residence; or (3) a reduction in the Participant's Total Compensation other than one occurring through reduction of the Participant's Bonus based on actual financial performance of the Employer. 1.27 NCES means NovaCare Employee Services, Inc., a Delaware corporation. 1.28 NovaCare means NovaCare, Inc., a Delaware Corporation. 1.29 Participant means any Eligible Employee who has elected to participate in the Plan and has reached an Eligibility Date. 1.30 Performance Matching Contribution means the Employer contributions described in Section 3.4. -4- 8 1.31 Plan means the NCES/NovaCare, Inc. Supplemental Benefits Plan as described in this instrument, as amended. 1.32 Plan Year means the 12 consecutive month period beginning on each July 1 and ending on the following June 30. 1.33 Retirement means a severance from service by a Participant for any reason (other than death or termination of employment due to Disability) after reaching age 65 or after reaching age 55 and completing 10 years of service with the Employer. A year of service shall mean a Year of Service as defined in the NCES/NovaCare, Inc. 401(k) Retirement Savings Plan; provided, however, that years of service shall include service with a prior employer if so provided in the applicable acquisition agreement or in any agreement executed by the Participant and the Employer. 1.34 Total Compensation for a Plan Year means the Eligible Employee's Base Pay for the current Plan Year plus any Bonus paid for services rendered in the Plan Year; provided that, in determining compensation for coverage for insurance benefits for any policy period, the Eligible Employee's Base Pay shall be determined as of January 15 (or, if later, the date an employee becomes an Eligible Employee) and, if actual Bonus is unknown as of such date, anticipated bonus, as determined under the applicable bonus plan, shall be substituted for actual Bonus. 1.35 Trust means any grantor trust established by the Employer under the Agreement. 1.36 Trustee means the trustee or trustees of the Trust appointed by the Boards. 1.37 Trust Fund means the fund established under the Agreement, consisting of all contributions, together with the income and realized and unrealized appreciation and depreciation thereon. SECTION 2 PARTICIPATION IN THE PLAN 2.1 Commencement of Participation. Each Eligible Employee may elect to become a Participant and to make Elective Deferrals beginning as of a date described in Section 1.16A. He then shall be eligible to receive Fixed and, if any, Performance Matching Contributions beginning as of the date described in Section 1.16B. Each Eligible Employee shall receive coverage for insurance benefits beginning as of the date described in Section 1.16C. -5- 9 Notwithstanding the foregoing or any provision in this Plan to the contrary: A. An Eligible Employee who does not meet the definition of Eligible Employee set forth in Section 1.18(i), (ii) or (iii) shall not be eligible to make Elective Deferrals or to receive Fixed and Performance Matching Contributions, but shall be considered a Group II Eligible Employee for purposes of Section 5.1; and B. An Eligible Employee who is hired or promoted into a position with a Salary Grade or Equivalent Salary Grade of 33 or higher after June 1, 1997 shall not be eligible to make Elective Deferrals or to receive Fixed and Performance Matching Contributions unless he executes a Confidentiality and Non-Competition Agreement in a form approved by the Administrator, but shall be considered a Group I or Group II Eligible Employee (depending upon his Salary Grade or Equivalent Salary Grade) for purposes of Section 5.1. 2.2 Procedure For and Effect of Admission. Each Eligible Employee who desires to participate in the Plan shall complete such forms and provide such data as are required by the Administrator. 2.3 Cessation of Participation. A Participant shall cease to be an active Participant on the earlier of: A. the date on which an Employer terminates the Plan as to employees of such Employer; B. the date on which the Participant ceases to be an Eligible Employee; or C. the date on which the Participant's Employer ceases to be an affiliate of the Company. As long as an Account is maintained for a former active Participant, he shall be deemed a Participant for all purposes except that he shall not be permitted to make contributions to the Plan, receive Fixed or Performance Matching Contributions, or be entitled to Employer-provided insurance benefits under Section 5.1; provided, however, that a Participant may elect to continue insurance coverage at his own expense (or, at the sole discretion of the Administrator, at the Employer's expense) when he ceases to be an active Participant. 2.4 Transfer of Employee. If a Participant transfers his employment from one Employer to another Employer, the Participant shall not be deemed to have ceased being an active -6- 10 Participant under Section 2.3. Any obligations of a former Employer to the Participant under the Plan shall become the obligations of the Participant's new Employer. 2.5 Cessation of Employer's Affiliate Status. If a Participant ceases to be an active Participant pursuant to Section 2.3C, the Administrator shall determine in its absolute and unfettered discretion either to: (i) fully vest the Participant in all Employer contributions made on his behalf, transfer the vested portion of the Participant's Education Account and Fixed Period Account, if any, to the Participant's Retirement Account and distribute the vested value of the Retirement Account to the Participant pursuant to Section 5.2D or (ii) transfer the Participant's Accounts to a new trust to be maintained by the employer for the benefit of the Participant. SECTION 3 PLAN CONTRIBUTIONS 3.1 Deferral Contributions. Each Participant who is an employee may authorize the Employer to reduce his (i) Base Pay and/or (ii) Bonus for a Plan Year, and to have a corresponding amount credited to his Accounts, in accordance with Section 4.2, by executing and filing a Deferral Agreement with the Administrator during his initial Enrollment Period or any subsequent Enrollment Period designated by the Administrator. A Deferral Agreement specifying deferrals to be made from Base Pay and/or Quarterly Bonus (if any) shall be executed and filed during the Enrollment Period preceding the Plan Year during which such Base Pay or Quarterly Bonus (if any) will be earned. A Deferral Agreement specifying deferrals to be made from Annual Bonus shall be executed and filed during the Enrollment Period preceding the Plan Year during which such Bonus will be finally determined and paid. An Eligible Employee who has previously executed and filed a Deferral Agreement specifying deferrals to be made from the Bonus to be finally determined and paid during the Plan Year beginning July 1, 1997 may execute and file a new Deferral Agreement during the Enrollment Period preceding the Plan Year beginning July 1, 1997, provided that the new Deferral Agreement may increase, but may not decrease, the specified Bonus deferrals. Such Base Pay and Bonus deferrals shall be based on a fixed percentage. Base Pay deferrals shall equal not less than 1% nor more than 25% of Base Pay. Bonus deferrals shall equal not less than 1% nor more than 100% of Annual Bonus and/or Quarterly Bonus, respectively. The deferral shall be made from Base Pay, Annual Bonus and/or Quarterly Bonus as the Participant shall specify; however, to the extent the deferral is to be made from Annual Bonus and/or Quarterly Bonus, but no Annual Bonus and/or Quarterly Bonus is paid, the deferral shall be reduced. -7- 11 Notwithstanding the foregoing, a Participant may not make contributions to the Plan during any period for which contributions must be suspended in accordance with Treas. Reg. Section 1.401(k)-1(d)(2)(iv)(B)(4), as a condition of the Participant's receipt of a hardship withdrawal from any retirement plan of the Employer that includes a qualified cash or deferred arrangement under section 401(k) of the Code. 3.2 Rules Governing Deferral Contributions. A. Each annual election to defer shall be irrevocable. B. The amount that a Participant elects to defer shall be credited to the Participant's Accounts as soon as practicable after the date the amount would otherwise be paid to him as cash compensation. 3.3 Fixed Matching Contributions. Each Employer shall make a fixed matching contribution for each Group I Eligible Employee that shall equal 70% of the first 5% of his Total Compensation that is contributed to the Plan as a Deferral Contribution under Section 3.1. Each Employer shall make a fixed matching contribution for each Group II Eligible Employee that shall equal 30% of the first 5% of his Total Compensation that is contributed to the Plan as a Deferral Contribution under Section 3.1. Fixed Matching Contributions shall be credited to Participants' Accounts when Deferral Contributions are so credited. 