-----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, QerljHyFcHq67hmpdhIdx25T5hgDQ7VmP4eiGHzy4LqrplGrSjMY3URRV+DXrH7A cZh/43ocTLZvp7Q8rtrjcw== 0000893220-98-001493.txt : 19980917 0000893220-98-001493.hdr.sgml : 19980917 ACCESSION NUMBER: 0000893220-98-001493 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980916 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: NOVACARE INC CENTRAL INDEX KEY: 0000802843 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MISC HEALTH & ALLIED SERVICES, NEC [8090] IRS NUMBER: 133247827 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-10875 FILM NUMBER: 98710012 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-K405 1 NOVACARE, INC. FORM 10-K405 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, 1998 Commission file number 1-10875 NOVACARE, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 13-3247827 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.) 1016 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. [X] AS OF SEPTEMBER 7, 1998, 62,535,789 SHARES OF COMMON STOCK WERE OUTSTANDING, AND THE AGGREGATE MARKET VALUE OF THE SHARES OF COMMON STOCK HELD BY NON-AFFILIATES WAS APPROXIMATELY $387,620,825. (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 1998 ANNUAL MEETING OF SHAREHOLDERS TO BE HELD ON NOVEMBER 5, 1998. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 NOVACARE, INC. AND SUBSIDIARIES FORM 10-K -- FISCAL YEAR ENDED JUNE 30, 1998 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.................................. 2 Company Strategy..................................... 4 Outpatient Services.................................. 5 Strategy Statement................................ 5 Plan for Growth and Operations.................... 5 Business Profile.................................. 6 Competition....................................... 8 Reimbursement/Government Relations................ 9 Government Regulation............................. 9 Long-term Care Services.............................. 10 Strategy Statement................................ 10 Plan for Growth and Operations.................... 11 Business Profile.................................. 12 Competition....................................... 14 Reimbursement/Government Relations................ 15 Government Regulation............................. 16 Employee Services.................................... 16 Strategy Statement................................ 16 Plan for Growth and Operations.................... 17 Business Profile.................................. 18 Competition....................................... 20 Government Regulation............................. 20 Insurance............................................ 23 Employees............................................ 23 Executive Officers of the Registrant................. 24 2 Properties.................................................. 25 3 Legal Proceedings........................................... 25 4 Submission of Matters to a Vote of Security Holders......... 25 II 5 Market for Registrant's Common Equity and Related Stockholder Matters....................................... 26 6 Selected Financial Data..................................... 27 7 Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 28 8 Financial Statements and Supplementary Data................. 36 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................. 56 III 10 Directors and Executive Officers of the Registrant.......... 56 11 Executive Compensation...................................... 56 12 Security Ownership of Certain Beneficial Owners and Management................................................ 56 13 Certain Relationships and Related Transactions.............. 56 IV 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K....................................................... 56 Signatures......................................................................... 57
i 3 PART I ITEM 1. BUSINESS THE COMPANY Overview NovaCare, Inc. ("NovaCare" or the "Company") was formed in 1985 and is a national leader in physical rehabilitation services and employee services. In physical rehabilitation services, the Company treats 47,000 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 physical therapy and rehabilitation services and, through its 71% owned subsidiary NovaCare Employees Services, Inc. ("NCES"), the second largest employee services provider, 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. Physical rehabilitation services are the processes that restore individuals disabled by trauma, injury or disease to their optimal level of functionality and self-sufficiency. Across the health care spectrum, over 80% of individuals receiving physical rehabilitation services return to the community in productive endeavors or to active retirement. NovaCare's physical rehabilitation services are provided in two industry segments: (i) outpatient services -- providing outpatient physical therapy and rehabilitation, orthotic and prosthetic ("O&P") and occupational health rehabilitation services through a national network of patient care centers, and (ii) long-term care services -- providing rehabilitation therapy and health care consulting services on a contract basis to health care institutions, primarily long-term care facilities and acute care hospitals. The Company's employee services consist of comprehensive, fully integrated outsourcing solutions to human resource services, including payroll management, workers' compensation, risk management, benefits administration, unemployment services and human resource consulting services generally provided to small and medium-sized businesses through NCES. The Company believes it offers better solutions at the best value by providing a convenient integrated complement of services. The Company creates relationships with both its clients and worksite employees by contractually assuming certain administrative, regulatory and financial employer responsibilities with respect to worksite employees in a "co-employment" relationship. Corporate and Capital Structure Change NovaCare's strategy remains constant, however, a rapidly changing industry environment may dictate a new corporate and capital structure. The most critical success factor in all of the Company's businesses is recognizing and meeting the unique needs of its different customers. Clearly, the needs of long-term care providers are quite different from the needs of the payers, physicians and employers in the Company's outpatient services customer base. The capital requirements of the long-term care and outpatient services businesses also differ. NovaCare's long-term care business requires relatively little capital for growth. Stock price multiples in the long-term care sector are expected to be low for the foreseeable future, given the investment community's uncertainty regarding the recent changes in Medicare reimbursement. See "Reimbursement/Government Relations" discussed later. In contrast, the very fragmented outpatient services business offers substantial consolidation opportunities, with a corresponding need for capital to fund acquisitions. A stock with a higher price-earnings multiple that is typical of outpatient services industries would afford an attractive currency for strategic acquisitions and for raising capital. For all of these reasons, the Company is considering separating its physical rehabilitation services businesses into two publicly held companies -- a long-term care, geriatric-oriented business and an outpatient physical rehabilitation-oriented business. The precise course and timing the Company will follow depends on a variety of capital markets, tax, regulatory and operational issues. 1 4 INDUSTRY BACKGROUND Outpatient Services Outpatient services are rendered primarily in outpatient rehabilitation facilities, rehabilitation hospitals, rehabilitation units in acute care hospitals, rehabilitation clinics, industrial settings, schools and patients' homes. Health care professionals providing these services include physical and occupational therapists, physiatrists and other qualified rehabilitation physicians, orthotists, prosthetists, recreational therapists, rehabilitation counselors and others. The current market opportunity in outpatient services, inclusive of outpatient physical therapy and rehabilitation, O&P, occupational health and physician support services, is approximately $30 billion. The Company believes that the industry will grow at 5% per year due primarily to the following three factors: Proven cost-effectiveness of services. Providing outpatient services to patients who have suffered severe injury or disease can improve the patients' quality of life and return employees to the work place faster. Such services attempt to prevent short-term disabilities from becoming chronic conditions and to speed recovery from surgery and musculoskeletal injuries. A 1995 study by Health Insurance Corporation of America reported that for every dollar spent on rehabilitation services, $30 in future health care, lost wages, legal and other costs are saved. Purchasers and providers of outpatient services are seeking ways to reduce health care costs. Outpatient services health care professionals are able to provide services at lower costs than hospitals because of their lower overhead costs. Increased demand for services. Each year more than three million people are seriously injured due to auto accidents, sports injuries, strokes, heart attacks and other serious medical occurrences. These persons typically require outpatient services in order to regain their functionality. The high quality of life expectations for disabled people, the aging population and technological advances continue to drive demand for outpatient services. Comprehensive reimbursement for services. A broad array of payers cover the cost of outpatient services, including commercial health insurance, workers' compensation, managed care plans, employers, government programs and patients. Long-Term Care Services Depending on an individual's diagnostic and therapeutic needs, long-term care services are delivered primarily in skilled nursing facilities, acute care hospitals, rehabilitation agencies, patients' homes and assisted living facilities. These services are provided by a variety of health care professionals including occupational and physical therapists, speech-language pathologists, audiologists, respiratory therapists, physiatrists, rehabilitation nurses, social workers and others. Recent industry analysis suggests that the rehabilitation portion of long-term care services is an approximately $3.5 billion industry which is expected to grow by 5% per year. NovaCare believes that the industry's growth has been fueled primarily by the following three factors: Increased demand for services. Reimbursement for services, advances in technology, the aging population and high quality of life expectations for disabled and elderly people continue to drive demand for long-term care services. The reimbursement systems for patients in acute care hospitals encourages their discharge while they remain in need of rehabilitation services. Technological advances in medical care have lengthened lifespans and improved the quality of life for patients who have suffered 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 which is expected to increase 18% from 1996 to 2010 and 75% from 2010 to 2030. This group, among the 35 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. 2 5 Proven cost-effectiveness of services. Several studies have proven that the long-term care setting is a cost-effective setting for rehabilitation. An American Health Care Association 1995 study compared two groups of stroke and orthopedic patients and found that the functional outcomes for the group treated in skilled nursing facilities were the same as outcomes for the group treated in acute care hospitals; however, the cost of treatment in the skilled nursing facility was on average 30% lower than the cost of treatment in an acute care hospital. This study supported the findings of a similar report on stroke patients published in the Archives of Physical Medical Rehabilitation. Comprehensive reimbursement for services. Payments for long-term care services are covered by Medicare and Medicaid and are typically covered by commercial health insurance policies and managed care plans. Under the Omnibus Budget Reconciliation Act of 1987, long-term care facilities that participate in the Medicare program are required to offer physical therapy, occupational therapy and speech-language pathology services to improve the functionality of patients. Employee Services According to industry analysts, the PEO industry has approximately $22 billion in annual revenues with a historical growth rate over the last five years of approximately 30% per year. According to the U. S. Small Business Administration, there are nearly six million businesses in the United States with fewer than 500 employees, employing more than 52 million persons and with $1.2 trillion in aggregate annual payroll. The National Association of Professional Employer Organizations ("NAPEO") estimates that the PEO industry employs fewer than three million worksite employees. The Company believes, therefore, that approximately 49 million of these employees are currently unserved by the PEO industry. The PEO industry is highly fragmented. NAPEO data suggest that there are at least 2,400 PEOs currently in operation. According to industry analysts, the ten largest PEOs account for approximately 35% of existing revenues in the industry. The Company believes that significant consolidation opportunities exist within the PEO industry due to increasing industry regulatory complexity and capital requirements associated with developing larger service delivery infrastructures, more diversified services and more sophisticated management information systems. Demand for Services. The PEO industry evolved in the early 1980's in response to increasing employment and benefit costs, and the complexities of the legal and regulatory environment for the rapidly expanding small- to medium-sized business sector. The Company believes demand for PEO services will continue to increase as: (i) employment-related governmental regulation grows more complex, (ii) growth continues within the small- to medium-sized business community, (iii) the need to provide health and retirement benefits in a cost-effective convenient manner increases, and (iv) the business and regulatory communities accept and recognize the PEO industry. While various service providers, such as payroll processing firms, benefits and safety consultants and temporary services firms, are available to assist these businesses with specific tasks, such organizations do not typically provide the more comprehensive range of services generally offered by PEOs. PEOs enter into agreements with numerous small- to medium-sized employers, and can, therefore, achieve economies of scale as professional employers and offer benefits packages and human resource services at a level typically available only to larger companies which have greater resources to devote to human resources management. The Company believes PEO services will continue to experience growing demand because of the growing trend among small- to medium-sized employers to: (i) outsource non-core competencies, (ii) seek to reduce employee benefit costs, (iii) avoid employee-related risks and regulatory complexities, and (iv) attract better employees and retain them through improved benefit plans. Effectiveness of Services. According to estimates by the U.S. Small Business Administration, the management of 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 according to the survey): cost of health insurance (1), workers' compensation costs (3), federal 3 6 paperwork (7), frequent changes in federal tax laws (9), finding qualified employees (11), and state/local paperwork (13). Work-related injuries cost employers over $53 billion in medical expenses and lost employee productivity each year, according to industry estimates. Employees are typically attracted to small and medium-sized businesses that provide them with an array of human resources benefits and services typically characteristic of large employers. An industry analyst's study indicated that 40% of the companies that outsourced services to a PEO upgraded their employee benefits offerings and one-fourth of those clients offered health care and other benefits for the first time. 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 Outpatient and Long-term To effectively meet the rehabilitation and health care Care Services service needs of our patients through clinical leadership. Employee Services To effectively provide better human resource solutions at the best value to our customers through service leadership.