3.4 Performance Matching Contributions. Each Employer shall make a variable matching contribution for each contributing Participant who is an Eligible Employee as of the last day of the Plan Year for any Plan Year in which the applicable Company attains between 90% and 110% of EPS Budget. Unless otherwise determined by the Board for any Plan Year, if the parameters set forth in the preceding sentence have been met, the Performance Matching Contribution for each Group I Eligible Employee shall equal the first 5% of his Total Compensation that is contributed to the Plan as a Deferral Contribution under Section 3.1 multiplied by the percentage of EPS Budget attained by the applicable Company, and the Performance Matching Contribution for each Group II Eligible Employee shall equal 40% of the first 5% of his Total Compensation that is contributed to the Plan as a Deferral Contribution under Section 3.1 multiplied by the percentage of EPS Budget attained by the applicable Company. Performance Matching Contributions shall be credited to Participants' Accounts as soon as practicable following the annual determination of whether EPS Budget has been attained by the applicable Company. 3.5 Vesting. Benefits derived from Deferral Contributions are not subject to forfeiture for any reason other than corporate insolvency. Benefits derived from Fixed Matching Contributions and Performance Matching Contributions shall vest according to a schedule -8- 12 based on "Years of Participation" in the Plan. The term "A Year of Participation" means a full Plan Year during which an employee of the Employer is an Eligible Employee as defined in the Plan. For these purposes, the first Plan Year, though less than 12 months, shall qualify as a full Year of Participation. For an Eligible Employee on or before June 1, 1997, benefits derived from Fixed Matching Contributions and Performance Matching Contributions shall vest at the rate of 20% per completed Year of Participation beginning with the sixth (6th) completed Year of Participation, unless the Eligible Employee executes a Confidentiality and Non-Competition Agreement in a form approved by the Administrator before September 1, 1997, or during such other time period as the Administrator may thereafter designate. For an Eligible Employee on or before June 1, 1997 who timely executes a Confidentiality and Non-Competition Agreement in a form approved by the Administrator, or for any employee who becomes an Eligible Employee after June 1, 1997, benefits derived from Fixed Matching Contributions and Performance Matching Contributions shall become 100% vested upon completion of the fifth (5th) Year of Participation. Notwithstanding the foregoing, benefits derived from Fixed Matching Contributions and Performance Matching Contributions shall become 100% vested (i) upon a Participant's Retirement; (ii) if a Participant dies or suffers a Disability while employed by the Employer; or (iii) upon a Participant's Involuntary Termination by the Employer, provided that either (a) the Participant has completed at least one Year of Participation in the Plan and the combination of the Participant's age and Years of Participation at the time of his Involuntary Termination totals at least 50, or (b) the Participant's Involuntary Termination occurs within 12 months after the applicable Company undergoes a Change in Control. In addition, the Administrator may, in the Administrator's absolute and unfettered discretion, determine to vest Employer contributions made on a Participant's behalf if the Participant's termination of employment with the Employer was caused by events beyond the Participant's control. If a Participant terminates employment before becoming fully vested, any nonvested Employer contributions shall be forfeited and shall be used to reduce Employer contributions to the Plan. Notwithstanding the foregoing, if the distribution of a Participant's Retirement Account is deferred under Section 5.2B(5), the Participant shall not forfeit any unvested Employer contributions until the Participant's Retirement Account is actually distributed. For purposes of determining a Participant's vested interest in Employer contributions at the time the Participant's Retirement Account is distributed, any nonsuccessive Years of Participation in the Plan shall be aggregated to determine his vested percentage. -9- 13 SECTION 4 PARTICIPANT ACCOUNTS 4.1 Establishment of Accounts. The following Accounts shall be established with respect to each Participant: A. Retirement Account, B. Education Account, and C. Fixed Period Account. 4.2 Benefit Allocation. Each Participant may submit to the Administrator before the close of the Enrollment Period for each Plan Year a written statement specifying the Participant's allocation of future contributions as to his respective Accounts. If a Participant does not submit such a statement, all contributions for the Plan Year following the Enrollment Period shall be allocated to the Participant's Retirement Account. Matching Contributions shall be allocated in the same manner as Deferral Contributions. 4.3 Irrevocable Allocation. A Participant may not modify, alter, amend or revoke his allocation for a Plan Year after such Plan Year begins. 4.4 Adjustment of Accounts. A Participant may request in a writing delivered to the Administrator that his Accounts be valued as if they were hypothetically invested in one or more of the Investment Funds listed on the Benefit Account Allocations/Accumulation Options form provided by the Administrator. A Participant may request one or more Investment Fund(s) in multiples of 25% and may make a separate request with respect to each Account. A request shall be effective as of the Determination Date next following timely delivery to the Administrator, and shall apply to new contributions and previous accumulations as the Participant specifies. Each Participant's Accounts established under Section 4.1 shall be valued no less than monthly based upon the performance of the Investment Fund(s) requested by the Participant as determined by the Administrator. A Participant shall submit his investment measurement request to the Administrator in writing. -10- 14 If any Participant fails to file a request, he shall be deemed to have requested the fund which, in the opinion of the Administrator, has the least risk of loss of principal. The Administrator shall be under no obligation to invest Deferral Contributions in the manner requested by the Participant. 4.5 Suballocation Within the Education Account. If a Participant allocates a portion of his anticipated contributions to his Education Account, the Participant may further allocate among subaccounts on behalf of any Eligible Dependent. In the absence of such suballocation, all contributions to the Participant's Education Account shall be equally allocated to the Participant's Eligible Dependents. A Participant's directed adjustment request pursuant to Section 4.4 shall apply uniformly to each subaccount. 4.6 Investment Obligation of the Employer. Benefits are payable as they become due irrespective of any actual investments the Employer may make to meet its obligations. Notwithstanding, neither the Employer nor any trustee (in the event the Employer elects to use a grantor trust to accumulate funds) shall be obligated to purchase or maintain any asset, and any reference to investments or Investment Funds is solely for the purpose of computing the value of benefits. To the extent a Participant or any person acquires a right to receive payments from the Employer under this Plan, such right shall be no greater than the right of any unsecured creditor of the Employer. Neither this Plan nor any action taken pursuant to the terms of this Plan shall be considered to create a fiduciary relationship between the Employer and the Participants or any other persons, or to establish a trust in which the assets are beyond the claims of any unsecured creditor of the Employer. SECTION 5 BENEFITS 5.1 Employer Provided Insurance Benefits. A. The Employer shall purchase or otherwise provide additional life insurance for all Participants; provided that the Administrator shall have first received all information and executed documents from the Participants as the Administrator has requested. Group I Eligible Employees shall be provided additional life insurance coverage, subject to the terms of available coverage, equal to two times their Total Compensation for a Plan Year. Group II Eligible Employees shall be provided additional life insurance coverage, subject to the terms of available coverage, equal to their Total Compensation for a Plan Year. Notwithstanding the foregoing, the -11- 15 Administrator may, in its sole discretion, set a maximum limit on the amount of coverage to be provided to any class of Participants and reduce the amount of benefits available to Participants based on the cost thereof, consistent with applicable law. B. The Employer shall purchase or otherwise provide individual Disability insurance coverage for all Participants at a rate of 70% of Total Compensation, to a maximum of $15,000 per month; provided that the Administrator shall have first received all information and executed documents from the Participants as the Administrator has requested. Notwithstanding the foregoing, the Administrator may, in its sole discretion, limit the amount or time period of Disability insurance coverage consistent with applicable law. 5.2 Retirement Account. A. If a Participant terminates employment for any reason, including