It is management's belief that NovaCare's values unify the Company and mandate an open, participative and empowered environment. Health care is changing at a remarkable pace and NovaCare is expanding into new businesses. The Company's values-based culture enables NovaCare to set aside the organizational anxiety and self-interest that often accompany change. The pursuit of the Company's values unlocks NovaCare's inherent capacity to drive change, creating substantial opportunity. It is management's opinion that NovaCare's people, values-driven culture and capacity for change are its greatest strengths and its competitive advantage Strategy Statement NovaCare's strategy is to achieve a leading market position in each of its businesses. Each of the industry sectors in which the Company participates is large, fragmented, growing and suit the Company's core competencies: outsourcing, information technology, human resource management, and consolidation and integration. Outsourcing. NovaCare provides cost-effective outsourced solutions to business. The Company's ability to understand and anticipate the needs of customers, while smoothly integrating into their operations, allows NovaCare's customers to focus on their business' core competencies. NovaCare provides services that its customers may not have the necessary scale, expertise, time or staff to provide themselves. 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. For example, in response to the changes in reimbursement from Medicare to long-term care providers, NovaCare is currently enhancing its long-term care services business information systems that track patient assessment, utilization, census, case mix and outcomes. This same information technology capability that adds value for customers is utilized to improve NovaCare's efficiency and profitability. 4 7 Human Resource Management. Due to the historically competitive environment for clinical rehabilitation professionals, NovaCare has developed strong capabilities to attract and retain employees, a critical success factor in service industries. With approximately 20,000 employees working in small groups in customer long-term care facilities and NovaCare outpatient centers, the Company has experience in effectively managing a highly dispersed workforce on a national level. Consolidation and Integration. NovaCare believes that its consolidation and integration program allows the Company to achieve the scale economies 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. OUTPATIENT SERVICES STRATEGY STATEMENT NovaCare's outpatient services strategy is to leverage its core competencies to expand its local market presence and enhance relationships with providers and payers to achieve market leadership. The strategy is based on management's belief that: - Health care is a local business. Local market growth is dependent upon relationships with physicians, hospitals, post-acute care and managed care delivery systems, employers and payers. - The highest margins in a market generally accrue to the provider with the greatest regional market share and scale. - 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. - Outpatient physical therapy and 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. - Purchasers of outpatient physical therapy and rehabilitation services will continue to emphasize cost-effective, clinically proven outcomes in the selection of rehabilitation providers. - Clinical superiority through technological leadership should produce a clear competitive advantage. - Costs can be lowered through clinical, operational and information systems innovations coupled with "flat" organizations having broad spans of control. PLAN FOR GROWTH AND OPERATIONS The Company's outpatient services growth plan has four principal components: (i) attain the leading position in target markets, (ii) develop occupational health services, (iii) focus growth efforts in select target markets, and (iv) ensure clinical leadership and outcomes. Attain the Leading Position in Target Markets. NovaCare plans to continue to expand the Company's extensive network of outpatient services 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 health care delivery systems and to compete for referrals from managed care organizations, physician groups, hospitals and commercial customers. In fiscal 1998, the Company acquired 90 outpatient services businesses with aggregate pro forma annual revenues of $160 million, increasing its network of facilities by 41% to 910 locations. 5 8 Develop Occupational Health Services. Occupational health integrates injury prevention with physician services, rehabilitation, case management and other ancillary services to return work-injured employees 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 workplace injury. The system includes a network of physician practices specializing in occupational health care, which oversees 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 physical therapy and 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 physical therapy and rehabilitation services, capitalize on patient flow synergies and further position NovaCare for affiliation with hospital systems, managed care payers and commercial customers. Focus Growth in Select Target Markets. NovaCare intends to build and maintain leading market positions in 15 target geographic markets by leveraging relationships with leading health care providers in these target markets. The Company's goal is to enhance referral and health care system relationships, increase brand awareness and leverage its clinical resources and infrastructure investments in target markets. Management believes that with its combined outpatient services network, NovaCare is in a strong position to meet the needs of health care systems in a local or regional market. NovaCare offers the attributes that health care system partners find attractive: (i) dispersed outpatient services capabilities, (ii) cost-effective, clinically proven outcomes, and (iii) the financial ability to support network growth. Ensure Clinical Leadership and Outcomes. In a health care marketplace seeking the highest quality outcomes at the lowest possible costs, NovaCare believes that standardized, clinically proven treatment protocols can achieve superior results at a predictable cost. Innovative service and product offerings provides clinical differentiation. NovaCare's research and development efforts, particularly in O&P, are recognized worldwide for their achievements which improve the quality of life for patients. Carefully documented clinical outcomes, including functional improvement and patient satisfaction, are provided by the Company to referral sources and payers. BUSINESS PROFILE Outpatient services comprise: (i) outpatient physical therapy and rehabilitation services, (ii) O&P, and (iii) occupational health rehabilitation services. For the fiscal years ended June 30, 1998 and 1997, outpatient services represented 31% and 34%, respectively, of the Company's net revenues. Management believes that NovaCare is the second largest provider of freestanding outpatient physical therapy and rehabilitation services in the United States, with a national network of 506 centers, comprising stand-alone clinics, hospital-based clinics and employer on-site clinics in 29 states. Through these settings, approximately 1,000 licensed physical and occupational therapists develop individual treatment plans and utilize a sports medicine approach to rehabilitate patients and manage recovery from orthopedic surgery, injuries and disease-related conditions. Outpatient physical therapy and rehabilitation services include: (i) general rehabilitation, which is designed to return injured and post-operative patients to their optimal functional capacity, (ii) sports rehabilitation, which is designed to minimize the "downtime" of injured sports participants and safely return them to sports activities, (iii) 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 (iv) hospital-based services, which involve the provision of inpatient and outpatient rehabilitation services on a contract basis to acute care hospitals. 6 9 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," without a physician's referral. NovaCare rehabilitates and conditions the athletes of 20 professional sports teams and more than 300 college and high school athletic programs. Analysts estimate that the outpatient physical therapy and rehabilitation industry approximates $6 billion. NovaCare's share of the industry total, based on fiscal 1998 revenues, is approximately 4%. NovaCare is the largest custom O&P patient care services organization in the U.S. with an approximate 16% market share of a $1.6 billion industry, based on fiscal 1998 revenues. Services are provided by 780 orthotists and prosthetists, referred to as practitioners, through 365 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(R) 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 sources for O&P rehabilitation services are vascular and orthopedic surgeons, primary care physicians, case managers and amputee support groups. However, other specialized physicians, such as physiatrists, and managed care payers have emerged as important referral sources. Secondary referral sources include physical therapists, orthopedic nurses, orthopedic technicians and other rehabilitation professionals. An O&P practitioner consults with the referring physician and the patient to formulate a prescription for and the design of a device that meets the patient's needs. The fitting process involves several phases in order to achieve the desired functional and cosmetic results. The average prosthetic patient visit requires one extended visit, followed by several shorter visits during the fitting process. Checkups and servicing occur once every two years, or several times a year for more active patients. The average orthotic patient visits are more variable because of the broad range of orthotic devices. Generally, there is one extended visit and a follow-up visit. The O&P device and patient care are priced on an all-inclusive basis and have a six-month warranty. Devices typically need replacement every three to five years. 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 specialized occupational health physicians, general practitioners, physicians assistants, physiatrists and physical therapists in a variety of settings, including specialized occupational health clinics, specialized occupational health Preferred Provider Organization ("PPO") networks, general health care clinics and physician offices and hospital emergency departments. The care providers generally are trained and experienced in occupational and industrial medicine or have other medical backgrounds compatible with work-related injuries. Customers for occupational health services are workers' compensation insurance companies, commercial and government self-insured employers that operate through third-party administrators, and employees covered by various insurance programs. The occupational health services market is highly fragmented and many providers of occupational health care, such as hospital emergency departments and general practitioners, are not specialized in occupational health care. The Company believes that, due to increasing business and regulatory complexity, capital requirements and the development of health care systems in local and regional markets, an increasing number 7 10 of physicians specializing in occupational health services are seeking to affiliate with larger health care service organizations. Industry analysts estimate that there are more than 2,000 occupational health care locations in the United States, representing a $30 billion industry. Management estimates that approximately 95% of these centers are privately held, single-center businesses. The occupational health industry can be broadly divided into two categories: injury services and non-injury services. The injury services market consists of physicians, therapists and other health care professionals that provide the actual medical care for injured workers. The market for injury services is estimated to be about $22 billion, consisting of $4 billion in primary-care services and $18 billion in specialist and hospital care. The non-injury services market comprises case management, utilization management, bill review, claims processing, other administrative services and prevention programs related to managing an employer's workers' compensation program. The market for non-injury services is estimated to be about $4 billion. Some occupational health companies provide both injury and non-injury services, while others specialize in one or the other. NovaCare specializes in injury services and prevention programs. 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 state regulated requirement that employers pay the majority of lost wages, replacement wages, legal and other benefit expenses. In the aggregate, currently, workers' compensation costs amount to $70 billion annually in the United States. An occupational health service is an employer's solution to controlling workers' compensation costs attributable to medical costs and lost time from work. Trends in workers' compensation and the general business environment favor growth of the occupational health industry. As both the volume of workers' compensation injuries and the cost per injury continue to increase in a competitive, cost-oriented business environment, employers and insurance companies will increasingly seek ways to reduce such costs. Work-related injuries are more costly to treat because they require longer durations of care and result in more frequent visits to health care providers than comparable non-work injuries; as such, specialized occupational health companies that have expertise in returning injured employees to work quickly and cost effectively are best positioned to benefit from future growth. NovaCare is one of the five largest occupational health services provider managing work injury rehabilitation and prevention programs for employers through on-site programs and outpatient care through the Company's 39 freestanding occupational health centers and its 506 outpatient rehabilitation clinics. NovaCare performs work-site analyses to assess workplace risk, provides work-site safety programs and helps employers comply with work-related state and federal requirements. 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 physical therapy and rehabilitation and increase the attractiveness of the Company to workers' compensation insurers, commercial customers and potential health care system affiliates. COMPETITION The health care industry in general, and rehabilitation in particular, is highly competitive and subject to continual changes in methods of service delivery and provider selection. Rehabilitation is largely a local market business and competition varies considerably among markets. NovaCare competes primarily in the 15 target geographic markets 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. The Company believes that its national and local sponsorship and support of organizations for injured and disabled individuals and affiliations with professional sports teams enhance NovaCare's visibility, brand recognition and competitive position. 8 11 In the outpatient physical therapy and rehabilitation business, key competitive factors include the ability to: (i) develop and maintain relationships with referral sources (physicians, rehabilitation professionals, hospitals and payers), and (ii) 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: (i) its reputation for quality and service, (ii) an ability to provide geographic coverage and competitive prices, (iii) affiliation with health care systems, and (iv) 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) returning employees to work quickly at the lowest cost for the care provided, (ii) expertise in treating work-related injuries, (iii) relationships with employers, employees and payer sources, and (iv) information systems to analyze utilization and outcome data. REIMBURSEMENT/GOVERNMENT RELATIONS The principal sources of reimbursement for outpatient services are commercial insurance, workers' compensation insurance, managed care plans, motor vehicle insurance, Medicare, Medicaid, and individual patients. Commercial Insurance. Traditional indemnity insurance plans constituted 24% of outpatient services' fiscal 1998 net revenues. Workers' Compensation. Workers' compensation is a state mandated, comprehensive insurance program that requires employers to fund medical expenses, lost wages and other costs resulting from work-related injuries and illnesses. (See "Government Regulation" in the "Employee Services" section below.) Workers' compensation represented approximately 18% of fiscal 1998 outpatient services' net revenues. Managed Care. NovaCare receives revenues under managed care plans either on a discounted fee-for-service basis or, in a growing number of cases, on the basis of capitated fees per covered member per month. Managed care plans represented approximately 18% of fiscal 1998 outpatient services' net revenues. Medicare and Medicaid. NovaCare receives reimbursement by Medicare and Medicaid 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 Medicaid insurance programs represented approximately 23% of net revenues for outpatient services in fiscal year 1998. GOVERNMENT REGULATION The health care industry, including outpatient services, is subject to extensive Federal, state and local regulation. Various layers of regulation affect NovaCare's business by requiring licensure or certification of its employees and facilities and controlling reimbursement for services provided. Government and other third-party payers' health care policies and programs have been subject to changes in payment and methodologies for a number of years. NovaCare operates certified rehabilitation agencies to facilitate billing for a portion of its outpatient services. In order to receive Medicare reimbursement directly, outpatient centers must be certified by Medicare as rehabilitation agencies or comprehensive outpatient rehabilitation facilities. The certification 9 12 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, 1998, NovaCare operated 97 certified rehabilitation agencies for outpatient services. 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 compliance program to ensure conformance with these rules as well as other laws and regulations. LONG-TERM CARE SERVICES STRATEGY STATEMENT The Company's long-term care services strategy is to leverage its core competencies to capitalize on structural change in the industry and further enhance its market leadership. The strategy is grounded in management's belief that: - Health care services in long-term care settings are changing dramatically as a result of the Balanced Budget Act of 1997 (the "BBA"). See "Reimbursement/Government Relations" discussed later. The new reimbursement policies promulgated by the BBA shift from a cost-based reimbursement to a per diem and fee schedule based reimbursement, reducing the amount reimbursed per patient. In management's opinion, this shift in reimbursement makes outsourcing alternatives even more attractive to long-term care providers, converting fixed costs to variable costs. - Reimbursement expertise and the ability to educate long-term care providers regarding the BBA will maximize opportunities and minimize risks for long-term care services providers. - Advanced information technology will differentiate providers based on their ability to support complex patient information and reimbursement requirements. - Reimbursement changes set forth in the BBA will change the clinical delivery model staffing mix from that dominated by registered therapists to expanded use of trained assistants and aides supervised by therapists, without a decline in clinical outcomes. Such a shift in caregivers will require experience, on a national scale, in work force recruiting, training, deployment and labor cost management. - Differentiated clinical programs in long-term care settings will attract higher acuity patients and increase census, which will be necessary to drive revenue growth for long-term care providers. 10 13 - The aging of the population will increase the demand for long-term care services as the elderly consume a disproportionate amount of rehabilitation care. - Costs can be lowered through clinical and information system innovations coupled with "flat" management organizations having broad spans of control. PLAN FOR GROWTH AND OPERATIONS NovaCare's long-term care services business growth plan has five elements: (i) capitalize on reimbursement expertise, (ii) manage census and acuity, (iii) enhance information system capabilities, (iv) ensure clinical leadership and measurable outcomes, and (v) reduce labor costs. Capitalize on Reimbursement Expertise. Medicare is the predominant payer of rehabilitation services to the long-term care industry. See "Reimbursement/Government Relations" discussed later. From July 1, 1998 through June 30, 1999, skilled nursing facilities are in a period of transition from cost based reimbursement, under salary equivalency guidelines, to fixed fee reimbursement under the prospective payment system ("PPS") for Medicare Part A services and fee schedule reimbursement for Medicare Part B services. This transition is one of the most sweeping changes for skilled nursing facilities since Medicare's inception. PPS changes are to be implemented at various times throughout the aforementioned period, depending upon a facility's cost-reporting year. Fee schedule reimbursement will take effect January 1, 1999. While attempting to effectively manage the implementation of these sweeping changes at varying times throughout the twelve month period, nursing and hospital facilities serving long-term care patients are grappling with delivering quality care while lowering costs enough to achieve a reasonable profit margin with Medicare's fixed per diem rates and fee schedules. NovaCare expects to capitalize on its reimbursement expertise to educate long-term care providers with regard to changes in Medicare reimbursement and service delivery to maximize their opportunities and minimize their risk. Manage Census and Acuity. PPS aligns reimbursement for services provided with patient acuity. The greater the patient acuity, the higher the level of reimbursement. Patients requiring rehabilitation services are among those receiving the highest level of reimbursement. NovaCare plans to continue its joint efforts with its long-term care customers to provide a cost-effective, high quality clinical care program that attracts high acuity rehabilitation patients. Enhance Information Systems Capabilities. The BBA increased the information requirements for long-term care patients, making reimbursement dependent on the timeliness and accuracy of specific information. The Company is currently enhancing its NovaNet PLUS information system to integrate with customer information systems and track patient assessments, utilization, census, case mix and outcomes. Ensure Clinical Leadership and Measurable Outcomes. Management believes that payers will ultimately demand that low cost be accompanied by proof of quality outcomes. The Company has developed 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. Reduce Labor Costs. The Company intends to continue to position itself as a low-cost provider of quality long-term care rehabilitation services. Clinical and technological improvements and innovation, coupled with an optimal operating and staffing model, are expected to lower the cost of service delivery. Management believes its efforts to flatten and increase the flexibility of the organization to respond to change, and its investment in efficiency enhancing clinical and administrative systems, will allow the Company to operate successfully in an increasingly challenging reimbursement environment. 