death, the Employer shall pay such Participant a benefit in the form determined under Section 5.2B based on the vested value of his Retirement Account. If the Participant is deceased, the benefit shall be paid to his Beneficiary. B. Form of Payment: (1) If the Participant's termination of employment occurs due to Retirement, payment of the benefit shall begin within 120 days of Retirement. A Participant shall elect one of the following payment options at the time he establishes his Retirement Account, and at such other times as shall be determined by the Administrator, provided that any such subsequent election by the Participant shall apply only to amounts attributable to contributions to the Retirement Account to be made in Plan Years beginning after the Plan Year in which the election is made: (a) 100% joint and survivor annuity; (b) an annual benefit to be paid for a fixed period of 10 years, the amount to be paid in any one year to equal the vested value of the Retirement Account at the time of payment multiplied by a fraction, the numerator of which shall be one and the denominator of which shall be ten minus the number of benefit payments previously made under this option; or -12- 16 (c) a lump sum. (2) If the Participant's termination of employment occurs due to Disability, the benefit described in Section 5.2A shall be paid either as a lump sum or annually over a fixed period of 10 years (as calculated in (1)(b) above), as determined by the Administrator. (3) If a Participant's termination of employment occurs for any reason other than Retirement or Disability, the benefit described in Section 5.2A shall be paid in a lump-sum payment within 120 days from the date of termination. (4) Notwithstanding any provision to the contrary, if the Participant's Retirement Account has a value less than $20,000 at the time benefits are to commence, then the Participant's benefit may, at the discretion of the Administrator, be paid as a lump sum as soon as administratively feasible following the Participant's termination. (5) Notwithstanding anything to the contrary, if the Administrator determines at the time of a Participant's termination of employment with the Employer that a reasonable probability exists that the Participant will return to employment with the Employer, the Participant's Retirement Account shall not be distributed to the Participant. The Participant's Retirement Account shall instead be held under the Plan until (i) the Administrator determines that the Participant's return to employment with the Employer is no longer reasonably probable, or (ii) the Participant returns to employment with the Employer, at which point the Participant's Retirement Account shall be subject to distribution in accordance with this Section 5.2. Upon a Participant's reemployment by the Employer, any funds transferred to the Participant's Retirement Account from his Education Account or Fixed Period Account shall be re-transferred to the respective Account or Accounts. C. If benefits are payable in a form of payment under Section 5.2B(1)(a), the amount of each payment shall be determined based on the payments that would have been made if the Employer applied the Participant's Retirement Account on the date payments are to begin to purchase an annuity contract providing such payments from an insurance carrier selected by the Administrator. D. Subject to Section 5.2B(5) hereof, if a Participant continues to be employed by an entity that ceases to be an affiliate of either Company and the Administrator -13- 17 determines to fully vest and distribute the Participant's Account, the Employer shall, at the direction of the Administrator, pay such Participant a benefit based on the vested value of his Retirement Account. The benefit shall be paid in a lump sum as soon as administratively feasible following the later of the date the applicable entity ceases to be an affiliate of either Company and the date that all determinations have been made hereunder. 5.3 Education Account. A. If a Participant remains continuously employed by the Employer until January 1 of the calendar year in which an Eligible Dependent reaches age 18, the Employer shall pay to the Participant a benefit, as soon after such January 1st and each of the next three anniversaries thereof as administratively practicable, determined as follows: Distribution Percentage of Eligible January 1st Dependent's Subaccount 1 25% 2 33-1/3% 3 50% 4 100% B. A Participant may establish subaccounts under his Education Account, with separate payments for each. A Participant may have a maximum of five subaccounts at any time. C. If a Participant terminates his employment for any reason with a balance in his Education Account, the vested portion of the balance shall be transferred to his Retirement Account and distributed in accordance with Section 5.2. D. Notwithstanding any provision to the contrary, if on the January 1 of the calendar year in which an Eligible Dependent of a Participant reaches age 18, the Eligible Dependent's subaccount has a balance of less than $10,000, then the Administrator, at its discretion, may direct that the balance be paid to the Participant in one lump sum. E. If any portion of an Education Account is not vested on the date such portion is to be paid, distribution shall be postponed until the January 1 following the date it is vested. -14- 18 5.4 Fixed Period Account. A. A benefit equal to the lump sum value of the vested portion of a Participant's Fixed Period Account shall be paid to him as soon as administratively practicable after January 1 of the payment year specified by the Participant. Nonvested amounts will be paid as soon as administratively practicable after January 1 following the year the Participant becomes vested. B. A Participant may establish subaccounts under his Fixed Period Account, with separate payment years for each. A Participant may have a maximum of five subaccounts at any time. C. If a Participant's employment terminates for any reason and the Participant has a balance in his Fixed Period Account, the vested portion of the balance shall be transferred to his Retirement Account and be distributed in accordance with Section 5.2. 5.5 Tax Withholding. To the extent required by law, the Employer shall withhold or cause to be withheld taxes from payments made under the Plan. SECTION 6 ADMINISTRATION 6.1 Appointment of Administrator. The Boards shall appoint an individual or a committee to serve as Administrator. The Administrator (or any member of a committee) may be removed by the Boards at any time; and any individual may resign at any time by submitting his resignation in writing to the Boards. A new Administrator (or committee member) shall be appointed as soon as practicable in the event of a removal or resignation. 6.2 Administrator's Responsibilities. The Administrator is responsible for the administration of the Plan. The Administrator may appoint other persons or entities to perform any of its fiduciary functions. Such appointment shall be made and accepted by the appointee in writing. The Administrator and any such appointee may employ advisors and other persons necessary or convenient to help him carry out his duties, including his fiduciary duties. The Administrator shall have the right to remove any such appointee from his position. Any person, group of persons or entity may serve in more than one fiduciary capacity. -15- 19 6.3 Records and Accounts. The Administrator shall maintain or cause to be maintained accurate and detailed records and accounts of Participants, Employers and their respective rights under the Plan, and of all investments, receipts, disbursements and other transactions. Such accounts, books and records relating thereto shall be open at all reasonable times to inspection and audit by the Employer and by persons designated thereby. 6.4 Administrator's Specific Powers and Duties. In addition to any powers, rights and duties set forth elsewhere in the Plan, the Administrator shall have the following powers and duties: A. to adopt such rules and regulations consistent with the provisions of the Plan; B. to enforce the Plan in accordance with its terms and any rules and regulations it establishes; C. to maintain records concerning the Plan sufficient to prepare reports, returns and other information required by the Plan or by law; D. to construe and interpret the Plan and to resolve all questions arising under the Plan; E. to direct the Employer or the Trustee to pay benefits under the Plan, and to give such other directions and instructions as may be necessary for the proper administration of the Plan; and F. to be responsible for the preparation, filing and disclosure on behalf of the Plan of such documents and reports as are required by any applicable federal or state law. 6.5 Employer's Responsibility to Administrator. The Employer shall furnish the Administrator such data and information as it may reasonably require. The records of the Employer shall be determinative of each Participant's period of employment, termination of employment and the reason therefor, leave of absence, reemployment, years of service, personal data, and compensation reductions. Participants and their Beneficiaries shall furnish to the Administrator such evidence, data or information, and execute such documents, as the Administrator requests. 