11 14 BUSINESS PROFILE NovaCare's long-term care services portfolio consists of contract therapy and management consulting delivered principally to long-term care providers and hospitals. For the fiscal years ended June 30, 1998 and 1997, long-term care services represented 39% and 53%, respectively, of the Company's net revenues. Contract Rehabilitation Services NovaCare provides multi-disciplinary rehabilitation therapy services on a contract basis to skilled nursing and assisted living facilities and hospitals. The multi-disciplinary team comprises physical and occupational therapists and assistants, speech-language pathologists and assistants, and rehabilitation aides 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 independent contract rehabilitation provider to the long-term care industry. Analysts estimate that the market for therapy services delivered under contract to long-term care facilities is approximately $3.5 billion. The Company's market share is approximately 19%, as measured by fiscal 1998 net revenues. As of June 30, 1998, NovaCare provided these services in approximately 1,915 facilities located in 43 states. 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. The economics for a nursing facility to operate its therapy program were exacerbated by the BBA, which is expected to further reduce the scale of nursing home therapy practices. Expertise. Therapy revenues represent a relatively small percentage of a long-term care facility's total revenues and operating activities. Reimbursement and regulatory complexities concerning appropriate patient assessment, 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, especially in view of the changing reimbursement environment. Innovative Service Offerings. Under an exclusive proprietary arrangement with Nautilus(TM), NovaCare and Nautilus(TM) have jointly developed resistance training equipment uniquely designed for senior citizens. This specially adapted strength and conditioning equipment coupled with exclusive therapy protocols developed by NovaCare were being utilized in 86 long-term care services sites as of June 30, 1998, as an inpatient and outpatient community-based wellness program known as "Vigor"(SM). Employer of Choice Programs. NovaCare's "Employer of Choice" initiatives comprise defined career ladders for clinical staff, training and competitive compensation and benefit programs, as well as management and technological support designed to attract and retain clinicians. At June 30, 1998, NovaCare employed 56 recruiters. 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. NovaCare has been successful in hiring therapists and clinical extenders (assistants and aides) due in part to its "Employer of Choice" programs and clinical and systems support networks. The number of full-time-equivalent therapists and extenders hired in the Company's contract rehabilitation business during fiscal 1998 was 2,988. 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. 12 15 Systems Support. NovaCare's proprietary information system, NovaNet PLUS, reduces therapist recordkeeping 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. Information that is critical for patient and reimbursement management under the BBA are being incorporated into the system for fiscal 1999. Management believes that this innovative system enhances 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. During fiscal years 1995 through 1998, NovaCare reduced its dependence on national multi-facility, long-term care companies. The percentage of NovaCare's long-term care services net revenues attributable to national multi-facility, long-term care companies declined to 25% at June 30, 1998 from 38% and 42% at June 30, 1997 and 1996, respectively, and from 47% at June 30, 1994. The Company is in the process of transitioning its two largest long-term care services customers to in-house therapy programs. The June 30, 1998 percentage of long-term care services' net revenues attributable to national chains, excluding these two customers was 8%. Business lost due to the in-house transition has been replaced with predominantly regional and independent customers, diversifying the Company's customer base and increasing long-term care services' net revenues from $523.3 million in fiscal 1996 to $656.9 million in fiscal 1998. Other than the impact of the Company's two largest long-term care services customers transitioning to in-house therapy programs, 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. Of the 18,000 long-term care facilities in the United States, only approximately 4,100 are associated with large multi-facility long-term care companies. However, there may be no assurance that customers will not transition to in-house therapy programs and that the Company will be able to continue to replace contracts cancelled as a result of in-house conversions. NovaCare's therapist turnover in the contract rehabilitation business decreased in fiscal 1998 to 34% from 35% in fiscal 1997. Therapist turnover initiated by employees decreased from 31% in fiscal 1997 to 23% in fiscal 1998. The balance of therapist turnover was based on the Company's decision to terminate employment, principally due to in-house conversions. Therapist turnover rates in long-term care facilities have traditionally been higher than in other therapy settings. NovaCare has been compensated for its long-term care 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 long-term care services' net revenues 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 unless terminated. The pricing of services is generally stated in single year terms and renegotiated annually. Contracts are typically terminable upon 30 to 90 days' notice by either party. Contract turnover, exclusive of in-house conversion, has also declined to 3% in fiscal 1998 from 5% in fiscal 1997. 13 16 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 that is responsive 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 support of business growth, and (vii) reimbursement and regulatory expertise to assist long-term care facility operators in their dealings with third-party payers, principally Medicare. Health Care Management Consulting and Information Services The Company also delivers facility rehabilitation program management, consulting and information services to health care and long-term care institutions. Health Care Management Consulting Services. The Company provides rehabilitation program consulting and health care management services to long-term care and hospital facilities through the Polaris Group, a NovaCare business unit, and a 40%-owned subsidiary, Gill/Balsano Consulting, L.L.C. Demand for these services results from the complexities of regulatory and reimbursement changes in the long-term care and hospital industries. These services assist providers with strategic planning, utilization, census development, case mix management, documentation and record administration, receivables and denials management, cost reporting and quality oversight. The Company had arrangements to provide such services to approximately 800 facilities at June 30, 1998. 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. COMPETITION NovaCare provides long-term care services on a national basis. The health care industry in general, and rehabilitation in particular, is highly competitive and subject to continual changes in methods of service delivery and provider selection. Rehabilitation is largely a local market business and competition varies considerably among markets. Key competitive factors in the long-term care services businesses include: (i) the ability to provide reimbursement expertise in response to regulatory changes (see "Reimbursement/Government Relations), (ii) the ability to increase patient census and acuity levels through quality clinical care coupled with patient and physician awareness, (iii) innovative and flexible pricing alternatives compatible with customer needs, (iv) comprehensive and integrated patient information systems, (v) stable therapy staff to meet the therapy needs at customer facilities, and (vi) the ability to provide management and clinical support to such staff. NovaCare competes in its local markets with other national, regional and local contract therapy providers. NovaCare believes that in addition to being the largest independent provider of long-term care services, its industry leading reimbursement and regulatory expertise, demonstrated ability to deliver quality clinical care and build rehabilitation census, while offering multiple service pricing solutions, allows it to compete successfully with other contract therapy providers in the markets where it provides services. The nature of potential customers has changed and will continue to change as a number of large long-term care facility chains take all or part of their therapy services in-house. This may increase the competition for remaining customers. The Company has sought to diversify its customer base in the long-term care industry to replace business lost due to such in-house programs (see "Contract Rehabilitation Services," previously discussed). 14 17 REIMBURSEMENT/GOVERNMENT RELATIONS Reimbursement for long-term care 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. In many states, Medicaid reimburses for rehabilitation services for eligible recipients. The portion of long-term care services' net revenues that was reimbursed directly by Medicare and Medicaid for the years ended June 30, 1998, and 1997 was 5% and 7%, respectively. Regulations regarding Medicare and Medicaid eligibility, certification and reimbursement are, therefore, important to NovaCare's activities and changes in these programs or regulations could adversely affect NovaCare's business. Long-term care 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. Prior to April 10, 1998, Medicare reimbursed the long-term care facility for contract therapy services on a cost basis, and reimbursement levels were determined based on a reasonable-cost standard. Contract occupational therapy and speech-language pathology services were evaluated based upon the reasonableness of costs incurred by the provider under a "prudent buyer" standard. Specific guidelines existed for evaluating the reasonable cost of physical therapy and there were general guidelines for evaluating the reasonable cost of occupational therapy and speech-language pathology services. With respect to physical therapy, the specific guideline system was called salary equivalency, a method used to determine prudent hourly cost for physical therapy services in long-term care settings. The physical therapy salary equivalency rates had been adjusted annually based on a 1983 standard, but did not adequately reflect salary inflation since 1983. As a result, the portion of contract therapy services that relates to physical therapy services have been essentially a break-even business for many contractors, including NovaCare. During the past few years, the Health Care Financing Administration ("HCFA"), the Federal agency responsible for the rules governing Medicare and Medicaid, 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. Management does not believe that the ultimate resolution of these issues will have a material impact on the Company's financial position or results of operations. Effective April 10, 1998, HCFA implemented salary equivalency reimbursement guidelines for occupational therapy and speech-language pathology services and revised guidelines for physical therapy services. Physical therapy salary equivalency guidelines were increased in consideration of the substantial increases in salary and services standards since these guidelines were last revised. Based on the operating results of the long-term care services business for the fourth quarter of fiscal 1998, the first quarter under these salary equivalency guidelines, average net revenues per facility declined by approximately 20% and gross profit as a percentage of net revenues declined to 27% from 29% in the third quarter of fiscal 1998. The BBA enacted in August 1997 made a number of changes in the way Medicare will reimburse long-term care facilities and other providers for their services. Commencing July 1, 1998, these changes will take effect for long-term care facilities at different times throughout calendar years 1998 and 1999, depending on the starting date for each facility's Medicare cost reporting year. By June 30, 1999, the BBA mandates that each facility be reimbursed, for Medicare Part A services, under a comprehensive prospective payment system, which includes payment for therapy services in an all-inclusive per diem payment based on the acuity level of the patient. Medicare Part B services are covered by a fee schedule with total charges potentially being subject to an annual cap effective January 1, 1999. The application of an annual cap is being challenged by the long-term care services industry. 15 18 The BBA also mandates changes to the payment structure for services provided through certified rehabilitation agencies. Implementation of these changes will be complete by January 1999. 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. On May 12, 1998, HCFA issued proposed regulations and per diem payment schedules for skilled nursing facilities which are subject to a 60-day comment period. On July 13, 1998, the comment period was extended an additional 60 days. The Company is unable to predict with certainty when and in what form the proposed regulations and reimbursement schedules will become final. By changing Medicare reimbursement to long-term care facilities from a cost basis to a fixed fee, the BBA is a fundamental change in the economic assumptions underlying patient care in long-term care facilities. Due to the extensive nature of the reimbursement changes specified by the BBA, the uncertainty regarding the application of fee schedules and an annual cap on Medicare Part B services, the effect these changes may have on the demand for services and management's inability to predict what portion of the PPS and fee schedule rates that NovaCare will be able to receive based on negotiated term of service contracts with its customers, the Company is unable to determine the impact that the BBA will have on its financial position on results of operations. In fiscal 1998, NovaCare also received direct reimbursement by Medicare for 4% of long-term care services' net revenues. 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. GOVERNMENT REGULATION In general, the provision of long-term care services is subject to the same extensive Federal, state and local regulation as outpatient services. For a discussion of these regulations, see "Government Relations" discussed above under the section "Outpatient Services." In addition, as with outpatient services, government and other third-party payers' health care policies and programs with respect to long-term care services have been subject to changes in payment and methodologies for a number of years. See "Reimbursement/ Government Relations" previously discussed. Management believes its long-term care services operations are structured to comply with applicable laws and regulations and has established a compliance program to ensure conformance with these laws and regulations. As with outpatient services, NovaCare operates certified rehabilitation agencies to facilitate billing for a portion of its long-term care services. As of June 30, 1998, NovaCare operated 23 certified rehabilitation agencies for long-term care services. EMPLOYEE SERVICES STRATEGY STATEMENT The Company's strategy is to be the preferred human resources partner by leveraging operational excellence, technology and strategic alliances to achieve market leadership. The strategy is based on management's belief that: PEO services will continue to experience growing demand because of the trend among small- to medium-sized employers to: (i) outsource non-core competencies, (ii) reduce employee benefit costs, (iii) avoid employee-related risks and regulatory complexities, and (iv) attract better employees through improved benefit plans. - The market for PEO services, based on analyst reports, is more than 95% unserved and is expected to grow at the rate of 30% per year for the next five years. 16 19 - The PEO industry is highly fragmented with significant consolidation opportunities for companies with access to capital, larger service delivery infrastructures, and well-developed and sophisticated management information systems. - PEOs typically take a transaction processing approach to their services and do not emphasize the improved workforce performance characteristic of satisfied employees. - In selecting PEO providers, small- to medium-sized businesses will increase their emphasis on cost-effectiveness, service excellence and the breadth of services provided. - Employees are attracted to small and medium-sized businesses that provide employees with human resource services characteristic of large employers. - Strategic alliances will enable PEO's to enhance endorsement opportunities, widen the network distribution channel and broaden the service/product offering. PLAN FOR GROWTH AND OPERATIONS NovaCare's subsidiary, NCES, is the second largest PEO in the United States. NCES commenced operations in October 1996, concurrent with the acquisition of Resource One, Inc., a PEO based in Florida. In February 1997, NCES acquired three additional PEOs. NCES completed its initial public offering in November 1997 with an offering of 5,750,000 shares of common stock. In fiscal 1998, NCES acquired PEOs in Arizona and Maryland. As of June 30, 1998, NCES served approximately 3,000 client organizations with approximately 53,000 employees at more than 5,000 worksites primarily in ten industries and 45 states, including 20,000 employees employed by the Company in its outpatient services and long-term care services businesses. NCES intends to grow through (i) increasing investment in sales and marketing, (ii) focusing on geographic expansion, (iii) targeting high potential industries and services, (iv) acquiring PEOs and other employee service providers, and (v) entering into strategic alliances. Increasing Investment in Marketing and Sales. The Company's management is experienced in building businesses utilizing focused marketing strategies and professional sales forces. A significant part of NCES's marketing strategy is the continued development of its brand identity. By utilizing the nationally advertised brand name of NovaCare, NCES believes it will achieve a strong brand identity at lower cost. NCES believes that its marketing efforts will benefit from its brand strategy. NCES's brand promise is to provide better human resources solutions at the best value for its clients. By cost effectively and consistently delivering against this service commitment, NCES believes it will attain a brand name reputation for operational excellence among existing and potential clients. Focusing on Geographic Expansion. NCES has identified key attractive geographic target markets and has established a plan for entering those markets. The target markets are primarily those markets in which the relationship with NovaCare provides existing employee and potential new client base density. NCES believes that NovaCare's clients and other extensive business-to-business relationships represent significant opportunities to grow in these target markets. By concentrating on markets where NovaCare has achieved density, NCES will seek to have scale economies immediately because it already co-employs NovaCare's employees. NCES believes that its market development model will enable it to penetrate new markets quickly. This market development model consists of a highly structured sales management control system and efficient selling process. Entry priority for specific markets is determined by the level of PEO competition, the state regulatory environment and access to infrastructure to support operations. Since November 1997, NCES has entered Atlanta and Philadelphia as start up operations, while Phoenix and Maryland/Washington, D.C. were entered via acquisition. This market expansion model is expected to provide a significant basis for future growth. Targeting High Potential Industries and Services. Targeted industries will vary from market to market depending on economic characteristics and business demographics of each geographic location. NCES intends to focus on industries with high gross profit per worksite employee and significant workers' compensation profit 17 20 opportunities. High potential industries are those, such as health care and construction, that NCES believes could benefit most from its risk management expertise (e.g., traditional high workers' compensation classifications) and its offering of an extensive benefits package (e.g., industries facing a shortage of workers). Other high potential industries would include those characterized by rapid growth or change. The sales force is expected to utilize the key industry strategy and become expert in one or more select industries in the markets in which they are operating. NCES intends to enhance its service offerings to include temporary staffing, training, recruiting and human resource consulting. Acquiring PEOs and Other Employee Service Providers. The Company believes that the opportunities for PEO consolidation are substantial with at least 2,400 PEOs (according to an estimate by NAPEO) operating in a highly fragmented industry. The Company believes that industry consolidation will be driven by increasing industry and regulatory complexity, increasing capital requirements and the significant economies of scale available to PEOs with a concentration of clients and employees in target markets. NCES intends to make opportunistic acquisitions where appropriate to achieve greater density in targeted geographic markets. Entering into Strategic Alliances. NCES is creating strategic alliances with service providers to small and medium-sized businesses. For example, the Florida Home Builders Association, an organization that has 17,000 members with 450,000 employees, has endorsed the Company as the PEO of choice for its members. Additionally, The Greater Philadelphia Chamber of Commerce has endorsed NCES as the exclusive PEO of choice for its 6,000 small business client members under a three-year arrangement. With the trend toward outsourcing non-core competencies, small and medium-sized businesses typically have service relationships with accountants, attorneys, banks, trade associations and other business advisors. Alliances with these service providers offer a cross-selling opportunity for the NCES's services. Other potential alliances being pursued include additional product or service offerings, as well as creating additional sales distribution channels. NCES intends to develop such alliance opportunities as an extension of its sales and marketing capability. BUSINESS PROFILE As co-employer of worksite employees, NCES assumes responsibility for and manages the risks associated with: (i) worksite employee payroll, (ii) employee-related benefits, such as workers' compensation and health care insurance coverage, and (iii) compliance with certain employment-related governmental regulations that can be effectively managed away from the client's business. The client retains responsibility for supervision and direction of the worksite employees' services in its business and generally remains responsible for compliance with other employment-related governmental regulations that are more closely related to worksite employee supervision. The service fee charged by NCES to its clients covers the cost of certain employment-related taxes, workers' compensation insurance coverage and risk management services, administrative and field services, wages of worksite employees and the client's portion of health and retirement benefit plan costs. NCES also provides other value-added services such as temporary staffing, recruiting, training and human resource consulting. NCES believes its services enable small and medium-sized businesses to cost-effectively manage and enhance the employment relationship by: (i) controlling the risks and costs associated with workers' compensation, workplace safety and employee-related litigation, (ii) providing employees with high quality health care coverage and related benefits, (iii) managing the increasingly complex legal and regulatory environment affecting employment, (iv) providing payroll and human resource administrative services that are reliable and accurate, and (v) achieving scale advantages typically available to larger organizations. NCES contractually assumes certain administrative, regulatory and financial employer responsibilities with respect to worksite employees in a "co-employment" relationship. NCES believes its clients benefit from its services by: (i) improving profitability through lowering or controlling costs associated with workers' compensation, health insurance, other benefit coverage and regulatory compliance, (ii) improving productivity through reducing the time and effort expended by business owners and executives to deal with the complexities of employment management, enabling them to focus on their business core competencies and growth, and (iii) improving employee satisfaction and performance. NCES helps employers improve job 18 21 satisfaction and performance of the worksite employees by providing improved health care and related benefits, delivering training programs, and delivering dependable payroll and benefits administration. In order to implement its strategy to create a more satisfying and more productive relationship between employers and employees, NCES provides six primary categories of employee services: (i) workers' compensation cost containment and safety management, (ii) unemployment insurance cost containment, (iii) employee benefits procurement and administration, (iv) human resources and compliance management, (v) payroll management, and (vi) other value-added services. By engaging NCES to provide these services, clients can focus on their core competencies. These services are provided under NCES's PEO service agreement, which typically has an initial one-year term; thereafter, the agreement is renewed periodically, generally yearly. The agreement is subject to termination by NCES or the client upon 30 days' prior written notice. Service revenues, billed to clients along with each periodic payroll, are based on a pricing model that takes into account the gross pay of each employee and a mark-up, 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 human resource needs and the size of the client. Accordingly, NCES's average mark-up percentage will fluctuate based on client mix. Clients are required to pay NCES its total fee concurrent with the applicable payroll date. Although NCES is ultimately liable as the employer to pay employees for work previously performed, it retains the right to terminate the PEO services agreement as well as the employees upon non-payment by a client, which limits any future liability. This right and the periodic nature of payroll, combined with client credit verifications and NCES' client selection process, are used to control this exposure. Workers' Compensation Cost Containment and Safety Management. Pursuant to NCES's PEO services agreement, NCES assumes the obligations of its clients to pay workers' compensation claims. See "Government Regulation" below for a discussion of workers' compensation. NCES seeks to control its workers' compensation costs through comprehensive risk evaluation of prospective clients, the prevention of workplace injuries, timely intervention with employee injuries, aggressive management of the medical costs related to such injuries and the prompt return of employees to work. NCES seeks to prevent workplace injuries by implementing a wide variety of training and safety programs. NCES's efforts to return employees to work quickly involve both rehabilitation services and the placement of employees in transitional, light-duty positions until they are able to resume their former positions. Unemployment Insurance Cost Containment. Pursuant to NCES's PEO services agreement, NCES also assumes the obligation of its clients to pay unemployment insurance costs. NCES manages its unemployment insurance costs by establishing employee termination procedures, timely responding to unemployment claims, attending unemployment hearings and attempting to reassign employees to other worksites when a reduction in force occurs at any one worksite location. Employee Benefits Procurement and Administration. Pursuant to NCES's PEO services agreement, NCES is required to provide mandated employee benefits to the worksite employees. Additionally, NCES offers worksite employees a voluntary benefits package, that includes several health care options, such as point-of-service ("POS"), PPO, HMO and indemnity plans. Supplemental benefit programs offer dental care, prescription drugs, and life and disability insurance options. NCES also offers 401(k) retirement savings (a profit-sharing plan with an employee contribution feature) and cafeteria style plans to its eligible employees. NCES believes that its ability to provide and administer a wide variety of employee benefits on behalf of its clients tends to mitigate the competitive disadvantage small and medium-sized businesses normally face in the areas of employee benefit cost control and employee recruiting and retention. Human Resources and Compliance Management. Pursuant to NCES's PEO services agreement, NCES provides comprehensive human resources services to its clients. These services reduce the employment-related administrative burdens faced by its clients, and provide worksite employees with a wide array of benefits typically offered by large employers. NCES develops and administers human resources policies and 19 22 procedures for each of its clients, relating to, among other things, recruiting, retention programs, performance management, discipline and terminations. NCES also provides orientation, training and development, counseling and substance abuse awareness for worksite employees. By contract, NCES generally assumes responsibility for complying with many employment-related regulatory requirements. In addition, NCES assists its clients in understanding and complying with other employment-related requirements for which NCES does not assume responsibility. Laws and regulations applicable to employers include state and Federal tax laws, state workers' compensation laws, state unemployment laws, occupational safety laws, immigration laws, and discrimination, sexual harassment and other civil rights laws. Payroll Management. Pursuant to the PEO services agreement, NCES is responsible for payroll processing, check preparation, distribution and recordkeeping, payroll tax deposits, payroll tax reporting, employee file maintenance, unemployment claims and monitoring and responding to changing regulatory requirements. NCES indemnifies the client against NCES's failure to comply with regulatory requirements. Payroll reports are prepared for clients for financial and other recordkeeping purposes. Provision of these services by NCES generally reduces the client's employment liabilities and allows clients to focus on their core business. Other Value-Added Services. NCES offers rehabilitation temporary staffing in the long-term care industry. The rehabilitation temporary staffing service currently can draw on a pool of over 6,000 rehabilitation clinicians to provide staff to health care providers, at which over 2,500 worksite employees were performing services during the fourth quarter of fiscal 1998. This business is supported by technology, which provides detailed recruitment and sales productivity information for management purposes. It also generates billing and utilization reports for clients. NCES also plans to offer additional value-added services to clients and worksite employees. Such services may include such things as temporary staffing to non-health care clients, employee recognition programs, travel discount arrangements, vision care, credit union membership, smart cards, warehouse club memberships and various financial services. Some of these services may generate fee income or commissions for NCES. COMPETITION The PEO industry consists of at least 2,400 companies, most of which serve a single market or region. NCES believes that it is the second largest PEO in the United States. NCES considers its primary competition to include: (i) traditional in-house human resources departments; (ii) other PEOs, and (iii) providers of unbundled employment-related services such as payroll processing firms, temporary employment firms, commercial insurance brokers, human resource consultants, workers' compensation insurers, HMOs and other specialty managed care providers. Competition in the highly fragmented PEO industry is generally on a local or regional basis. Management believes that the primary elements of competition are quality of service, choice and quality of benefits, reputation and price. NCES believes that brand recognition, regulatory expertise, financial resources, risk management, information technology capability, strategic alliances and economies of scale can distinguish a large-scale PEO from the rest of the industry. NCES believes that it competes favorably in these areas. NCES believes that barriers to entry into the PEO industry are increasing primarily due to the following factors: (i) the complexity of the PEO business and the need for expertise in multiple disciplines; (ii) the three to five years of experience required to establish experience ratings in key cost areas of workers' compensation, health insurance and unemployment; and (iii) the need for sophisticated management information systems to track all aspects of business in a high growth environment. GOVERNMENT REGULATION NCES is subject to local, state and Federal regulations, which include operating, fiscal and licensing requirements. Adding complexity to NCES's regulatory environment are: (i) uncertainties resulting from the 20 23 non-traditional employment relationships created by PEOs, (ii) variations in state regulatory schemes, and (iii) the ongoing evolution of regulations regarding health care and workers' compensation. Many of the Federal and state laws and regulations relating to tax, benefit and employment matters applicable to employers were enacted prior to the development of non-traditional employment relationships and, accordingly, do not specifically address the obligations and responsibilities of PEOs or the co-employment relationship. Moreover, NCES's PEO services are regulated primarily at the state level. Regulatory requirements regarding NovaCare's business therefore vary from state to state, and as NCES enters new states it will be faced with new regulatory and licensing environments. There can be no assurance that NCES will be able to satisfy the licensing requirements or other applicable regulations of any particular state, 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 of any state in which it does not obtain regulatory approval. The absence of required licenses would require NCES to restrict the services it offers. New legislation or new interpretations of current licensing and regulatory requirements could impose operating or licensing requirements on NovaCare which it may not be able to satisfy or which could have a material adverse effect on NCES's business, financial condition, results of operations and liquidity. Additionally, interpretation of such legislation or regulation by regulatory agencies with broad discretionary powers could require NCES to modify its existing operations materially in order to comply with applicable regulations. The application of many laws to NCES's PEO services will depend on whether NCES is considered an employer under the relevant statutes and regulations. The Internal Revenue Service ("IRS") is currently examining this issue. See "Employee Benefit Plans" below. In addition, from time to time there have been proposals to enact a statutory definition of employer for certain purposes of the Internal Revenue Code of 1986, as amended (the "Code"). PEO Licensing Requirements. A critical aspect of the growth of the PEO industry has been increasing recognition and acceptance of PEOs by state authorities. While many states do not explicitly regulate PEOs, approximately one-third of the states have passed laws that have licensing or registration requirements for PEOs and several additional states are considering such regulation. Such laws vary from state to state but generally provide for monitoring the fiscal responsibility of PEOs. NCES is licensed in thirteen states and expects to be licensed in several more over the next twelve months. State regulation assists in screening insufficiently capitalized PEO operations, imposes requirements regarding payment of wages, taxes, benefits and workers' compensation and resolves issues concerning an employee's status for specific purposes under applicable state law. Because existing regulations are relatively new, there is limited interpretive or enforcement guidance available. The development of additional regulations and interpretation of existing regulations can be expected to evolve over time. Federal and State Employment Taxes. NCES assumes the responsibility and liability for the payment of Federal and state employment taxes with respect to wages and salaries paid to its employees, including worksite employees. To date, the IRS has relied extensively on the common law test of employment in determining employer status and the resulting liability for failure to withhold. However, the IRS has formed a Market Segment Study Group for the stated purpose of examining whether PEOs, such as NCES, are the employers of the worksite employees under the Code provisions applicable to Federal employment taxes and, consequently, whether they are exclusively responsible for payment of employment taxes on wages and salaries paid to such employees. Another stated purpose of the Market Segment Study Group is to determine whether owners of client companies can be employees of PEOs under the Federal employment tax laws. The interpretive uncertainties raised by the Market Segment Study Group may affect NCES's ability to report employment taxes on its own account rather than for the accounts of its clients and would increase administrative burdens on NCES's payroll service function. In addition, while NCES believes that it can contractually assume the client company's withholding obligations, in the event NCES fails to meet these obligations, the client company may be held jointly and severally liable for those obligations. Employee Benefit Plans. NCES offers various employee benefit plans to its worksite employees, including 401(k) plans, cafeteria plans, group health plans, group life insurance plans, group disability 21 24 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"). The Market Segment Study Group established by the IRS is examining whether PEOs, such as NCES, are the employers of worksite employees under Code provisions applicable to employee benefit plans and consequently able to offer to worksite employees benefit plans that qualify for favorable tax treatment. The Market Segment Study Group is also examining whether client company owners are employees of PEOs under Code provisions applicable to employee benefit plans. NCES is unable to predict the actual timing or nature of the findings of the Market Segment Study Group or the ultimate outcome of such conclusions or findings. If the IRS study were to conclude that a PEO is not an employer of its worksite employees for plan purposes, worksite employees might not be able to continue to make contributions to NCES's 401(k) plans or cafeteria plans. NCES believes that although unfavorable to NCES, a prospective application by the IRS of an adverse conclusion would not have a material adverse effect on its financial position and results of operations. If such conclusion were applied retroactively, employees' vested account balances would become taxable immediately, NCES would lose its tax deduction to the extent the contributions were not vested, the plans' trusts would become taxable trusts and penalties could be assessed. In such a case, NCES would face the risk of client dissatisfaction as well as potential litigation. A retrospective application by the IRS could have an adverse effect on NCES's business, financial position, and results of operations and liquidity. While NCES believes that a retroactive disqualification is unlikely, there can be no assurance as to the ultimate resolution of these issues. In addition to the employer/employee relationship requirement described above, pension and profit-sharing plans, including NCES's 401(k) plans, must satisfy certain other requirements under the Code. These other requirements are generally designed to prevent discrimination in favor of highly compensated employees to the detriment of non-highly compensated employees with respect to both the availability of, and the benefits, rights and features offered in, qualified employee benefit plans. NCES applies the nondiscrimination requirements of the Code at both a consolidated and client company level to ensure that its 401(k) plans are in compliance with the requirements of the Code. Workers' Compensation. Workers' compensation is a state-mandated, comprehensive insurance program that requires employers to fund or insure medical expenses, lost wages and other costs resulting from work-related injuries and illnesses. In exchange for providing workers' compensation coverage for employees, employers are not subject to litigation by employees for benefits in excess of those provided by the relevant state statute. In most states, the extensive benefits coverage (for both medical costs and lost wages) is provided through the purchase of commercial insurance from private insurance companies, participation in state-run insurance funds or employer self-insurance. Workers' compensation benefits and arrangements vary on a state-by-state basis and are often highly complex. These laws establish the rights of workers to receive benefits and to appeal benefit denials. Workers' compensation laws also regulate the methods and procedures which NCES may employ in its workers' compensation managed care programs. As a creation of state law, workers' compensation is subject to change by each state's legislature and is influenced by the political processes in each state. Several states have mandated that employers receive coverage only from state-operated funds. Other states have adopted legislation requiring that all workers' compensation injuries be treated through a managed care program. While such legislation may increase the market for NCES's workers' compensation managed care services, it may also intensify the competition faced by NCES for such services. In addition, Federal health care reform proposals include a proposal that may require 24-hour health coverage, in which the coverage of traditional employer-sponsored health plans is combined with workers' compensation coverage to provide a single insurance plan for health problems, whether or not related to work. Incorporating workers' compensation coverage into conventional health plans may adversely affect the market for NovaCare's services and may intensify the competition faced by NCES from HMOs and other health care providers. Moreover, because workers' compensation benefits are mandated by law and are subject to extensive regulation, payers and employers do not have the same flexibility to alter benefits as they have with other health benefit programs. Finally, because workers' compensation programs vary from state to state, it is difficult for payers and multi-state employers to adopt uniform policies to administer, manage and control the costs of benefits. 