6.6 Liability. Neither the Administrator nor the Employer shall be liable to any person for any action taken or omitted in connection with the administration of the Plan unless attributable to its own fraud or willful misconduct; nor shall the Employer be liable to any person for such action unless attributable to fraud or willful misconduct on the part of a director, officer or employee of the Employer. -16- 20 6.7 Payment of Expenses. All expenses of the Administrator incurred in the operation or administration of the Plan shall be paid by the Employer. 6.8 Indemnity of Administrator. The Employer shall indemnify the Administrator (or any individual who is a delegate) against any and all claims, loss, damage, expense or liability arising from any action or failure to act, except when due to gross negligence, willful misconduct or breach of fiduciary duty. SECTION 7 CLAIMS PROCEDURE 7.1 Claim. If a Participant or Beneficiary is denied all or a portion of an expected Plan benefit for any reason, he must file a written notification of his claim with the Administrator. The Administrator shall notify the Participant or Beneficiary within 60 days of allowance or denial of the claim. If the Administrator fails to notify the claimant of his decision to grant or deny the claim within 60 days, such claim shall be deemed to have been denied; and the review procedure described in Section 7.2 shall become available to the claimant. The notice provided by the Administrator under this Section shall be in writing, sent by mail to the Participant's last known address and, if a denial, must contain the following information: A. the specific reasons for the denial; B. the specific reference to the pertinent Plan provision on which the denial is based; C. if applicable, a description of any additional information or material necessary to perfect the claim, and an explanation of why such information or material is necessary; and D. an explanation of the claims review procedure and the time limitations of the review procedure applicable thereto. 7.2 Review Procedure. A Participant or Beneficiary is entitled to request a review of any denial of his claim by the Administrator. The request for review must be submitted in writing within 60 days of mailing of notice of the denial. Absent a request for review within the 60-day period, the claim will be deemed to be conclusively denied. The Participant or Beneficiary or his representative shall be entitled to review all pertinent documents and to -17- 21 submit issues and comments in writing. The Administrator shall provide a full and fair review of the claim and render the final decision. 7.3 Final Decision. Within 60 days of mailing of a request for review, the Administrator shall allow or deny the claim, unless special circumstances require an extension (such as for a hearing); provided, however, that in no event shall the decision be delayed beyond 120 days after receipt of the request for review. The decision shall be communicated in writing to the Participant or Beneficiary. The decision shall recite the facts and reasons for denial, with specific reference to the pertinent Plan provisions. SECTION 8 AMENDMENT AND TERMINATION 8.1 Plan Amendment. The Plan may be amended in whole or in part by the Boards at any time. 8.2 No Premature Distribution. Subject to Section 8.3, no amendment hereto shall permit amounts accumulated prior to the amendment to be paid to a Participant or Beneficiary prior to the time he would otherwise be entitled thereto. 8.3 Termination of the Plan. The Employer reserves the right to terminate the Plan and/or the Deferral Agreement pertaining to any Participant at any time prior to the commencement of benefits. In the event of any such termination, the Employer shall pay a benefit to the Participant or the Beneficiary of any deceased Participant, in addition to other insurance benefits hereunder, equal to the vested value of the Participant's Accounts. SECTION 9 MISCELLANEOUS 9.1 Supplemental Benefits. The benefits provided for the Participants under the Plan are in addition to benefits provided by any other plan or program of the Employer and, except as otherwise expressly provided herein, the benefits of the Plan shall supplement and shall not supersede any plan or agreement between the Employer and any Participant or any provisions contained herein. -18- 22 9.2 Governing Law; Jurisdiction. The Plan shall be governed and construed under the laws of the Commonwealth of Pennsylvania, and the courts of the Commonwealth of Pennsylvania shall have exclusive jurisdiction in any or all actions not superseded by federal law. 9.3 No Assignment Permitted. No Participant, Beneficiary or anyone claiming through them shall have any right to commute, sell, transfer, assign or otherwise convey the right to receive any payment under the terms of the Plan. Any such attempted assignment shall be considered null and void. 9.4 Binding Terms. The terms of the Plan shall be binding upon and inure to the benefit of the parties hereto, their respective heirs, executors, administrators and successors. 9.5 Spendthrift Provision. The interest of any Participant or any Beneficiary receiving payments hereunder shall not be subject to anticipation, nor to voluntary or involuntary alienation, until distribution is actually made. 9.6 Headings. All headings preceding the text of the several Sections hereof are inserted solely for reference and shall not constitute a part of this Plan, nor affect its meaning, construction or effect. 9.7 Rule of Interpretation. Where appropriate, words in the masculine gender shall include the feminine and neuter genders. -19- 23 IN WITNESS WHEREOF, to record the adoption of the amendment and restatement of the Plan, NovaCare and NCES have caused their respective authorized officers to affix their corporate names and seals as of the day and year first written above. [CORPORATE SEAL] NOVACARE, INC. Attest: /s/ Peter D. Bewley By: /s/ Robert E. Healy, Jr. ---------------------------- ---------------------------------- Name: Robert E. Healy, Jr. Title: Sr. VP and CFO [CORPORATE SEAL] NOVACARE EMPLOYEE SERVICES, INC. Attest: /s/ Marie L. Martino By: /s/ Thomas D. Schubert ----------------------------- ---------------------------------- Name: Thomas D. Schubert Title: Sr. V.P. and CFO September 8, 1997 -20- EX-13 10 ANNUAL REPORT TO SHAREHOLDERS 1 EXHIBIT 13 NOVACARE 1997 ANNUAL REPORT Front Cover Photo of Tony Volpentest, world record holder and gold medal winner in the 1996 Paralympic Games. Photo of swallowing test A new computer-based technology for treating swallowing disorders dramatically improves patient outcomes. Photo of employees from a shoe manufacturer Small company employees receive big company benefits through NovaCare Employee Services. Photo of NovaCare physical therapist, Ed Malloy, working with Rod Brind'Amour of the Philadelphia Flyers. HELPING MAKE LIFE A LITTLE BETTER 2 Inside Front Cover HELPING MAKE LIFE A LITTLE BETTER RESPECT FOR THE INDIVIDUAL SERVICE TO THE CUSTOMER PURSUIT OF EXCELLENCE COMMITMENT TO PERSONAL INTEGRITY NOVACARE, INC. is a national leader in physical rehabilitation services and employee services. As the clinical leader in rehabilitation, the company treats 37,000 patients per day in cost-effective outpatient and long-term care settings, and has achieved number one market shares in long-term care and orthotic and prosthetic rehabilitation. In addition, NovaCare is the nation's second largest provider of outpatient rehabilitation services and the second largest professional employer organization, administering the full array of human resource functions, including the management of health care benefits and workers' compensation, for small and medium-sized businesses. NOVACARE'S VALUES unify our Company and mandate an open, participative, empowered environment. Health care is changing at a remarkable pace and our Company is expanding into new businesses. Our values-based culture enables us to set aside the organizational anxiety and self-interest that often accompany change. Instead, the pursuit of our values unlocks our inherent capacity to drive change, creating immense opportunity. Without question, our greatest strength and competitive advantage is our people, values-driven culture and capacity for change. FINANCIAL HIGHLIGHTS (In thousands, except per share data)
FOR THE YEAR ENDED JUNE 30, 1997 1996 1995 - --------------------------------------------------------------------------------------------------- Net revenues $1,066,451 $793,038 $905,359 Net income 38,910 15,281 61,924 Net income per common share $ .62 $ .24 $ .95 Weighted average number of common shares outstanding 63,081 64,325 65,163
AS OF JUNE 30, 1997 1996 1995 - --------------------------------------------------------------------------------------------------- Working capital $ 173,576 $223,712 $225,126 Total assets 1,014,304 789,731 852,557 Total liabilities 506,298 305,337 364,922 Shareholders' equity 508,006 484,394 487,635