22 25 Other Employer-Related Requirements. As an employer, NCES is subject to a wide variety of Federal, state and local laws and regulations governing employer-employee relationships, including the Immigration Reform and Control Act, the Americans with Disabilities Act, the Family and Medical Leave Act, the Occupational Safety and Health Act, wage and hour regulations, and comprehensive local, state and Federal civil rights laws and regulations, including those prohibiting discrimination and sexual harassment. The definition of employer may be broadly interpreted under these laws. Responsibility for complying with various state and Federal laws and regulations is allocated by agreement between NCES and its clients, or in some cases is the joint responsibility of both. Because NCES acts as a co-employer with the client company, it is possible that NCES could incur liability for violations of laws even though NCES is not contractually or otherwise responsible for the conduct giving rise to such liability. NCES's standard client agreement generally provides that the client will indemnify NCES for liability incurred as a result of an act of negligence of a worksite employee under the direction and control of the client or to the extent the liability is attributable to the client's failure to comply with any law or regulation for which it has specified contractual responsibility. However, there can be no assurance that NCES will be able to enforce such indemnification and NCES may therefore be ultimately responsible for satisfying the liability in question. INSURANCE The Company maintains professional liability insurance in amounts deemed appropriate by management based upon historical claims and the nature and risks of the business. The Company also maintains property and general liability insurance for the customary risks inherent in the operation of business in general. While NovaCare believes its insurance policies to be adequate in amount and coverage for its current operations, there can be no assurance that any future claims will not exceed the limits of those policies or that such insurance will continue to be available. EMPLOYEES At June 30, 1998, the Company had approximately 53,000 employees. Of these, approximately 7,500 were outpatient services personnel, 11,000 were long-term care services personnel and 34,200 were employee services personnel. Of the employee services personnel, approximately 400 were "administrative" employees and 33,800 were worksite employees of client companies. NovaCare's employees are not represented by any labor union and the Company is not aware of any current activity to organize any of its non-worksite employees. Management considers relations between the Company and its employees to be good. For information with respect to the Company's worksite employees, see "Business Profile" in the "Employee Services" section above. 23 26 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 56 Timothy E. Foster......................... Chief Executive Officer and Director 46 James W. McLane........................... President, Chief Operating Officer and Director 59 Daryl A. Dixon............................ President and General Manager, Long-term Care Services 38 Ronald G. Hiscock......................... President and General Manager, Outpatient Services 47 Robert E. Healy, Jr. ..................... Senior Vice President, Finance and Administration and Chief Financial Officer 45 Laurence F. Lane.......................... Senior Vice President, Regulatory Affairs 53 Steven M. Wise............................ Senior Vice President, Information Systems and Chief Information Officer 42 Susan J. Campbell......................... Vice President, Investor Relations 47 Richard A. McDonald....................... Vice President and Treasurer 51 Barry E. Smith............................ Vice President, Controller and Chief Accounting Officer 45 James T. Walmsley......................... Vice President, Reimbursement 48
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 Integra, Inc., a national mental health services company, and a director of Corning Incorporated, an international corporation with business interests in specialty materials and communications, as well as a director of NCES. 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 from March 1992 to October 1994, Secretary of the Company from September 1987 to May 1994 and has been a director since December 1984. Mr. Foster currently serves as a Director of Integra, Inc., a national mental health services company, a position he has held since February 1995, as well as a director of NCES. Mr. Foster also serves as a consultant to Foster Management Company. JAMES W. MCLANE has been President and Chief Operating Officer and a director of the Company since May 1997. From 1991 to 1997, Mr. McLane served as Chief Executive Officer of Aetna Health Plans and as Executive Vice President of Aetna Life and Casualty. He is also a director of FemRx, Inc. a medical device manufacturer, and Alignis, Inc., a complementary health care services company. DARYL A. DIXON has been President and General Manager of NovaCare's Long-term Care Services, formerly the Contract Rehabilitation Division, since January 1994, and was Vice President, Operations of the Contract Rehabilitation Division from November 1992 until January 1994. RONALD G. HISCOCK has been President and General Manager of NovaCare's Outpatient Services, formerly the 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 for the Orthotics and Prosthetics Division and was the Division's Vice President of Operations from July 1994 through March 1995. 24 27 ROBERT E. HEALY, JR. has been Senior Vice President, Finance and Administration and Chief Financial Officer since December 1995. From January 1994 to December 1995, he was Vice President, Finance and Chief Financial Officer of NovaCare's 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. STEVEN M. WISE has been Senior Vice President, Information Systems and Chief Information Officer since January 1998. He was Vice President, Information Systems and Chief Information Officer from December 1995 to January 1998. He joined NovaCare in 1993 as Director, Systems and Programming, for the Contract Rehabilitation Division. SUSAN J. CAMPBELL has been Vice President, Investor Relations of NovaCare since April 1994. She joined NovaCare in March 1993 as Director of Investor Relations and also served as Vice President, Communications from April 1995 to March 1998. RICHARD A. MCDONALD has been Vice President and Treasurer since August 1996 and was Director, Treasury Services from May 1995 until August 1996. Prior to joining the Company, he was a financial consultant to Continental Medical Systems, Inc. He served as an assistant treasurer with American Healthcare Management from 1990 until 1994. BARRY E. SMITH has been Vice President, Controller and Chief Accounting Officer of the Company since December 1995 and was Vice President of Finance of the Contract Rehabilitation Division from March 1995 to October 1997. He was Vice President of Finance of the Medical Rehabilitation Hospital Division from February 1994 through the sale date of the division in April 1995. JAMES T. WALMSLEY has been Vice President, Reimbursement of NovaCare since January 1994 and was Director of Reimbursement from April 1992 to January 1994. ITEM 2. PROPERTIES NovaCare's principal executive offices are located at 1016 West Ninth Avenue, King of Prussia, Pennsylvania 19406 where NovaCare leases approximately 149,000 square feet of office space. The principal lease for this office space expires in June 2005. In addition, the Company leases other office space in various cities within the United States for terms which typically are three years or less. See Note 9 of Notes to Consolidated Financial Statements for information concerning the Company's leases for its facilities. The Company does not anticipate that it will experience difficulty in renewing such leases upon their expiration or obtaining different space on comparable terms if such leases are not renewed. The Company believes that these facilities are well maintained and are of adequate size for present needs and planned expansion in the near future. NovaCare also has sublease agreements for approximately 21,500 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. 25 28 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 7, 1998, there were 1,580 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, 1998: First Quarter............................................. $17.06 $12.50 Second Quarter............................................ 17.31 11.81 Third Quarter............................................. 14.87 11.87 Fourth Quarter............................................ 14.81 10.62 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
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. 26 29 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, ------------------------------------------------------------ 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- STATEMENT OF OPERATIONS DATA: Net revenues................... $1,671,925 $1,066,451 $793,038 $905,359 $789,745 Gross profit................... 354,659 260,086 208,082 256,240 255,511 Income from operations......... 89,690 80,541 37,499 143,881 108,208 Net interest expense........... (27,455) (13,504) (7,537) (17,893) (11,773) Income before income taxes..... 99,546 66,801 29,866 125,584 95,892 Income taxes................... 41,631 27,891 14,585 63,660 37,678 Net income..................... 57,915 38,910 15,281 61,924 58,214 Net income per share: Basic....................... .94 .64 .24 .95 .91 Assuming dilution........... .91 .62 .24 .93 .88
AS OF JUNE 30, ------------------------------------------------------------ 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- BALANCE SHEET DATA: Working capital................ $ 225,773 $ 173,576 $223,712 $255,126 $194,324 Total assets................... 1,356,042 1,014,304 789,731 852,557 850,541 Total indebtedness............. 508,382 342,678 192,215 225,015 344,602 Total liabilities(1)........... 775,369 506,298 305,337 364,922 434,837 Shareholders' equity........... 580,673 508,006 484,394 487,635 415,704
- --------------- (1) Includes minority interest in consolidated subsidiaries. 27 30 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW In the fiscal years ended June 30, 1998 and 1997, the Company experienced significant revenue and earnings expansion resulting from acquisitions and internal growth of its existing businesses. During fiscal 1998, the Company purchased 90 outpatient services businesses, consisting of 43 outpatient physical therapy and rehabilitation businesses, 42 orthotic and prosthetic ("O&P") businesses, and five occupational health businesses; and two professional employer organization ("PEO") businesses. During fiscal 1997, the Company acquired 55 outpatient services businesses, consisting of 19 outpatient physical therapy and rehabilitation businesses, 33 O&P businesses, and three occupational health businesses; and four PEO businesses. During fiscal 1996, the Company acquired seven outpatient physical therapy and rehabilitation businesses and six O&P businesses. During fiscal 1998, NovaCare Employee Services, Inc. ("NCES") sold approximately 5.8 million shares to third parties in an initial public offering, receiving net proceeds of $45.7 million. As of June 30, 1998, the Company retains a 71% interest in NCES. Segment Reporting In fiscal 1998, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related Information", which requires companies to report operating segments based upon the way a company manages its activities. Because of the Company's reporting, organization and management structure, segment information has been presented for outpatient services, long-term care services and employee services. Outpatient services relate to the provision of outpatient physical therapy, O&P and occupational health rehabilitation services through a national network of patient care centers. Long-term care services provide rehabilitation therapy and health care consulting services on a contract basis to health care institutions, primarily long-term care facilities. Employee services are comprehensive, fully integrated outsourcing solutions to human resource issues. These services include payroll management, workers' compensation, risk management, benefits administration, unemployment services and human resource consulting services, and are generally provided to small and medium-sized business. The Company entered this business on October 1, 1996 with the acquisition of its first PEO business. Effective January 25, 1997, employee services were also provided to the outpatient services and long-term care services segments of the Company. See Note 13 to the Consolidated Financial Statements for financial data for each of the Company's operating segments. Gain from Issuance of Subsidiary Stock During fiscal 1998, the Company recorded a gain of $38.8 million ($22.9 million after tax) related to the sale of stock by NCES to third parties through an initial public offering of its stock, issuance of stock in connection with conversion of its mandatorily redeemable common stock and acquisitions. Provision for Restructure During fiscal 1998, the Company recorded a $23.5 million ($13.7 million net of tax) restructure charge related to an evaluation of changes in Medicare related to the Balanced Budget Act of 1997. In response to these changes, the Company is converting its long-term care services contract rehabilitation model from one characterized by a high concentration of one-on-one therapy, with licensed professionals treating individual 28 31 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) patients, to a model which: (i) relies more heavily on well-trained therapy assistants and aides closely supervised by licensed professionals, and (ii) employs simultaneous therapy, wherein licensed professionals, along with well-trained therapy assistants and aides, treat multiple patients on a coordinated basis. During fiscal 1996, the Company recorded a $13.4 million ($7.6 million net of tax) restructure charge related to the reorganization of the Company's outpatient services businesses. Change in Estimate In 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 fiscal 1996 and prior years. Regulatory Changes In the fourth quarter of fiscal 1998, Medicare changed its reimbursement to long-term care facilities for occupational and speech therapies to a salary equivalency methodology. Effective July 1, 1998, the reimbursement methodology changes to a prospective payment system for Medicare Part A services over an eleven month period and a fee schedule for Medicare Part B services effective January 1, 1999 (See "Business -- Long-term Care Services -- Reimbursement/Government Relations"). YEAR ENDED JUNE 30, 1998 COMPARED WITH THE YEAR ENDED JUNE 30, 1997 Net revenues for the year ended June 30, 1998 were $1.7 billion, an increase of $605.5 million (57%) over fiscal 1997. Gross profit for fiscal 1998 was $354.7 million, an increase of $94.6 million (36%) over fiscal 1997. These increases resulted principally from acquisitions (19% increase in gross profit year-over-year) and internal growth (17% increase in gross profit year-over-year). Other operating expenses, excluding the $23.5 million restructure charge described above, were $241.5 million, an increase of $61.9 million (34%) over fiscal 1997. Other operating expenses include selling, general and administrative expenses, depreciation (other than depreciation included in cost of services) and amortization of excess cost of net assets acquired ("amortization") and provision for uncollectible accounts. The increase in operating expenses resulted principally from the inclusion of acquisitions completed in fiscal 1998 and 1997, additional costs incurred in the expansion of the Company's employee services business and those costs required to support internal growth. As a percentage of net revenues, other operating expenses decreased to 14.4% in fiscal 1998 compared to 16.8% in fiscal 1997. This decrease resulted principally from an increase in employee services revenues, where these operating expenses are typically a smaller percentage of net revenues than in outpatient services or long-term care services. Depreciation expense, including depreciation reported in cost of services and selling, general and administrative expenses, was $30.1 million, an increase of $5.7 million (23%) over fiscal 1997. The increase resulted primarily from the effect of acquisitions in fiscal 1998 and 1997 and capital investments, primarily in information systems and outpatient facilities. Amortization was $20.3 million, an increase of $6.7 million (50%) over fiscal 1997, which increase resulted from acquired businesses. Interest expense, net of interest income, was $27.5 million, an increase of $14.0 million over net interest expense of $13.5 million in fiscal 1997. Net interest expense increased primarily as a result of increased borrowings as discussed under "Liquidity and Capital Resources". Income tax expense as a percentage of pretax income remained constant at 41.8%. See Note 10 to the Consolidated Financial Statements for a reconciliation of expected tax rate to actual tax expense. 29 32 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) OPERATING RESULTS BY SEGMENT Outpatient Services Net revenues for the outpatient services segment were $512.7 million in fiscal 1998, an increase of $155.1 million (43%) over fiscal 1997. The increase in net revenues was due principally to businesses acquired in fiscal 1998 and the full-year effect of businesses acquired in fiscal 1997, along with same-market growth in O&P and occupational health. Gross profit (excluding depreciation) was $158.7 million, an increase of $51.9 million (49%) over fiscal 1997. The increase in gross profit resulted primarily from: (i) businesses acquired in fiscal 1998 and the full-year effect of businesses acquired in fiscal 1997 (aggregating to a 39% increase in gross profit year-over-year), (ii) same market growth of 4% in O&P and occupational health, and (iii) improved productivity (6% increase in gross profit year-over-year). Gross profit as a percentage of net revenues ("gross profit margin") increased to 30.9% in fiscal 1998 compared to 29.8% in fiscal 1997 principally as a result of improved productivity in outpatient physical therapy and rehabilitation, O&P and occupational health operations. Income from operations was $65.2 million, an increase of $20.4 million (46%) compared with fiscal 1997. The increase was due to the higher gross profit noted above, partially offset by higher selling, general and administrative expenses, an increase in the provision for bad debts and higher depreciation and amortization expense. The increase in those costs was principally a result of expenses associated with businesses acquired. Long-term Care Services Net revenues for long-term care services were $656.9 million in fiscal 1998, an increase of $87.0 million (15%) over fiscal 1997. The increase in net revenues resulted primarily from new contract sales and price increases on existing contracts, partially offset by lower reimbursement rates in the fourth quarter of fiscal 1998 caused by the implementation of the salary equivalency reimbursement system for speech and occupational therapies. Gross profit (excluding depreciation) was $182.7 million in fiscal 1998, an increase of $26.6 million (17%) over fiscal 1997. The gross profit margin was 27.8% in fiscal 1998 compared with 27.4% in fiscal 1997. The improvement in gross profit and gross profit margin resulted from an increase in new customer contracts coupled with reduced salary and wage costs per employee, due to the conversion of the Company's clinical workforce from fixed salary compensation to variable hourly compensation, and improved productivity. Income from operations was $116.1 million, an increase of $22.7 million (24%) over fiscal 1997. The increase resulted from the higher gross profit noted above, partially offset by slightly higher selling, general and administrative costs and higher depreciation and amortization incurred to support business growth. Employee Services Employee services net revenues were $1.3 billion in fiscal 1998 (before an intercompany elimination of $769.5 million related to services provided to the outpatient services and long-term care services segments), an increase of $877.6 million over fiscal 1997 net revenues of $394.2 million (before an intercompany elimination of $255.3 million). This increase in total net revenues is due to: (i) an increase in net revenues of $514.2 million under the employee services segment's contract with the outpatient services and long-term care services segments (the "NovaCare Contract"), and (ii) an increase of $363.4 million in third party net revenues. Gross profit (excluding depreciation) was $41.5 million in fiscal 1998, an increase of $29.3 million over fiscal 1997. Income from operations was $10.9 million, an increase of $8.0 million over fiscal 1997. The increases in net revenue, gross profit and income from operations resulted from: (i) a full year's operation of the NovaCare Contract in fiscal 1998 compared with only five months in fiscal 1997, as well as a 30 33 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) 5% increase in the number of worksite employees covered by the NovaCare Contract in fiscal 1998, (ii) a full year of operations in fiscal 1998 compared to only nine months in fiscal 1997 (the employee services segment commenced operations October 1, 1996 with the acquisition of its first PEO business), (iii) the full-year effect of fiscal 1997 acquisitions, (iv) acquisitions completed in fiscal 1998, and (v) same market growth. YEAR ENDED JUNE 30, 1997 COMPARED WITH THE YEAR ENDED JUNE 30, 1996 Net revenues for the year ended June 30, 1997 were $1.1 billion, an increase of $273.4 million (34%) over fiscal 1996. Gross profit for fiscal 1997 was $260.1 million, an increase of $52.0 million (25%) over fiscal 1996. These increases resulted principally from acquisitions (15% increase in gross profit year-over-year) and internal growth (5% increase in gross profit year-over-year) and a fiscal 1996 $10.5 million charge to revenues for a change in estimate discussed in "Overview" above. Other operating expenses were $179.5 million, an increase of $22.3 million (14%) over fiscal 1996, excluding a $13.4 million restructure charge in fiscal 1996. The increase in costs resulted primarily from businesses acquired in fiscal 1997. As a percentage of net revenues, other operating expenses decreased to 16.8% in fiscal 1997 from 19.8% in fiscal 1996, principally as a result of employee and facility cost savings from productivity and cost reduction programs initiated in fiscal 1996 and 1995. Depreciation expense, including depreciation reported in cost of services and selling, general and administrative expenses, was $24.4 million in fiscal 1997, an increase of $1.1 million (5%) over fiscal 1996, principally as a result of the full year effect of assets acquired in fiscal 1996 and certain internally-developed