3 1 LEADERSHIP PERFORMANCE GROWTH NOVACARE HOLDS NUMBER ONE OR NUMBER TWO MARKET POSITIONS IN EACH OF ITS MAJOR BUSINESSES AND LEADING SHARES IN ALMOST HALF OF ITS 17 TARGET MARKETS. Outpatient Rehabilitation Centers Graph (1995) 324 (1996) 466 (1997) 638 INVESTMENTS IN INFORMATION TECHNOLOGY CREATE SUPERIOR CUSTOMER SERVICE AND IMPROVE ADMINISTRATIVE EFFICIENCY TO HELP NOVACARE MAINTAIN A LOW-COST POSITION. Therapists per Manager Graph (1995) 10.5 (1997) 17.1 NOVACARE PROVIDES CREATIVE OUTSOURCED SOLUTIONS TO THOUSANDS OF CUSTOMERS -- FROM LONG-TERM CARE FACILITIES TO PHYSICIANS, ATHLETIC TEAMS AND EMPLOYERS. Long-term Care Contracts Graph ($ millions) New Contract Sales (1995) 116 (1996) 120 (1997) 127 Customer Cancellations (1995) 86 (1996) 127 (1997) 82 WITH ITS ENTRY INTO THE EMPLOYEE SERVICES BUSINESS, NOVACARE LEVERAGES ITS PROVEN EXPERTISE IN HUMAN RESOURCE MANAGEMENT. Total Employees Graph (1993) 9,550 (1994) 14,125 (1995) 15,440 (1996) 14,685 (1997) 39,291 4 TO OUR SHAREHOLDERS EXECUTIVE PHOTO Timothy E. Foster Chief Executive Officer (left) John H. Foster Chairman of the Board (center) James W. McLane President and Chief Operating Officer (right) Net Revenues($ millions) Rehabilitation Services (1992) 392 (1993) 582 (1994) 789 (1995) 905 (1996) 793 (1997) 927 Employee Services (1997) 139 To Our Shareholders: Fiscal 1997 was an excellent year: a year in which the restructure and strategy development of 1995 and 1996 yielded strong returns. Spurred by expanding market share and margins in each of our businesses, earnings per share reached $.62 compared with $.24 per share in fiscal 1996. Adjusting fiscal 1996 for a restructure charge and a provision to increase accounts receivable reserves, 1997 earnings per share increased 29% over the prior year. Our dramatic return to growth was fueled by the successful implementation of the strategy set forth in last year's annual report. - Expand outpatient services - Develop occupational health services - Launch a professional employer organization, or employee services business - Focus growth and integration efforts in select target markets This report will discuss the progress and impact of our strategy and organizational development, while highlighting four themes that underpin our current success and plans for the future. GROWTH IN OUTPATIENT SERVICES Revenues from rehabilitation services grew 15% in fiscal 1997, and operating income increased 63%. The revenue enhancement stemmed principally from growth in our outpatient services, comprising physical and occupational therapy, artificial limbs (prosthetics) and custom braces (orthotics). An 88% increase in the number of managed care contracts led to 2% growth in our base outpatient clinics business despite an 8% decrease in pricing. We also acquired 52 outpatient businesses with aggregate annualized revenues of $140 million. Disciplined cost controls and greater scale offset the price declines and our outpatient base business gross profit margins increased from 26% in fiscal 1996 to 28% in fiscal 1997. In addition to outpatient growth, our rehabilitation business benefited from a significant increase in the number of long-term care facilities outsourcing their rehabilitation programs to NovaCare. Propelled by our outstanding clinical programs, information technology advances and unsurpassed levels of therapist recruiting, new contract sales reached record levels and cancellations dropped to a three-year low. As a result, contract rehabilitation revenues increased 9%. While this business faces the prospect of changing Medicare reimbursement, which will decrease margins, we are confident that our preparation will enable us to better manage costs, while differentiating our service and expanding our already overwhelming market leadership in this business. The faster growth of our outpatient services relative to our long-term care outsourcing business reduced our reliance on Medicare as a payer to 45% of gross profits in fiscal 1997. DEVELOPMENT OF OCCUPATIONAL HEALTH SERVICES Leveraging the expertise gained from annually rehabilitating thousands of patients with work-related injuries, we expanded our occupational health business with acquisitions in Connecticut, 5 3 Arizona and Northern California. NovaCare provides "workplace-to-workplace" service, from worksite evaluation, to injury/illness diagnosis and physician treatment, through rehabilitation and back to work, to minimize health care, disability and lost productivity costs to employers. Occupational health remains a highly fragmented $30 billion industry in which market leadership is far from decided. ENTERING THE EMPLOYEE SERVICES INDUSTRY We entered the employee services industry and became an industry leader in fiscal 1997. The acquisition of four professional employer organizations (PEOs) and the outsourcing of NovaCare's 19,000 employees to the newly formed NovaCare Employee Services, Inc., established that subsidiary as the second largest PEO in the United States. In return for an administrative fee and a share of reduced costs, PEOs assume administrative activities and risks associated with employment, typically for small and mid-sized businesses. It is a market opportunity that exceeds $1 trillion and leverages NovaCare's expertise in human resource management, outsourcing, information technology, occupational health, and existing relationships with innumerable smaller health care companies. FOCUSED GROWTH IN TARGET MARKETS To build and maintain leading market positions in our rehabilitation services businesses, we focused on 17 selected markets. Our goals were to enhance physician and health system relationships, increase brand awareness and leverage our infrastructure investments in those communities. In 1997, nearly 90% of our rehabilitation acquisitions and start-up centers were in the target markets -- the same markets in which we will expand our employee services business. By year-end, we held leading market share positions in almost half of these markets. ORGANIZATIONAL DEVELOPMENT It was very clear to us that our aggressive growth strategy coupled with the rapidly changing health care environment would require expansion of the leadership team. Accordingly, in late April, Timothy E. Foster was appointed Chief Executive Officer. A founding Director of NovaCare, Tim served most recently as President and Chief Operating Officer and, prior to that, as Senior Vice President and Chief Financial Officer. His strategic contributions and leadership in repositioning NovaCare have increased market share, improved margins and return on equity, and enhanced shareholder value. James W. McLane simultaneously was appointed President and Chief Operating Officer. Jamie brings a wealth of health policy and managed care expertise and relationships, as well as extensive executive leadership and business-building experience. Prior to joining NovaCare, Jamie served as Chief Executive Officer of Aetna Health Plans, a $7.5 billion managed care insurer, the nation's third largest. Jamie already has made positive contributions to our operations and service delivery. (See article on page 12.) To bring new insight and marketing expertise to the PEO industry, Loren J. Hulber was appointed President and Chief Executive Officer of NovaCare Employee Services. Loren was formerly of American Brands where he served as President and Chief Executive Officer of Day-Timers, Inc., the leader in personal time management services. Loren also brings an exceptional background as a business builder with specific expertise in brand development. LOOKING AHEAD Our plans for the future are aggressive. In outpatient rehabilitation, we will focus on internal growth and acquisitions to strengthen market positions and plan to accelerate the expansion of our occupational health business. The contract rehabilitation business continues to show increases, and we are confident about our ability to gain market share in this changing reimbursement environment. Finally, we plan to forge ahead in the employee services business by expanding into at least two new markets. This is perhaps NovaCare's greatest growth opportunity, since less than 5% of potential customers currently utilize PEO services. NovaCare Employee Services intends to make an initial public offering in fiscal 1998. Approximately 20% of the subsidiary's stock will be sold to the public with a majority ownership position retained by NovaCare. The public offering allows us to capitalize on the increasing interest of investors in this high-growth industry, recoup NovaCare's initial investment, and create an attractive security with which to acquire additional PEOs. As we conclude 1997, we are firmly on the road to realizing our long-term strategy of building a strong rehabilitation and employee services company. We are number one in outsourced rehabilitation services in long-term care settings and orthotics and prosthetics, and we hold the number two market position in outpatient physical therapy and employee services, having entered the latter two businesses more recently. We have attained our leadership positions by investing in a unique set of knowledge-based capabilities: our expertise in outsourced services, information technology and human resource management, which differentiates our services. We describe these capabilities in more detail later in