software placed in service in fiscal 1997. Amortization was $13.5 million in fiscal 1997, an increase of $3.7 million (37%) over fiscal 1996, resulting from businesses acquired in fiscal 1997 as well as the full-year effect of businesses acquired in fiscal 1996. Interest expense, net of interest income, was $13.5 million in fiscal 1997, an increase of $6.0 million as a result of increased borrowings and lower invested cash in fiscal 1997, principally due to acquisitions. Income tax expense as a percentage of pretax income decreased to 41.8 % in fiscal 1997 compared to 48.8% in fiscal 1996. The decrease in the income tax rate resulted principally from the reduced impact of nondeductible amortization on higher income subject to income tax in fiscal 1997 as a result of the fiscal 1996 provision for restructure and charge to revenues. See Note 10 to the Consolidated Financial Statements for a reconciliation of expected tax expense to actual tax expense. OPERATING RESULTS BY SEGMENT Outpatient Services Net revenues for the outpatient services segment were $357.6 million, an increase of $87.9 million (33%) over fiscal 1996. The increase in net revenues was attributable to: (i) businesses acquired in fiscal 1997 and the full year effect of businesses acquired in fiscal 1996, (ii) the absence of the $10.5 million charge to revenues discussed previously, and (iii) internal growth. These increases were somewhat offset by lower net revenues resulting from facilities closed or sold in fiscal 1997 and the full year effect of facilities closed, sold or contributed to joint ventures in fiscal 1996. Gross profit (excluding depreciation) was $106.7 million, an increase of $39.5 million (59%) over fiscal 1996. The increase in gross profit resulted from: (i) businesses acquired in fiscal 1997 and the full year effect of businesses acquired in fiscal 1996 (aggregating to a 37% increase in gross profit year-over-year), (ii) the absence of the $10.5 million charge to revenues, and (iii) an increase in productivity (6% increase in gross profit year-over-year). Gross profit margin was 29.8% in fiscal 1997 compared with 24.9% in fiscal 1996. The increase in gross profit margin resulted principally from improved productivity and the consolidation and 31 34 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) reorganization of certain outpatient physical therapy and rehabilitation and O&P functions in the third quarter of fiscal 1996, as well as the impact of the $10.5 million charge to revenues. Income from operations was $44.8 million, an increase of $28.5 million over fiscal 1996. This increase resulted from the higher gross profit noted above, partially offset by higher selling, general and administrative expenses related to acquisitions and an increase in the provision for uncollectible accounts. Long-term Care Services Net revenues for the long-term care segment were $569.9 million, an increase of $46.6 million (9%) over fiscal 1996. The increase resulted principally from: (i) new contract sales, (ii) price increases on existing contracts, and (iii) increased productivity. Gross profit, excluding depreciation, was $156.1 million, an increase of $6.5 million (4%) over fiscal 1996. Gross profit margin was 27.4% in fiscal 1997 compared with 28.6% in fiscal 1996. The decrease in gross profit margin resulted principally from increased cost of competitive compensation and benefits per employee and increased independent contractor useage in fiscal 1997. Income from operations was $93.4 million, an increase of $15.4 million (20%) over fiscal 1996 due to the increase in gross profit noted above, coupled with lower selling, general and administrative expenses and provision for uncollectible accounts. Employee Services Revenues for employee services were $394.2 million in fiscal 1997 (before an intercompany elimination of $255.3 million related to services provided to the outpatient and long-term care segments), representing nine months of operations. Employee services operations commenced on October 1, 1996, with the Company's purchase of its first PEO business. During fiscal 1997, the Company purchased three additional PEO businesses, resulting in revenues from third parties of $138.9 million. In January 1997, the employee services segment commenced providing services under the NovaCare Contract. Gross profit was $12.2 million (before an intercompany elimination of $5.7 million), or 3.1% of net revenues. Income from operations was $2.9 million. LIQUIDITY AND CAPITAL RESOURCES At June 30, 1998, cash and cash equivalents totaled $32.8 million, an increase of $10.0 million over June 30, 1997. Cash generated from operations increased $25.9 million to $73.1 million in fiscal year 1998 from $47.2 million in fiscal 1997, which was a decrease of $10.5 million from $57.7 million in fiscal 1996. The $25.9 million increase from fiscal 1997 to 1998 resulted principally from improved earnings of $19.0 million, higher depreciation and amortization and higher deferred taxes of $28.2 million, which were offset partially by the net increase in the non-cash portion of nonrecurring items of $15.3 million. Increased working capital requirements, principally accounts receivable and inventory totaling $34.5 million, net of higher accounts payable balances and accrued expenses totaling $28.5 million, partially offset these improvements. Cash flows from operating activities decreased $10.5 million from fiscal 1996 to 1997 principally due to an increase in accounts and notes receivable of $41.2 million offset, somewhat, by an increase in net income of $23.6 million and $8.2 million of non-cash charges consisting of depreciation, amortization and provision for doubtful accounts. Investing activities used $213.9 million of cash in fiscal 1998 compared with $187.8 million and $64.9 million in fiscal 1997 and 1996, respectively. Cash paid for acquisitions increased to $180.6 in fiscal 1998 compared with $164.4 million in fiscal 1997, which was an increase from the $20.8 million paid in fiscal 1996. 32 35 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) Capital expenditures remained relatively constant at $29.5 million, $21.7 million, and $26.6 million for fiscal 1998, 1997 and 1996, 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 borrowings, net of repayments, of $97.3 million in fiscal 1998, compared with net borrowings of $87.0 million in fiscal 1997, compared with net payments of $33.6 million in 1996. Also, during fiscal 1998 NCES sold approximately 5.8 million shares to third parties in an initial public offering, receiving net proceeds of $45.7 million. The net proceeds of the offering were used principally to pay obligations associated with acquisitions and other debt. The Company retains a 71% interest in NCES after reductions in its ownership interest for the initial public offering and NCES shares issued in the conversion of its mandatorily redeemable common stock and to sellers of acquired PEO businesses. The Company amended its bank credit facility, increasing the amount of available borrowings to $400.0 million at June 30, 1998. The term of the credit facility was also extended to June 2003 and certain working capital and net worth requirements were modified. At June 30, 1998, $168.3 million remained available after reduction for borrowings and letters of credit totaling $4.2 million. In November 1997, NCES entered into a $25.0 million three-year revolving credit agreement with a syndicate of lenders. At June 30, 1998, $23.9 million of the NCES line of credit was available after reduction for a letter of credit of $1.1 million. The Company's growth strategy contemplates expansion of the outpatient services and employee services segments in target markets, principally through acquisitions and start-ups. The Company's anticipated acquisitions and capital expenditures in fiscal 1999 exceed its anticipated cash from operations plus the remaining amount available under its lines of credit. The Company is presently evaluating its strategic alternatives for obtaining additional capital. Such alternatives could involve placing additional debt through a high-yield offering or private placement, or the separation of the Company's activities into two independent companies, one of which would operate its outpatient services business segment and the other of which would operate its long-term care and employee services segments, and the offering for sale of equity securities. If the Company is unable to secure additional financing, or such financing is available only on uneconomic terms, the Company could be forced to curtail, to some extent, its expansion plans. The Company expects to be in compliance with the terms of its credit facilities during fiscal 1999. INFLATION A significant portion of the Company's operating expenses have been subject to inflationary increases. In particular, therapist salary increases historically have exceeded other medical industry salary rate increases due to the existing supply shortage of therapists. Historically, the Company has been unable to offset any portion of these inflationary increases through charge increases, but has mitigated somewhat the effect of these salary increases through expanding services and increasing operating efficiencies. Recently, however, the Company has begun to see an increase in the availability of therapists, due in part to changes in the regulatory environment affecting the reimbursement of therapy services. The supply of therapists coupled with the Company's intention to convert its long-term care services business to an operating model that emphasizes the increased use of well-trained therapy assistants and aides, closely supervised by licensed professionals, should at least partially mitigate the effects of inflation on therapist salaries and wages. However, to the extent that inflationary trends continue, 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. Management believes that the Company can continue to offset most, if not all, of the potential effects of inflation through business expansion and increasing operating efficiencies. 33 36 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) RECENTLY ISSUED ACCOUNTING STANDARDS In March 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statements of Position ("SOP") 98-1 "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". SOP 98-1 provides guidance on accounting for the costs of computer software developed or obtained for internal use. The SOP is effective for the year ended June 30, 2000. Management does not believe the adoption of SOP 98-1 will have a material effect on the Company's financial position or results of operation. In June 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 98-5 "Reporting on the Cost of Start-Up Activities" which the Company is required to adopt no later than June 30, 2000. SOP 98-5 provides the reporting standards for the costs of start-up activities, including organizational costs, which should be expensed as incurred. Management does not believe the adoption of SOP 98-5 will have a material effect on the Company's financial position or results of operations. YEAR 2000 READINESS Historically, certain computer programs have been written using two digits, rather than four digits, to define the applicable year. This could lead, in many cases, to a computer's recognizing a date using "00" as 1900 rather than the year 2000. This phenomenon could result in major computer system failures or miscalculations, and is generally referred to as the "Year 2000" problem or issue. The Company is currently in the process of assessing its exposure to the Year 2000 problem, and has established a comprehensive response to that exposure. Generally, the Company has Year 2000 exposure in three areas: (i) financial and management operating computer systems used to manage the Company's business, (ii) microprocessors and other electronic devices included as components of therapy and other equipment used by the Company ("embedded chips") and (iii) computer systems used by third parties, in particular financial institutions, customers and suppliers of the Company. At June 30, 1998, the Company had completed an inventory of its financial and management operating systems and made a preliminary determination of which programs were or were not Year 2000 compliant. During the fiscal year ending June 30, 1999, the Company intends to test each significant program which is believed to be Year 2000 compliant and to remediate all significant programs that are not Year 2000 compliant. In some cases, Year 2000 issues will be corrected in the development of new programs, which enhance or provide new functionality to these financial and management operating systems. The Company estimates the cost of this effort to be approximately $9 million, including $5 million of capital costs for new computers and related equipment. This amount does not include costs for computer software developed in order to provide or improve functionality. At June 30, 1998, the Company had already spent approximately $525 thousand in this effort. The Company has increased its overall information technologies budget to accommodate Year 2000 issues and has not delayed other projects critical to the Company's business. The Company expects to substantially complete Year 2000 testing and remediation on its financial and management operating systems by June 30, 1999. The Company has begun an inventory and assessment of its exposure to embedded chips in its facilities or equipment used in those facilities and capability of vendors of such equipment to successfully remediate Year 2000 problems in equipment with embedded chips. The Company has recently begun interviewing vendors and customers to determine their exposure to Year 2000 issues, their anticipated risks and responses to those risks. 34 37 NOVACARE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) If the Company is unsuccessful in completing remediation of non-compliant systems, correcting embedded chips and if customers or vendors cannot rectify Year 2000 issues, the Company could incur additional costs, which may be substantial, to develop alternative methods of managing its business and replacing non-compliant equipment, and may experience delays in payments by customers or to vendors. The Company has not yet established a contingency plan in the event of noncompliance by its customers and vendors. CAUTIONARY STATEMENT Except for historical information, matters discussed above including, but not limited to, statements concerning future growth and Year 2000 readiness, are forward-looking statements that are based on management's estimates, assumptions and projections. Important factors that could cause results to differ materially from those expected by management include reimbursement system changes, including customer response to the establishment of salary equivalency guidelines for certain therapies and the change from cost-based reimbursement to fee schedules and per diem payments, the number and productivity of clinicians, pricing of payer contracts, management retention and development, management's success in integrating acquired businesses and in developing and introducing new products and lines of business, the ability of the Company, its customers and its suppliers to complete assessment, testing and remediation of Year 2000 issues, adverse Internal Revenue Service rulings with respect to the employer status of employee services businesses and the Company's ability to implement the employee services business model. 35 38 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA NOVACARE, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE DATA)
AS OF JUNE 30, ------------------------ 1998 1997 ---- ---- ASSETS Current assets: Cash and cash equivalents................................. $ 32,760 $ 22,716 Accounts receivable, net of allowance in 1998 and 1997 of $55,060 and $33,263, respectively...................... 338,328 256,477 Inventories............................................... 38,207 18,450 Deferred income taxes..................................... 14,580 13,939 Other current assets...................................... 27,978 18,313 ---------- ---------- Total current assets.............................. 451,853 329,895 Property and equipment, net................................. 80,857 69,740 Excess cost of net assets acquired, net..................... 767,729 568,027 Investment in joint ventures................................ 14,881 12,719 Deferred income taxes....................................... 2,886 2,570 Other assets, net........................................... 37,836 31,353 ---------- ---------- $1,356,042 $1,014,304 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of financing arrangements................. $ 32,074 $ 15,978 Accounts payable and accrued expenses..................... 193,025 135,272 Income taxes payable...................................... 981 5,069 ---------- ---------- Total current liabilities......................... 226,080 156,319 Financing arrangements, net of current portion.............. 476,308 326,700 Deferred income taxes....................................... 41,067 14,779 Other....................................................... 13,608 4,851 ---------- ---------- Total liabilities................................. 757,063 502,649 ---------- ---------- Minority interest in consolidated subsidiaries.............. 18,306 3,649 Commitments and contingencies............................... -- -- Shareholders' equity: Common stock, $.01 par value; authorized 200,000 shares, issued 67,935 shares in 1998 and 66,630 shares in 1997................................................... 679 666 Additional paid-in capital................................ 273,157 259,915 Retained earnings......................................... 350,255 292,340 ---------- ---------- 624,091 552,921 Less: Common stock in treasury (at cost), 5,401 shares in 1998 and 5,590 shares in 1997....................... (43,418) (44,915) ---------- ---------- Total shareholders' equity........................ 580,673 508,006 ---------- ---------- $1,356,042 $1,014,304 ========== ==========
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 36 39 NOVACARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE YEARS ENDED JUNE 30, ------------------------------------ 1998 1997 1996 ---- ---- ---- Net revenues............................................ $1,671,925 $1,066,451 $793,038 Cost of services........................................ 1,317,266 806,365 584,956 ---------- ---------- -------- Gross profit....................................... 354,659 260,086 208,082 Selling, general and administrative expenses............ 199,293 146,289 130,980 Provision for uncollectible accounts.................... 21,907 19,708 16,359 Amortization of excess cost of net assets acquired...... 20,269 13,548 9,874 Provision for restructure............................... 23,500 -- 13,370 ---------- ---------- -------- Income from operations............................. 89,690 80,541 37,499 Gain from issuance of subsidiary stock.................. 38,805 -- -- Investment income....................................... 830 1,740 4,999 Interest expense........................................ (28,285) (15,244) (12,536) Minority interest....................................... (1,494) (236) (96) ---------- ---------- -------- Income before income taxes......................... 99,546 66,801 29,866 Income taxes............................................ 41,631 27,891 14,585 ---------- ---------- -------- Net income......................................... $ 57,915 $ 38,910 $ 15,281 ========== ========== ======== Net income per share: Basic............................................ $ .94 $ .64 $ .24 ========== ========== ======== Assuming dilution................................ $ .91 $ .62 $ .24 ========== ========== ======== Weighted average number of shares outstanding: Basic............................................ 61,742 61,031 63,459 ========== ========== ======== Assuming dilution................................ 63,584 62,455 63,918 ========== ========== ========
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 37 40 NOVACARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
COMMON SHARES ISSUED STOCK ADDITIONAL ----------------- ($.01 PAR TREASURY PAID-IN RETAINED COMMON TREASURY VALUE) STOCK CAPITAL EARNINGS ------ -------- --------- -------- ---------- -------- Balance at June 30, 1995........ 65,476 (187) $656 $ (1,614) $250,857 $238,149 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.................. -- -- -- -- -- -- Net income...................... -- -- -- -- -- 15,281 ------ ------ ---- -------- -------- -------- Balance at June 30, 1996........ 66,091 (3,190) 661 (23,465) 253,918 253,430 Issued in connection with employee benefit plans........ 539 17 5 11 4,284 -- Issued in connection with acquisitions.................. -- 344 -- 2,474 1,713 -- Repurchase of common stock...... -- (2,761) -- (23,935) -- -- Amortization of deferred compensation.................. -- -- -- -- -- -- Net income...................... -- -- -- -- -- 38,910 ------ ------ ---- -------- -------- -------- Balance at June 30, 1997........ 66,630 (5,590) 666 (44,915) 259,915 292,340 ISSUED IN CONNECTION WITH EMPLOYEE BENEFIT PLANS........ 1,305 59 13 465 9,674 -- ISSUED IN CONNECTION WITH ACQUISITIONS.................. -- 130 -- 1,032 3,568 -- NET INCOME...................... -- -- -- -- -- 57,915 ------ ------ ---- -------- -------- -------- BALANCE AT JUNE 30, 1998........ 67,935 (5,401) $679 $(43,418) $273,157 $350,255 ====== ====== ==== ======== ======== ========
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 38 41 NOVACARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