this report. Of course, behind the competencies that differentiate us, stand our employees. We continue to invest in them, and they return that investment time and again with substantial results -- all the while Helping Make Life a Little Better for our patients, customers, and communities. On behalf of your Board and management, we extend our thanks to all NovaCare employees and offer our appreciation to you, our shareholders, for your continuing confidence and support. /s/ John H. Foster /s/ Timothy E. Foster John H. Foster Timothy E. Foster Chairman Chief Executive Officer 6 ACHIEVING MARKET LEADERSHIP Photo of Tony Volpentest, world record holder and gold medal winner in the 1996 Paralympic Games. Revenues From Sabolich Socket Technology Graph($ millions) (1995) .57 (1996) 7.95 (1997)15.18 HELPING MAKE LIFE A LITTLE BETTER 7 5 Revenues From Upper Extremity Prosthetics Graph ($ million) (1995) 3.44 (1996) 5.65 (1997) 8.54 NOVACARE HAS ACHIEVED NUMBER ONE OR TWO MARKET POSITIONS IN EACH OF ITS MAJOR BUSINESSES THROUGH CLINICAL LEADERSHIP, SUPERIOR OUTCOMES AND EXPERT SERVICES. The race for leading market positions is hard won, but the rewards are substantial -- higher margins, superior return on equity and enhanced shareholder value. Our process begins with the selection of industry sectors that are large, fragmented, growing rapidly and that would benefit from our expertise in outsourcing, information technology and human resource management. We start with an aggressive consolidation and integration program. Rapid consolidation is key to achieving the scale that creates margin opportunity and warrants the investment made in service differentiation. We focus on target geographic markets to leverage the cost of field management and concentrate our resources on the most critical relationships in a community. We invest heavily in the employees of acquired businesses, orienting them to our core values, and creating alignment with common goals which, in turn, facilitates integration. Consolidating industries to create scale is part of our history. Twelve years ago, we entered the rehabilitation business as the nation's largest provider of speech-language pathology services with $5 million in revenues. Since then, we have completed 38 acquisitions and created a $550 million business in outsourced rehabilitation services in the long-term care market. Similarly, early in this decade, we entered the outpatient rehabilitation and orthotic and prosthetic sectors by acquiring 197 businesses. Today, we have an integrated network of 644 outpatient centers across 37 states, with net revenues of approximately $360 million in fiscal 1997. Finally, last year, we entered the employee services industry with four acquisitions. Our scale has enabled us to make the investments necessary to differentiate our services. In rehabilitation, we have invested in research and development to distinguish our services clinically. Two recent innovations, the Vigor(SM) rehabilitation and wellness program for seniors, developed in partnership with Nautilus(R), and a computer-based technology for the treatment of swallowing disorders, are enjoying strong demand from customers that wish to be clinically differentiated in their local communities. We have been a leader in the development of outcomes, which are so critical to defining quality of care. We have the nation's largest database of rehabilitation outcomes in long-term care -- data that has been utilized in several high-profile research studies. Further, we have established a professorship to advance rehabilitation outcomes research at the Harvard School of Public Health. NovaCare is recognized internationally for technological leadership in prosthetics, including prosthetics that sense hot and cold, our unique Sabolich socket that offers both comfort and a secure fit, and our use of myoelectrics to enable amputees to open and close their hands at will. In employee services, we are differentiated by our human resource management expertise gained through 12 years of managing large numbers of employees in dispersed locations. We help our customer, the small and mid-sized business, attract and retain a quality workforce through employee benefits historically available only to employees of much larger organizations. We are unique in our ability to manage health care costs for employers, including workers' compensation and rehabilitation. At NovaCare, each of our major businesses ranks number one or two in its sector. These leadership positions have been enhanced through the development of outsourcing capabilities and investments in information technology and human resource management, discussed on the following pages. 8 PROVIDING CREATIVE OUTSOURCED SOLUTIONS Photo of NovaCare physical therapist, Ed Malloy, working with Rod Brind'Amour of the Philadelphia Flyers. Service Relationships by Customer Type Graph (Total Customers 13,900) (1997) Temporary Staffing 1,700 Contract Rehabilitation 1,770 Employee Services 1,700 Athletic Teams 1,100 Managed Care 351 Management Consulting 797 Occupational Health 6,500 HELPING MAKE LIFE A LITTLE BETTER 9 7 FROM NURSING HOMES TO MANUFACTURERS TO HOCKEY TEAMS, NOVACARE PROVIDES CREATIVE, COST-EFFECTIVE OUTSOURCED SOLUTIONS FOR HEALTH CARE ORGANIZATIONS, EMPLOYERS AND BUSINESSES. Instrumental in our success in outsourcing is an ability to understand and anticipate the needs of our customers, while smoothly integrating into their operations, so they can focus on their businesses. We manage activities that our customers may not have the necessary scale, expertise, time or staff to handle. Our goal is to be a partner with our customers, whether a small business, an orthopedic surgeon, a managed care organization or a facility administrator. Our expertise in long-term care has led to considerable growth in our outsourced rehabilitation services within that industry. Although rehabilitation is a relatively small department in a long-term care facility, it is critical to attracting patients. Yet, effectively managing a rehabilitation program, including recruiting and retaining therapists, developing and implementing clinically differentiated programs, and complying with frequently changing regulations, calls for scale and specialized knowledge beyond that of most facilities. This is why, with reimbursement rules becoming ever more complex, we are signing a record number of new contracts and increasing our market share. As partners with our customers, we add and adapt services as our customers' needs change. Last year, through NovaPro(SM) Temporary Staffing, we established relationships with approximately 1,700 health care institutions to provide clinicians on a temporary basis. And, we expanded the services of Polaris Group, our management consulting division, which provides expertise in program development, reimbursement and regulatory compliance, and added 173 new clients. Physicians, hospitals, managed care companies and employers turn to our outpatient services for their patients, members and employees because we are experts in rehabilitation. Our athletic trainers and physical therapists work with 13 professional teams and more than 1,000 high school teams; our emerging occupational health business serves 6,500 employers; and we operate 644 outpatient clinics nationwide. We strive to integrate seamlessly into our customers' operations and to improve their service to their customers. Our long-term care employees are part of the facility team, participating with nursing in every patient care activity, from admissions to daily care plan conferences to training programs for staff members and families. We offer strength-building rehabilitation and wellness programs for seniors, which our customers present as their Vigor(SM) programs. Our athletic trainers are on the playing field in customer team jerseys. As a co-employer with 1,700 employee services customers, we work directly with employees, fielding questions that range from health care coverage to vacation policy and other benefits. 10 DRIVING RESULTS WITH INFORMATION TECHNOLOGY Photo of swallowing test A new computer-based technology for treating swallowing disorders dramatically improves patient outcomes. Facilities with NovaCare's Information System Graph (1995) 1,500 (1996) 1,600 (1997) 1,730 HELPING MAKE LIFE A LITTLE BETTER 11 9 Patient Outcomes in NovaNet Plus Database Graph (1995) 5,100 (1996) 15,600 (1997) 36,000 FROM TECHNOLOGIES APPLIED TO PATIENT CARE TO INFORMATION MANAGEMENT, WE IMPROVE OUR CUSTOMERS' PERFORMANCE BY PROVIDING KNOWLEDGE-BASED SERVICES AND TECHNOLOGY BEYOND THE REACH OF THEIR INTERNAL SYSTEMS. We create value for our customers by providing them information specific to their needs - information which is generally unavailable from their internal systems. In long-term care, we support our customers with information that allows them to differentiate their services in the local community. This information is provided through our proprietary system, NovaNet PLUS, introduced in mid-1995. With NovaNet PLUS, customers can manage their clinical caseload, track referral and discharge patterns, determine the cost of care per patient, evaluate the effectiveness of various treatment methods, and compare their clinical outcomes with a national database of comparable patients. This system has proven so popular with customers that today we are in the process of installing NovaNet PLUS throughout two large long-term care organizations, including many locations where NovaCare is not currently the rehabilitation services provider. Occupational health and employee services customers want to return disabled employees to work as quickly and safely as possible. We support the employer's information needs by providing critical data on caseload, incidence of injury, absence and costs. We also provide progress reports so that supervisors can make informed decisions on staffing and production. Through applied technologies, we provide health care customers with clinical advances otherwise unavailable to them. Estimates are that swallowing problems affect as many as 40% of the patient population in nursing homes. The new NovaCare program for the diagnosis and treatment of swallowing dysfunction, pictured here, incorporates computer-based technology that is noninvasive, portable, and provides real-time information on swallowing functions. Additionally, this program offers the opportunity to provide a cost-effective, convenient alternative to patients who might otherwise need to travel to a distant hospital for repeated diagnostic procedures. The same information technology that adds value for our customers has substantially improved NovaCare's efficiency and profitability. With the implementation of NovaNet PLUS, our managers have access to daily information on billing, payroll, productivity and clinical management to optimize caseload and profitability. This support has allowed us to reduce the time formerly invested by field management in information gathering and analysis by 90% and to increase managers' spans of control by 62%, while at the same time improving customer and employee retention rates. Developments like these contributed to an increase in our operating profit margin for rehabilitation services from 6% in fiscal 1996 to 8% in fiscal 1997, at a time when most health care providers experienced profit erosion. 12 MANAGING HUMAN RESOURCES Photo of employees from a shoe manufacturing company Small company employees receive big company benefits through NovaCare Employee Services. "Employer of Choice" Results Clinicians Recruited For Customer Facilities Contract Rehabilitation (1993) 2,297 (1994) 2,340 (1995) 2,447 (1996) 2,298 (1997) 2,605 Temporary Staffing (1997) 1,783 HELPING MAKE LIFE A LITTLE BETTER 13 11 NOVACARE HAS LEVERAGED ITS EXPERTISE AS THE "EMPLOYER OF CHOICE" IN REHABILITATION SERVICES TO BECOME THE NATION'S SECOND LARGEST EMPLOYEE SERVICES COMPANY. NovaCare's most critical resources -- our 19,000 people -- are highly dispersed and working in small groups in 2,400 locations nationwide -- in our customers' health care facilities and our own outpatient centers. With NovaCare Employee Services, we have added 20,000 employees -- located in the workplaces of our employee services customers. To manage this number of employees effectively requires a strong core competency in human resource management. In rehabilitation, our ability to recruit and retain rehabilitation professionals for our customers has been critical to our customers' success. In fact, one of the reasons for outsourcing rehabilitation is the difficulty that health care facilities experience in attracting and maintaining an adequate number of therapists. We support new customers and the growth of existing customers' programs with the most effective recruiting organization for rehabilitation professionals in the industry, with a proprietary information system that tracks every contact with prospective clinical employees and today represents a database of 96,000 clinicians. Demand for rehabilitation clinicians continues to exceed the supply, yet NovaCare has been successful in recruiting a disproportionate share of therapists and is, today, one of the leading employers of rehabilitation therapists in the world. Over the past five years, we have hired an average of 2,400 therapists per year to work in our contract rehabilitation business and, in fiscal 1997, we recruited an additional 1,800 clinicians for our temporary staffing division. Creating an organization of highly productive employees has required that we develop "best practices" in recruiting, training and development, and rewards, including pay, flexible benefits and recognition programs. Employee surveys conducted by an outside firm consistently rank the satisfaction of NovaCare's employees above average in comparison with that of employees of other health care companies. The employee services business is a natural outgrowth of our strength and experience in managing a dispersed workforce. In addition, the advantage to our customer is our ability to control the cost of health care, including rehabilitation and workers' compensation, which for many employers represents the highest cost after payroll expenses. At NovaCare, for example, effective management of workers' compensation reduced our costs as a percentage of salaries by 38% over the past three years. Our human resources capabilities have provided attractive returns for NovaCare shareholders. Through training, management and systems support, we have improved the productivity of our therapists in both long-term care and outpatient settings, helping to mitigate pricing pressures. For example, in 1990 our therapists in the long-term care business spent 65% of their time on direct patient care; today that number is 73%. Further, last year, we were able to transition most of our salaried clinicians to an hourly pay and flexible time basis, to better align with the way our customers pay for services. With this change, we reduced unit labor costs by 2% and, at the same time, realized the highest employee retention rate in two years. Our capabilities in human resource management have differentiated us in rehabilitation services and will differentiate us in our employee services business, where we are the outsourced human resources department for our clients. 14 12 NovaCare dove logo JAMES W. McLANE JOINS NOVACARE EXECUTIVE TEAM Jamie McLane joins NovaCare with 28 years' experience in senior management positions in the Federal Government, Citicorp and Aetna. Just prior to joining NovaCare as its new President and Chief Operating Officer, Jamie served as Chief Executive Officer of Aetna Health Plans. Prior to 1991, he held various positions at Citicorp, including Senior Vice President and Division Executive of both the Global Insurance and Capital Investments Divisions. He has served as co-chair of the task force on Medicare reform for the Executive Committee of the Health Care Leadership Council, as a member of the Jackson Hole Group, and as Chairman of Outward Bound USA. "I look forward to melding my management and leadership experience, my knowledge of the rapidly evolving and ever challenging health care system, and my relationships with employers, providers and managed care organizations with the proven abilities of NovaCare's management team," says McLane. "Working together with all NovaCare employees, we will continue to create shareholder value by HELPING MAKE LIFE A LITTLE BETTER for our customers and patients. We will accomplish this through a disciplined focus on the four themes that underlie NovaCare's recent success and our plans for the future: o Attaining market leadership in each business and each target market; o Providing creative outsourced solutions for an expanding array of customers; o Developing information technology capabilities to ensure superior customer service and outcomes-oriented health care quality at a competitive cost; and o Managing human resource programs for employers so they can better care for their patients, customers and employees." 15 NovaCare, Inc. Inside Back Cover DIRECTORS John H. Foster Chairman of the Board Timothy E. Foster Chief Executive Officer E. Martin Gibson Retired Chairman and Chief Executive Officer, Corning Lab Services, Inc. Siri S. Marshall, Esq. Senior Vice President and General Counsel, General Mills, Inc. James W. McLane President and Chief Operating Officer Stephen E. O'Neil Private Investor George W. Siguler Founding Partner, Siguler, Guff & Company, LLC Robert G. Stone, Jr. Retired Chairman of the Board, The Kirby Corporation Daniel C. Tosteson, M.D. Caroline Shields Walker Distinguished Professor of Cell Biology and Dean Emeritus of the Medical Faculty, Harvard University SENIOR MANAGEMENT Peter D. Bewley Senior Vice President, General Counsel and Secretary Susan J. Campbell Vice President, Communications and Investor Relations Daryl A. Dixon President and General Manager, Contract Rehabilitation Division John H. Foster Chairman of the Board Timothy E. Foster Chief Executive Officer Robert E. Healy, Jr. Senior Vice President, Finance and Administration and Chief Financial Officer Ronald G. Hiscock President and General Manager, Outpatient Division Loren J. Hulber President and Chief Executive Officer, NovaCare Employee Services, Inc. Aven A. Kerr Senior Vice President, Human Resources Laurence F. Lane Senior Vice President, Regulatory Affairs James W. McLane President and Chief