FOR THE YEARS ENDED JUNE 30, ---------------------------------- 1998 1997 1996 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income............................................... $ 57,915 $ 38,910 $ 15,281 Adjustments to reconcile net income to net cash flows from operating activities: Depreciation and amortization.......................... 50,407 37,978 33,159 Minority interest...................................... 1,494 236 96 Provision for uncollectible accounts................... 21,907 19,708 16,359 Deferred income taxes.................................. 21,838 6,017 3,631 Noncash portion of nonrecurring items.................. (15,305) -- 8,256 Changes in assets and liabilities, net of effects from acquisitions: Accounts and notes receivable....................... (71,430) (53,844) (12,676) Inventories......................................... (14,377) 2,502 (2,039) Other current assets................................ (6,256) (1,434) 10 Accounts payable and accrued expenses............... 23,628 (725) (6,152) Income taxes payable................................ 4,248 110 1,553 Other, net.......................................... (952) (2,217) 220 --------- --------- -------- Net cash flows provided by operating activities..... 73,117 47,241 57,698 --------- --------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Payments for businesses acquired, net of cash acquired... (180,578) (164,370) (20,764) Additions to property and equipment...................... (29,486) (21,653) (26,621) Net payment related to the sale of medical rehabilitation hospitals.............................................. -- -- (13,208) Other, net............................................... (3,816) (1,752) (4,326) --------- --------- -------- Net cash flows used in investing activities......... (213,880) (187,775) (64,919) --------- --------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from long-term debt and credit arrangements..... 470,640 263,200 133 Payment of long-term debt and credit arrangements........ (373,299) (176,174) (33,769) Proceeds from subsidiary stock issued.................... 45,709 -- -- Proceeds from common stock issued........................ 7,757 3,750 2,898 Payment for purchase of treasury stock................... -- (23,250) (24,953) --------- --------- -------- Net cash flows provided by (used in) financing activities........................................ 150,807 67,526 (55,691) --------- --------- -------- Net increase (decrease) in cash and cash equivalents..... 10,044 (73,008) (62,912) Cash and cash equivalents, beginning of year............. 22,716 95,724 158,636 --------- --------- -------- Cash and cash equivalents, end of year................... $ 32,760 $ 22,716 $ 95,724 ========= ========= ========
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 39 42 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations: NovaCare, Inc. ("NovaCare" or the "Company") is a national leader in three business segments: outpatient services, long-term care services, and employee services. Outpatient services consist of providing outpatient, orthotic and prosthetic ("O&P") and occupational health rehabilitation services through a national network of patient care centers. Long-term care services provide rehabilitation and healthcare consulting services on a contract basis to health care institutions, primarily long-term care facilities. Employee services are comprehensive, fully integrated outsourcing solutions to human resource issues, including payroll management, workers' compensation, risk management, benefits administration, unemployment services and human resource consulting services, and are generally provided to small and medium-sized businesses. Operating Segments: The Company has adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS 131 uses a "management approach" to defining and reporting the activities of operating segments. The management approach defines operating segments along the lines used by management to assess performance and make operating and capital decisions. The adoption of SFAS 131 did not affect the Company's results of operations or financial position, but did affect the disclosure of segment information provided in Note 13. Principles of Consolidation: The Consolidated Financial Statements include the accounts of the Company, its majority-owned subsidiaries and companies effectively controlled through management agreements. Investments in 20% or more of the voting interest of affiliates are accounted for using the equity method. All significant intercompany accounts and transactions have been eliminated. The Company recognizes a minority interest in its Balance Sheets and Statements of Operations for the portion of majority-owned subsidiaries attributable to its minority owners. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In fiscal 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: Net revenues for long-term care rehabilitation services and outpatient rehabilitation services are reported at the net realizable amounts from customers and third-party payers. Net revenues generated directly from Medicare and Medicaid reimbursement programs represented 7%, 12%, and 12% of the Company's consolidated net revenues for fiscal 1998, 1997 and 1996, respectively. Fiscal intermediaries determine settlement amounts due to or receivable from Medicare and Medicaid programs. Management believes that adequate provision has been made in the consolidated financial statements for potential adjustments resulting from such determinations. Employee services revenues and related costs of wages, salaries, and employment taxes pertaining to worksite employees are recognized in the period in which the employee performs the service. Because the Company is at risk for all of its direct costs, independently of whether payment is received from its clients, and consistent with industry practice, all amounts billed to clients for gross salaries and wages, related employment 40 43 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA) taxes, and health care and workers' compensation coverage are recognized as revenue by the Company. The Company establishes an allowance for doubtful accounts based on prior experience. Inventories: Inventories consist of customized orthotic and prosthetic merchandise held for sale, work in process and raw materials and are carried at the lower of cost or market. Cost of inventories is determined by the first-in, first-out method. 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. Effective July 1, 1997, the Company adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of", which establishes accounting standards for the impairment of long-lived assets, certain identified intangible assets and goodwill related to those assets to be held and used and for long-lived assets and certain intangible assets to be disposed of. In accordance with SFAS No. 121, the Company reviews the realizability of long-lived assets, certain intangible assets and goodwill whenever events or circumstances occur which indicate recorded cost may not be recoverable. The Company also reviews the overall recoverability of goodwill based primarily on estimated future undiscounted cash flows. If the expected future cash flows (undiscounted) are less than the carrying amount of such assets, the Company recognizes an impairment loss for the difference between the carrying amount of the assets and their estimated fair value. In estimating future cash flows for determining whether an asset is impaired, and in measuring assets that are impaired, assets are grouped by geographic region. 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 non-qualified savings plan offered to Company executives. Contributions made to the fund by eligible employees are partially matched by the Company. Withdrawals from the fund by employees are limited to events specified by the plan. Workers' Compensation: The Company is contractually obligated to provide workers' compensation coverage for its employees and co-employees. 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, 1998 would not have a material impact on the Company's financial position or results of operations. 41 44 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA) On July 1, 1997, the Company entered into a three-year contract with a commercial insurance company for worker's compensation coverage. Under this program, the Company's outpatient and long-term care services segment worksite employees continue to be covered under a self insurance program. Third-party worksite employees are covered under a fixed cost insurance program, which is subject to certain per incident and aggregate deductibles. Income Taxes: The Company records deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. Net Income Per Share: SFAS No. 128, "Earnings Per Share," became effective for periods ending after December 15, 1997. This statement revised the calculation of earnings per share from the "primary" and "fully diluted" methods previously employed to the "basic" and "assuming dilution" methods. The Company had not previously presented fully diluted earnings per share because the result was not materially different than the primary calculation. Under the new statement, earnings per share-basic represents earnings divided by the weighted average number of shares outstanding during the period. Earnings per share-assuming dilution represents the basic weighted average shares outstanding adjusted for the effects of stock options and contingently issuable shares under certain acquisition agreements. The calculation of the Company's earnings per share-assuming dilution is comparable to that used in prior calculations of primary earnings per share. In accordance with this statement, the Company has replaced its disclosure of primary net income per share with net income per share-basic and net income per share-assuming dilution. The following table sets forth the computation and reconciliation of net income per share-basic and net income per share-assuming dilution:
YEARS ENDED JUNE 30, ----------------------------- 1998 1997 1996 ---- ---- ---- Net income.................................................. $57,915 $38,910 $15,281 ======= ======= ======= Weighted average shares outstanding: Weighted average shares outstanding -- basic.............. 61,742 61,031 63,459 Stock options.......................................... 1,801 1,305 95 Contingently issuable shares -- assuming dilution...... 41 119 364 ------- ------- ------- Weighted average shares outstanding -- assuming dilution............................................... 63,584 62,455 63,918 ======= ======= ======= Net income per share: Basic..................................................... $ .94 $ .64 $ .24 ======= ======= ======= Assuming dilution......................................... $ .91 $ .62 $ .24 ======= ======= =======
The Company did not include convertible subordinated debentures, equivalent to 6,567 shares of common stock, or options to purchase 83, 323 and 5,750 shares of common stock in 1998, 1997, and 1996, respectively, because their effects are antidilutive. There were no transactions that occurred subsequent to June 30, 1998 that would have materially changed the number of shares used in computing net income per share-basic or net income per share-assuming dilution. 2. PROVISION FOR RESTRUCTURE The following table sets forth the Company's provision for restructure for the years ended June 30, 1998 and 1996. There was no provision for restructure in fiscal 1997. 42 45 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED JUNE 30, -------------------- 1998 1996 ---- ---- Productivity and cost reduction programs: Employee severance costs.................................. $21,730 $ 2,931 Lease terminations........................................ 450 4,032 Asset write-offs, net of estimated sale proceeds.......... 360 5,965 Other..................................................... 960 442 ------- ------- Total provision............................................. $23,500 $13,370 ======= =======
In fiscal 1998, the Company recorded a provision for restructure based on an evaluation of changes in the Medicare reimbursement system recently mandated by the Balanced Budget Act. In response to these changes, the Company is converting its long-term care services contract rehabilitation model from one characterized by a high concentration of one-on-one therapy, with licensed professionals treating individual patients, to a model which: (i) relies more heavily on well-trained therapy assistants and aides closely supervised by licensed professionals, and (ii) employs simultaneous therapy, wherein licensed professionals, along with well-trained therapy assistants and aides, treat multiple patients on a coordinated basis. The provision reflects principally employee severance costs, which represent the accumulation of termination benefits set forth in the Company's severance policy, related to changes in workforce composition dictated by the revised operating model. The 1996 productivity and cost reduction programs pertained to the consolidation and reorganization of the Company's outpatient services operations and certain administrative functions. A schedule of the Company's reserves for restructure is as follows:
YEARS ENDED JUNE 30, ----------------------------- 1998 1997 1996 ---- ---- ---- Beginning balance..................................... $ 5,286 $ 8,241 $11,730 Provision for restructure............................. 23,500 -- 13,370 Less: non-cash portion................................ (360) -- (7,229) Payments and other reductions......................... (4,678) (2,955) (9,630) ------- ------- ------- Ending Balance........................................ $23,748 $ 5,286 $ 8,241 ======= ======= =======
3. GAIN FROM ISSUANCE OF SUBSIDIARY STOCK In fiscal 1998, a subsidiary of the Company, NovaCare Employee Services, Inc. ("NCES"), completed an initial public offering, converted its mandatorily redeemable common stock, and issued common stock to former owners of acquired companies. As a result of these common stock transactions, the Company's percentage ownership of NCES decreased to 70.9% at June 30, 1998 from 98.7% at June 30, 1997. The initial public offering included 5,750 shares of NCES common stock issued at $9.00 per share. Proceeds received by NCES, net of underwriting and issuance costs, were $45,709. Mandatorily redeemable common stock was converted into 813 common shares, valued at $4.82 per share. The issuance of common stock to former owners included 723 shares valued at $8.29 per share and 120 shares valued at $8.31 per share. The Company recorded a gain of $38,805 ($22,895 net of tax) for the difference between the Company's historical cost of its investment in NCES and its portion of NCES equity at June 30, 1998. The Company will continue to record NCES investment adjustments through its statement of operations as NCES's equity changes as a result of capital transactions. 43 46 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA) 4. ACQUISITION AND JOINT VENTURE TRANSACTIONS During the year ended June 30, 1998, the Company acquired 90 outpatient services businesses consisting of 43 outpatient physical therapy and rehabilitation businesses, 42 O&P businesses and five occupational health businesses; and two employee services businesses. The following unaudited pro forma consolidated results of operations of the Company give effect to each of the acquisitions as if they occurred on July 1, 1996:
YEARS ENDED JUNE 30, ------------------------ 1998 1997 ---- ---- Net revenues................................................ $1,836,042 $1,508,378 Net income.................................................. 63,152 52,047 Net income per share-basic.................................. 1.02 .85 Net income per share-assuming dilution...................... $ .99 $ .83
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, 1996, or the results that may occur in the future. Information with respect to businesses acquired in purchase transactions was as follows (the allocation for fiscal 1998 acquisitions is preliminary):
AS OF JUNE 30, -------------------- 1998 1997 ---- ---- Excess cost of net assets acquired.......................... $838,752 $618,781 Less: accumulated amortization.............................. (71,023) (50,754) -------- -------- $767,729 $568,027 ======== ========
YEARS ENDED JUNE 30, --------------------- 1998 1997 ---- ---- Cash paid (net of cash acquired)............................ $146,643 $149,147 Deferred purchase price obligations......................... 4,600 19,294 Notes issued................................................ 50,754 44,275 Other consideration......................................... 17,118 4,781 -------- -------- 219,115 217,497 Liabilities assumed......................................... 26,724 11,685 -------- -------- 245,839 229,182 Fair value of assets acquired, principally accounts receivable and property and equipment..................... 43,247 19,501 -------- -------- Cost in excess of fair value of net assets acquired......... $202,592 $209,681 ======== ========
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, 1998 of approximately $75,019 in cash and 41 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, 1998, 1997 and 1996, the Company paid $33,935, $15,223 and $14,914, respectively, in cash and issued 130, 344 and 619 shares of common stock, respectively, in connection with businesses acquired in prior years. 44 47 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA) Deferred purchase price obligations represent guaranteed purchase price amounts due to former owners of businesses acquired. Obligations of $8,756 are accrued at June 30, 1998, and are included in accounts payable and accrued expenses. Approximately $17,500 of the total amount accrued at June 30, 1997 was satisfied with proceeds from the initial public offering of NCES common stock. The Company has formed several joint ventures. The carrying value of these investments is $14,881 and $12,719 at June 30, 1998 and 1997, respectively. The Company accounts for investments in joint ventures by the equity method. 5. INVENTORIES Inventories consisted of the following:
AS OF JUNE 30, ------------------ 1998 1997 ---- ---- Materials and supplies...................................... $24,068 $12,569 Work in process............................................. 10,840 4,509 Finished goods.............................................. 3,299 1,372 ------- ------- $38,207 $18,450 ======= =======
6. PROPERTY AND EQUIPMENT The components of property and equipment were as follows:
AS OF JUNE 30, --------------------- 1998 1997 ---- ---- Land and buildings.......................................... $ 2,005 $ 3,983 Property, equipment and furniture........................... 110,657 84,733 Capitalized software........................................ 38,974 31,792 Leasehold improvements...................................... 29,670 20,559 --------- -------- 181,306 141,067 Less: accumulated depreciation and amortization............. (100,449) (71,327) --------- -------- $ 80,857 $ 69,740 ========= ========
Depreciation expense, including depreciation of property under capital leases, for fiscal 1998, 1997, and 1996 was $30,138, $24,430 and $23,285, respectively. 45 48 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA) 7. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses are summarized as follows:
AS OF JUNE 30, -------------------- 1998 1997 ---- ---- Accounts payable............................................ $ 19,679 $ 13,647 Accrued compensation and benefits........................... 87,985 65,564 Accrued workers' compensation and health claims............. 25,000 8,471 Accrued costs of productivity and cost improvement programs.................................................. 23,748 5,286 Deferred and contingent purchase price obligations.......... 8,756 25,624 Accrued interest............................................ 7,080 1,002 Other....................................................... 20,777 15,678 -------- -------- $193,025 $135,272 ======== ========
The Company is self-insured for certain health benefits up to $150 per individual per year. The Company recorded expenses 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. 8. FINANCING ARRANGEMENTS Financing arrangements consisted of the following:
AS OF JUNE 30, -------------------- 1998 1997 ---- ---- $400,000 revolving credit facility (Euro Dollar rate plus 0.875% to 1.5%), due June 30, 2003........................ $227,500 $109,600 Convertible subordinated debentures (5.5%), due January 2000...................................................... 175,000 175,000 Subordinated promissory notes (5% to 10%), payable through 2007...................................................... 98,318 56,859 $25,000 revolving credit facility of subsidiary............. -- -- Other....................................................... 7,564 1,219 -------- -------- 508,382 342,678 Less: current portion....................................... 32,074 15,978 -------- -------- $476,308 $326,700 ======== ========
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 1998, the credit agreement was amended to extend the term of the agreement from November 1999 to June 30, 2003 and to increase the available line of credit from $190,000 to $400,000. As of June 30, 1998, $168,278 of the line of credit was available after reduction for borrowings and letters of credit totaling $4,222. The revolving credit facility arrangement requires the maintenance of minimum net worth amounts as well as certain financial ratios. At June 30, 1998, the Company was in compliance with these requirements. The Company is charged a commitment fee ranging from .20% to .325% per annum on the average daily available balance. The weighted average borrowing rate for fiscal 1998 was 6.7%. 46 49 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA) In November 1997, NCES entered into a $25,000 three-year revolving credit facility with a syndicate of lenders. The credit facility provides for interest at a variable rate, depending on certain financial ratios, equal to: (i) the Euro Dollar rate plus a range of 1.375% to 2.5% or (ii) the lead lender's prime rate plus a range of .125% to 1.25%. Loans made under the credit facility are collateralized by a pledge of all of (i) NCES's subsidiaries' common stock, (ii) the assets of NCES and its subsidiaries, and (iii) the Company's interest in the common stock of NCES. As of June 30, 1998, $23,859 of the NCES line of credit was available after reduction for a letter of credit of $1,141. 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, 1998 and 1997 was $166,700 and $164,500 respectively. The estimated fair value of all other debt and financing arrangements approximates carrying value. At June 30, 1998, aggregate annual maturities of financing arrangements were as follows for the next five fiscal years and thereafter:
FISCAL YEAR - ----------- 1999........................................................ $ 32,074 2000........................................................ 200,592 2001........................................................ 21,550 2002........................................................ 15,958 2003........................................................ 236,444 Thereafter.................................................. 1,764 -------- $508,382 ========
Interest paid on debt during fiscal 1998, 1997 and 1996 amounted to $21,676, $18,120 and $11,730, respectively. 9. LEASES The Company is obligated under capital leases for office space and office, transportation and therapy equipment. Included in property and equipment in the accompanying Consolidated Balance Sheets are the following assets held under capital leases.