Operating Officer Steven M. Wise Vice President, Information Systems and Chief Information Officer 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 (800) 331-8840 Online address: www.novacare.com 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 16 Back Cover NovaCare Logo NovaCare, Inc. 1016 West Ninth Avenue King of Prussia, PA 19406 800-331-8840 www.novacare.com EX-21 11 SUBSIDIARIES OF THE COMPANY 1 EXHIBIT 21 09/10/97 Page 1 Subsidiary Name Only Listing Corporation A.D. Craig Company ASK Colorado Health Care Services, P.C. Advance Orthotics, Inc. Advanced Orthopedic Technologies (Clayton), Inc. Advanced Orthopedic Technologies (Lett), Inc. Advanced Orthopedic Technologies (New Jersey), Inc. Advanced Orthopedic Technologies (New Mexico), Inc. Advanced Orthopedic Technologies (New York), Inc. Advanced Orthopedic Technologies (OTI), Inc. Advanced Orthopedic Technologies (Parmeco), Inc. Advanced Orthopedic Technologies (SFV), Inc. Advanced Orthopedic Technologies (Virginia), Inc. Advanced Orthopedic Technologies (West Virginia),Inc. Advanced Orthopedic Technologies Management Corp. Advanced Orthopedic Technologies, Inc. Advanced Orthopedic Technologies, Inc. Affiliated Physical Therapists, Ltd. Artificial Limb and Brace Center Ather Sports Injury Clinic, Inc. Atlantic Rehabilitation Services, Inc. Boca Rehab Agency, Inc. Bowman-Shelton Orthopedic Service, Incorporated Buendel Physical Therapy, Inc. C.O.A.S.T. Institute Physical Therapy, Inc. CMC Center Corporation CMC Medical Center, P.C. Cannon & Associates, Inc. Cenla Physical Therapy & Rehabilitation Agency, Inc. Center for Physical Therapy & Sports Rehabilitation, Inc. CenterTherapy, Inc. Certified Orthopedic Appliance Co., Inc. Champion Physical Therapy, Inc. ConsulTemps, Inc. Coplin Physical Therapy Associates, Inc. Crowley Physical Therapy Clinic, Inc. Dale Clark Prosthetics, Inc. Douglas Avery & Associates, Ltd. Douglas C. Claussen, R.P.T., Physical Therapy, Inc. Elk County Physical Therapy, Inc. Employee Benefits Management, Inc. Employee Services, Inc. of North Carolina Employers' Risk Management, Inc. Fine, Bryant & Wah, Inc. Francis Naselli, Jr. & Stewart Rich Physical Therapists, Inc. Frank J. Malone & Son, Inc. GP Therapy, L.L.C. Gallery Physical Therapy Center, Inc. 2 Georgia Physical Therapy of West Georgia, Inc. Georgia Physical Therapy, Inc. Greater Sacramento Physical Therapy Associates, Inc. Grove City Physical Therapy and Sports Medicine, Inc. Gulf Breeze Physical Therapy, Inc. Gulf Coast Hand Specialists, Inc. Hand Therapy Associates, Inc. Hand Therapy and Rehabilitation Associates, Inc. Hawley Physical Therapy, Inc. 09/10/97 Page 2 Subsidiary Name Only Listing Heartland Rehabilitation, Inc. Indianapolis Physical Therapy and Sports Medicine, Inc. Industrial Health Care Company, Inc. J. E. Hanger, Incorporated Jim All, Inc. Kesinger Physical Therapy, Inc. Lynn M. Carlson, Inc. Marilyn Hawker, Inc. McFarlen & Associates, Inc. McKinney Prosthetics/Orthotics, Inc. MedStat, P.C. Medical Arts O&P Services, Inc. Metro Rehabilitation Services, Inc. Mica Corporation, Inc. Michigan Therapy Centre, Inc. Mill River Management, Inc. Mitchell Tannebaum I, Inc. Mitchell Tannebaum II, Inc. Mitchell Tannenbaum III, Inc. Monmouth Rehabilitation, Inc. NC (Wisconsin), S.C. NC Cash Management, Inc. NC Occupational Therapy, P.C. NC Physical Therapy, P.C. NC Resources, Inc. New Mexico Physical Therapists, Inc. Northland Regional Orthotic and Prosthetic Center, Inc. Northside Physical Therapy, Inc. NovaCare (Arizona), Inc. NovaCare (Colorado), Inc. NovaCare (Texas), Inc. NovaCare Administrative Employee Services of New York, Inc. NovaCare Administrative Employee Services, Inc. NovaCare Easton & Moran Physical Therapy, Inc. NovaCare Employee Services Club Staff, Inc. NovaCare Employee Services Easy Staff, Inc. NovaCare Employee Services Northeast, Inc. NovaCare Employee Services Resource One, Inc. NovaCare Employee Services TPI, Inc. 3 NovaCare Employee Services of America, Inc. NovaCare Employee Services of Boston, Inc. NovaCare Employee Services of Bradenton, Inc. NovaCare Employee Services of Florida, Inc. NovaCare Employee Services of New York, Inc. NovaCare Employee Services of Orlando, Inc. NovaCare Employee Services, Inc. NovaCare Management Company, Inc. 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 East, Inc. NovaCare Outpatient Rehabilitation I, Inc. NovaCare Outpatient Rehabilitation West, Inc. NovaCare Outpatient Rehabilitation, Inc. NovaCare Rehab Agency of Alabama, Inc. 09/10/97 Page 3 Subsidiary Name Only Listing NovaCare Rehab Agency of Florida, Inc. NovaCare Rehab Agency of Georgia, Inc. NovaCare Rehab Agency of Illinois, Inc. NovaCare Rehab Agency of Kansas, Inc. NovaCare Rehab Agency of Missouri, Inc. NovaCare Rehab Agency of New Jersey, Inc. NovaCare Rehab Agency of North Carolina, Inc. NovaCare Rehab Agency of Northern California, Inc. NovaCare Rehab Agency of Ohio, Inc. NovaCare Rehab Agency of Oklahoma, Inc. NovaCare Rehab Agency of Oregon, Inc. NovaCare Rehab Agency of Pennsylvania, Inc. NovaCare Rehab Agency of South Carolina, Inc. NovaCare Rehab Agency of Southern California, Inc. NovaCare Rehab Agency of Tennessee, Inc. NovaCare Rehab Agency of Virginia, Inc. NovaCare Rehab Agency of Washington, Inc. NovaCare Rehab Agency of Wyoming, Inc. NovaCare Rehabilitation Agency of Wisconsin, Inc. NovaCare Rehabilitation, Inc. NovaCare Service Corp. NovaCare Speech Therapy & Audiology, Inc. NovaCare, Inc. NovaCare, Inc. (Delaware) NovaFunds, Inc. NovaMark, Inc. NovaMed, Inc. NovaStock, Inc. OSI Midwest, Inc. 4 Opus Care, Inc. Ortho East, Inc. Ortho Rehab Associates, Inc. Ortho-Fab Laboratories, Inc. Orthopedic Rehabilitative Services, Ltd. Orthopedic and Sports Physical Therapy of Cupertino, Inc. Orthotic & Prosthetic Rehabilitation Technologies, Inc. Orthotic and Prosthetic Associates, Inc. Peters, Starkey & Todrank Physical Therapy Corporation Physical Focus, Inc. Physical Rehabilitation Partners, Inc. Physical Therapy Institute, Inc. Professional Insurance Planners of Florida, Inc. Professional Orthotics and Prosthetics, Inc. Professional Orthotics and Prosthetics, Inc. of Santa Fe Progressive Orthopedic Prosthetics-Orthotics Associates, Inc. Quad City Management, Inc. Quad City Regional Spine Institute, P.C. 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 Managed Care of Arizona, Inc. 09/10/97 Page 4 Subsidiary Name Only Listing Rehab Provider Network - California, Inc. Rehab Provider Network - Delaware, Inc. Rehab Provider Network - Georgia, Inc. Rehab Provider Network - Illinois, Inc. Rehab Provider Network - Indiana, 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 Colorado, Inc. Rehab Provider Network of Florida, Inc. Rehab Provider Network of Nevada, Inc. Rehab Provider Network of New Mexico, Inc. Rehab Provider Network of Texas, Inc. Rehab Provider Network of Wisconsin, Inc. 5 Rehab World, Inc. Rehab/Work Hardening Management Associates, Ltd. RehabClinics (Coast), Inc. RehabClinics (Galaxy), Inc. RehabClinics (New Jersey), Inc. RehabClinics (PTA), Inc. RehabClinics (SPT), Inc. RehabClinics Abilene, Inc. RehabClinics Dallas, Inc. RehabClinics Pennsylvania, Inc. RehabClinics, Inc. Rehabilitation Fabrication, Inc. Robert M. Bacci, R.P.T., Physical Therapy, Inc. Robin-Aids Prosthetics, Inc. Rx One, Inc. S.T.A.R.T., Inc. SG Rehabilitation Agency, Inc. SG Speech Associates, Inc. Salem Orthopedic & Prosthetic, Inc. San Joaquin Orthopedic, Inc. South Jersey Physical Therapy Associates, Inc. Southpointe Fitness Center, 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. Staffing Technologies, Inc. Star Physical Therapy, Inc. Start to Finish Therapy, P.C. Stephenson-Holtz, Inc. T.J. Partnership I TJ Corporation I, L.L.C. Texoma Health Care Center, Inc. The Center for Physical Therapy and Rehabilitation, Inc. The Orthopedic Sports and Industrial Rehabilitation Network, Inc. Theodore Dashnaw Physical Therapy, Inc. Therex, P.C. 09/10/97 Page 5 Subsidiary Name Only Listing Treister, Inc. Union Square Center for Rehabilitation & Sports Medicine, Inc. Vanguard Rehabilitation, Inc. Wayzata Physical Therapy Center, Inc. West Side Physical Therapy, Inc. West Suburban Health Partners, Inc. Western Rehab Services, Inc. WorkCare, L.L.C. Workers Rehabilitation Services, Inc. EX-23 12 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 July 31, 1997 appearing on page 50 of this Form 10-K. PRICE WATERHOUSE LLP Philadelphia, PA September 19, 1997 EX-27 13 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AS OF JUNE 30, 1997 AND THE CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED JUNE 30, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH STATEMENTS IN FORM 10-K FOR THE FISCAL PERIOD ENDED JUNE 30, 1997. 0000802843 NOVA CARE, INC. 1,000 U.S. DOLLARS YEAR JUN-30-1997 JUL-01-1996 JUN-30-1997 1 22,716 0 289,740 (33,263) 18,450 329,895 141,067 (71,327) 1,014,304 156,319 326,700 0 0 666 507,340 1,014,304 0 1,066,451 0 952,654 12,044 19,708 15,244 66,801 27,891 38,910 0 0 0 38,910 .62 .62 "Total Costs" consist of cost of services and selling and administrative expenses. "Other Expenses" consist of amortization of goodwill and minority interest offset by interest income.
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