AS OF JUNE 30, ------------------ 1998 1997 ---- ---- Property and equipment...................................... $ 5,940 $ 3,316 Less: accumulated amortization.............................. (4,763) (2,497) ------- ------- $ 1,177 $ 819 ======= =======
The Company 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. 47 50 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA) The Company is fully reimbursed for its lease costs for the aforementioned office space under noncancelable sublease agreements. Future minimum lease commitments for all non-cancelable leases as of June 30, 1998 are as follows:
CAPITAL OPERATING SUB-LEASE FISCAL YEAR LEASES LEASES RECEIVABLES - ----------- ------- --------- ----------- 1999................................................. $ 784 $ 40,775 $ 938 2000................................................. 776 30,906 582 2001................................................. 362 24,632 454 2002................................................. 207 17,247 357 2003................................................. 242 9,444 288 Thereafter........................................... 114 6,732 -- ------ -------- ------ Total minimum lease payments......................... 2,485 $129,736 $2,619 ======== ====== Less: amount representing interest................... (348) ------ Present value of minimum payments under capital lease obligations........................................ $2,137 ======
10. INCOME TAXES The components of income tax expense were as follows:
YEARS ENDED JUNE 30, ----------------------------- 1998 1997 1996 ---- ---- ---- Current: Federal............................................. $18,116 $17,757 $ 8,048 State............................................... 1,677 4,117 2,906 ------- ------- ------- 19,793 21,874 10,954 ------- ------- ------- Deferred: Federal............................................. 19,854 5,470 3,301 State............................................... 1,984 547 330 ------- ------- ------- 21,838 6,017 3,631 ------- ------- ------- $41,631 $27,891 $14,585 ======= ======= =======
48 51 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA) The components of net deferred tax assets (liabilities) as of June 30, 1998 and 1997 were as follows:
AS OF JUNE 30, -------------------- 1998 1997 ---- ---- Accruals and reserves not currently deductible for tax purposes.................................................. $ 9,669 $ 12,557 Restructure reserves........................................ 7,051 3,232 Other....................................................... 746 720 -------- -------- Gross deferred tax assets................................. 17,466 16,509 -------- -------- Expenses capitalized for financial statement purposes....... (14,766) (9,828) Depreciation and capital leases............................. (9,446) (3,586) Gain from issuance of subsidiary stock...................... (15,600) -- Other, net.................................................. (1,255) (1,365) -------- -------- Gross deferred tax liabilities............................ (41,067) (14,779) -------- -------- Net deferred tax asset (liability)........................ $(23,601) $ 1,730 ======== ========
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, ----------------------------- 1998 1997 1996 ---- ---- ---- Expected federal income tax expense................... $34,841 $23,380 $10,453 State income taxes, less federal benefit.............. 4,274 3,244 2,108 Non-deductible nonrecurring items..................... 579 549 1,027 Non-deductible amortization of excess cost of net assets acquired..................................... 4,400 2,974 2,011 Dividend exclusion and non-taxable interest income.... -- 59 (395) Other, net............................................ (2,463) (2,315) (619) ------- ------- ------- $41,631 $27,891 $14,585 ======= ======= =======
Income taxes paid during fiscal 1998, 1997 and 1996 amounted to $15,359, $21,981 and $38,699, respectively. 11. MINORITY INTEREST Minority interest resulted from investments in the following entities:
AS OF JUNE 30, ----------------- 1998 1997 ---- ---- NovaCare Employee Services, Inc............................. $17,863 $3,334 All other entities.......................................... 443 315 ------- ------ $18,306 $3,649 ======= ======
During fiscal 1998 and 1997, NCES issued equity instruments on its own behalf. The Company recognizes a minority interest liability for NCES equity issued to third-party investors plus the portion of NCES net income attributable to those investors. 49 52 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA) 12. BENEFIT PLANS Stock Option Plans: The Company's stock option plans, as amended, provide for issuance of options to purchase up to 5,800 shares of common stock to employees, officers and directors. Under the plans, substantially all options are granted for a term of up to 10 years at prices equal to the fair market value at the date of grant. In May 1996, the Board approved an option exchange for one of its plans 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 stated levels. The following summarizes the activity of the stock option plans:
YEARS ENDED JUNE 30, ---------------------------------------------- 1998 1997 1996 ---- ---- ---- Options: Outstanding at beginning of year..... 2,900 3,188 2,649 Granted.............................. 1,020 551 2,592 Exercised............................ (881) (364) (71) Canceled............................. (256) (475) (1,982) -------------- ------------ ------------ Outstanding at end of year........... 2,783 2,900 3,188 ============== ============ ============ Option price per share ranges: Outstanding at beginning of year..... $ .09-$20.58 $ .09-$20.58 $ .09-$21.00 Granted.............................. 12.94- 13.56 7.38- 13.38 5.75- 7.50 Exercised............................ .09- 14.25 .09- 10.63 .09- 9.13 Canceled............................. .09- 16.50 2.00- 16.50 .12- 20.58 Outstanding at end of year........... $ .12-$20.58 $ .09-$20.58 $ .09-$20.58 Options exercisable at end of year..... 1,074 1,464 363 Exercisable option price ranges........ $ .12-$20.58 $ .09-$20.58 $ .09-$20.58 Options available for grant at end of year under stock option plans........ 267 1,034 982
Other Stock Awards: During 1997, the President of the Company was granted 850 options to purchase the Company's common stock at an exercise price equal to the fair market value on the grant date. During 1996, certain officers of the Company were offered a modified exchange. Under the modified exchange, the Chairman received fewer options than would have been warranted under the Black-Scholes formula while the President 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. 50 53 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA) The following summarizes the other stock award activity:
YEARS ENDED JUNE 30, --------------------------------------------- 1998 1997 1996 ---- ---- ---- Options: Outstanding at beginning of year...... 4,404 3,554 4,704 Granted............................... -- 850 3,500 Exercised............................. (304) -- -- Canceled.............................. -- -- (4,650) ------------ ------------ ------------- Outstanding at end of year............ 4,100 4,404 3,554 ============ ============ ============= Option price per share: Outstanding at beginning of year...... $2.25-$10.88 $2.25-$ 6.88 $ 2.25-$19.50 Granted............................... -- 10.88 6.88 Exercised............................. 2.25- 6.88 -- -- Canceled.............................. -- -- 10.44-19.50 Outstanding at end of year............ $2.25-$10.88 $2.25-$10.88 $ 2.25-$ 6.88 Options exercisable at end of year...... 2,800 2,254 54 Exercisable option price ranges......... $4.88-$10.88 $2.25-$10.88 $ 2.25-$ 4.88
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 plan. The table below sets forth the pro forma information as if the Company had adopted the compensation recognition provisions of SFAS 123:
1998 1997 1996 ---- ---- ---- Decrease to: Net income................................... $2,794 $5,268 $1,585 Net income per share basic................... .05 .09 .02 Net income per share-assuming dilution....... $ .04 $ .08 $ .02 Assumptions: Expected life (years)........................ 1.6 1.6 1.6 Risk-free interest rate...................... 4.2%-7.8% 4.2%-7.8% 4.2%-7.8% Volatility................................... 37.08% 43.93% 59.01% Dividend yield............................... N/A N/A N/A
The weighted average fair value of the stock options, calculated using the Black-Scholes option pricing model, granted during the fiscal years ended June 30, 1998, 1997 and 1996 is $13.10, $10.59 and $6.76 respectively. The remaining contractual life of all options granted as of June 30, 1998 is 6.7 years. Retirement Plans: The Company has defined contribution 401(k) plans covering substantially all of its employees. Company contributions for fiscal 1998, 1997 and 1996 were $4,508, $3,916, and $3,634, respectively. The Company established a non-qualified supplemental benefit plan covering certain key employees. 51 54 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA) The Company's matching contributions were $859, $224 and $582 for fiscal 1998, 1997 and 1996, respectively. 13. OPERATING SEGMENTS The Company adopted SFAS 131 in fiscal 1998. Prior years' segment information has been restated to present information for the Company's three business segments described in Note 1, Nature of Operations. The accounting policies of the segments are the same as those described in Note 1, Nature of Operations. Intrasegment revenue relates to the provision of services by the employee services segment to the other two segments. The Company evaluates the performance of its segments and allocates resources to them based on income from operations and earnings before interest, income taxes, depreciation and amortization ("EBITDA"). The Company does not allocate investment income, interest expense, gain on sale of subsidiary stock or minority interest for management reporting purposes. Unallocated assets consist principally of cash and cash equivalents as well as deferred income taxes, property and equipment and other assets. Operating results and other financial data are presented for the principal operating segments of the Company as follows:
YEARS ENDED JUNE 30, ------------------------------------ 1998 1997 1996 ---- ---- ---- NET REVENUES: Outpatient services................................... $ 512,729 $ 357,634 $269,764 Long-term care services............................... 656,907 569,913 523,274 Employee services..................................... 1,271,757 394,193 -- ---------- ---------- -------- Total......................................... 2,441,393 1,321,740 793,038 Intrasegment elimination -- employee services......... (769,468) (255,289) -- ---------- ---------- -------- Consolidated net revenues.......................... $1,671,925 $1,066,451 $793,038 ========== ========== ======== GROSS PROFIT: Outpatient services................................... $ 158,676 $ 106,744 $ 67,239 Long-term care services............................... 182,676 156,055 149,562 Employee services..................................... 41,547 12,238 -- ---------- ---------- -------- Total......................................... 382,899 275,037 216,801 Intrasegment elimination -- employee services......... (16,646) (5,739) -- Depreciation.......................................... (11,594) (9,212) (8,719) ---------- ---------- -------- Consolidated gross profit.......................... $ 354,659 $ 260,086 $208,082 ========== ========== ======== INCOME FROM OPERATIONS: Outpatient services................................... $ 65,234 $ 44,811 $ 16,289 Long-term care services............................... 116,057 93,367 77,962 Employee services..................................... 10,898 2,931 -- ---------- ---------- -------- Total......................................... 192,189 141,109 94,251 Unallocated selling, general and administrative expenses........................................... (78,999) (60,568) (43,382) Provision for restructure............................. (23,500) -- (13,370) ---------- ---------- -------- Consolidated income from operations................ $ 89,690 $ 80,541 $ 37,499 ========== ========== ========
52 55 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED JUNE 30, ------------------------------------ 1998 1997 1996 ---- ---- ---- DEPRECIATION AND AMORTIZATION: Outpatient services................................... $ 25,345 $ 17,415 $ 17,651 Long-term care services............................... 11,239 10,291 12,832 Employee services..................................... 3,828 1,286 -- ---------- ---------- -------- Total......................................... 40,412 28,992 30,483 Unallocated selling, general and administrative expenses........................................... 9,995 8,986 2,676 ---------- ---------- -------- Consolidated depreciation and amortization......... $ 50,407 $ 37,978 $ 33,159 ========== ========== ======== EBITDA: Outpatient services................................... $ 90,579 $ 62,226 $ 33,940 Long-term care services............................... 127,296 103,658 90,794 Employee services..................................... 14,726 4,217 -- ---------- ---------- -------- Total......................................... 232,601 170,101 124,734 Unallocated selling, general and administrative expenses........................................... (69,004) (51,582) (40,706) Provision for restructure............................. (23,500) -- (13,370) ---------- ---------- -------- Consolidated EBITDA................................ $ 140,097 $ 118,519 $ 70,658 ========== ========== ======== ASSETS: Outpatient services................................... $ 876,250 $ 602,998 $405,273 Long-term care services............................... 326,872 301,865 270,681 Employee services..................................... 112,583 68,684 -- Unallocated assets.................................... 40,337 40,757 113,777 ---------- ---------- -------- Total assets.................................. $1,356,042 $1,014,304 $789,731 ========== ========== ========
14. 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. 15. SHAREHOLDER RIGHTS PLAN Under the terms of a Shareholder Rights Plan adopted in 1995, the Company's Board of Directors declared a dividend distribution of one right for each outstanding common share. The rights may not be exercised or traded apart from the common shares to which they are attached until 10 days after a person or group has acquired, obtained the right to acquire, or commenced a tender offer for, at least 20% of the Company's outstanding common shares. In such event, each right will become exercisable for one common share for a price of $27. If a person or group acquires, or obtains the right to acquire, 20% or more of the Company's outstanding common shares, each right will become exercisable for common shares worth $54 and the rights held by the acquiror will become null and void. If the Company is involved in a merger and its common shares are changed or exchanged, or if more than 50% of its assets or earnings power is sold or transferred, each right will become exercisable for common stock of the acquiror worth $54. The rights will expire on March 20, 2000 unless earlier redeemed by the Company for $.001 per right. Subject to its right to 53 56 NOVACARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JUNE 30, 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA) 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. 16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
FOURTH THIRD SECOND FIRST QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- YEAR ENDED JUNE 30, 1998: Net revenues.................................. $464,642 $451,767 $398,818 $356,698 Gross profit.................................. 96,361 93,568 86,333 78,397 Income from operations........................ 32,933 29,778 3,631 23,348 Net income.................................... 14,474 12,645 20,572 10,224 Net income per share -- basic................. $ .23 $ .21 $ .34 $ .17 Net income per share -- assuming dilution..... $ .23 $ .20 $ .33 $ .16 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 share -- basic................. $ .20 $ .17 $ .15 $ .12 Net income per share -- assuming dilution..... $ .19 $ .16 $ .15 $ .12
Results for the second quarter of fiscal 1998 include a $23,500 pretax provision for restructure related to the conversion of the Company's long-term care services contract rehabilitation operating model in response to the Balanced Budget Act. Results for the fourth quarter and second quarter of fiscal 1998 include pretax gains of $677 and $38,128, respectively, related to issuance of shares to third parties by NCES. 54 57 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of NovaCare, Inc. In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) on page 56 present fairly, in all material respects, the financial position of NovaCare, Inc. and its subsidiaries at June 30, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1998, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule listed in the index appearing under item 14(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PRICEWATERHOUSECOOPERS LLP Philadelphia, PA July 31, 1998 55 58 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 1998 annual meeting of shareholders to be held on November 5, 1998 (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 15, 1998" 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, 1998 and 1997. ..... 36 Consolidated Statements of Operations for the three years ended June 30, 1998. ............................................. 37 Consolidated Statements of Changes in Shareholders' Equity for the three years ended June 30, 1998. ................... 38 Consolidated Statements of Cash Flows for the three years ended June 30, 1998. ............................................. 39 Notes to Consolidated Financial Statements.................. 40 Report of Independent Accountants........................... 55 (2) FINANCIAL STATEMENT SCHEDULES: II -- Valuation and Qualifying Accounts for each of the three years in the period ended June 30, 1998. ............. 58 (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.................................................... 59
(b) Current Reports on Form 8-K: On July 10, 1998, the Company filed a Current Report on Form 8-K dated July 9, 1998 with the Securities and Exchange Commission reporting information under Item 5, Other Events. 56 59 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 15, 1998 - --------------------------------------------------- (JOHN H. FOSTER) /s/ TIMOTHY E. FOSTER Chief Executive Officer and Director September 15, 1998 - --------------------------------------------------- (TIMOTHY E. FOSTER) /s/ JAMES W. MCLANE President, Chief Operating Officer September 15, 1998 - --------------------------------------------------- and Director (JAMES W. MCLANE) /s/ ROBERT E. HEALY, JR. Senior Vice President, Finance and September 15, 1998 - --------------------------------------------------- Administration and Chief Financial (ROBERT E. HEALY, JR.) Officer /s/ BARRY E. SMITH Vice President, Controller and Chief September 15, 1998 - --------------------------------------------------- Accounting Officer (BARRY E. SMITH) Director September , 1998 - --------------------------------------------------- (PETER O. CRISP) /s/ E. MARTIN GIBSON Director September 15, 1998 - --------------------------------------------------- (E. MARTIN GIBSON) /s/ SIRI S. MARSHALL Director September 15, 1998 - --------------------------------------------------- (SIRI S. MARSHALL) /s/ STEPHEN E. O'NEIL Director September 15, 1998 - --------------------------------------------------- (STEPHEN E. O'NEIL) /s/ GEORGE W. SIGULER Director September 15, 1998 - --------------------------------------------------- (GEORGE W. SIGULER) /s/ ROBERT G. STONE, JR. Director September 15, 1998 - --------------------------------------------------- (ROBERT G. STONE, JR.) Director September , 1998 - --------------------------------------------------- (DANIEL C. TOSTESON, M.D.)
57 60 SCHEDULE II NOVACARE, INC. VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED JUNE 30, 1998, 1997 AND 1996 (IN THOUSANDS)
BALANCE AT CHARGED TO BALANCE BEGINNING COSTS AND AT END DESCRIPTION OF PERIOD EXPENSES OTHER DEDUCTIONS OF PERIOD - ----------- ---------- ---------- ----- ---------- --------- Year ended June 30, 1998: Allowance for uncollectible accounts.......................... $33,263 21,907 8,127(1) (25,676) $55,060 17,439(2) Year ended June 30, 1997: Allowance for uncollectible accounts.......................... $18,995 19,708 11,295(1) (25,005) $33,263 8,270(2) Year ended June 30, 1996: Allowance for uncollectible accounts.......................... $19,718 16,359 1,187(1) (27,287) $18,995 9,018(2)
- --------------- (1) Allowances for doubtful accounts related to acquired receivables. (2) Charged against net revenues. 58 61 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 (incorporated by -- reference to Exhibit 4(a) to the Company's Annual Report on Form 10-K for the year ended June 30,1997). 4 (b)* Form of Indenture dated as of January 15, 1993 between the -- Company and Pittsburgh National Bank relating to 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) (i) Employment Agreement dated as of January 6, 1995 between -- the Company and Daryl A. Dixon and Promissory Note of Daryl A. Dixon in favor of the Company dated January 6, 1995 (incorporated by reference to Exhibit 10(i) to the Company's Annual Report on Form 10-K for the year ended June 30, 1995). (ii) Amendment dated October 10, 1997 to the employment -- agreement dated as of January 6, 1995 between the Company and Daryl A. Dixon (incorporated by reference to Exhibit 10(e) to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1997). 10 (c) (i) Employment Agreement dated as of July 1, 1996 between -- the Company and Timothy E. Foster (incorporated by reference to Exhibit 10(e) to the Company's Annual Report on Form 10-K for the year ended June 30, 1997). (ii) Amendment dated May 15, 1998 to the employment agreement dated as of July 1, 1996 between the Company and Timothy E. Foster. 10 (d) 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 (e) (i) 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). (ii) Amendment dated May 12, 1998 to the employment agreement dated as of April 14, 1997 between the Company and James W. McLane. 10 (f) Stock Purchase Agreement dated as of May 1, 1997 between -- NovaCare Employee Services, Inc. and James W. McLane (incorporated by reference to Exhibit 10(i) to the Company's Annual Report on Form 10-K for the year ended June 30, 1997).
59 62
EXHIBIT PAGE NUMBER EXHIBIT DESCRIPTION NUMBER - ------- ------------------- ------ 10 (g) Employment agreement dated as of June 13, 1997 between the -- Company and Robert E. Healy, Jr. (incorporated by reference to Exhibit 10(a) to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1997). 10 (h) Employment agreement dated as of March 18, 1998 between the -- Company and Ronald G. Hiscock (incorporated by reference to Exhibit 10(a) to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998). 10 (i) (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).
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EXHIBIT PAGE NUMBER EXHIBIT DESCRIPTION NUMBER - ------- ------------------- ------ (viii) Revolving Credit Facility Agreement Seventh Amendment -- dated as of November 4, 1996 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank of North Carolina, Mellon Bank, N.A., Nationsbank, N.A. (Carolina), CoreStates Bank, N.A., and Fleet Bank of Massachusetts, N.A. (incorporated by reference to Exhibit 10(a) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996). (ix) Revolving Credit Facility Agreement Eighth Amendment -- dated as of January 30, 1997 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank of North Carolina, Mellon Bank, N.A., Nationsbank, N.A., CoreStates Bank, N.A., Fleet Bank of Massachusetts, N.A., The Bank of New York, and SunTrust Bank (Central Florida), N.A. (incorporated by reference to Exhibit (10)(j)(ix) to the Company's Annual Report on Form 10-K for the year ended June 30, 1997). (x) Revolving Credit Facility Agreement Ninth Amendment -- dated as of January 30, 1997 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank of North Carolina, Mellon Bank, N.A., Nationsbank, N.A., CoreStates Bank, N.A., Fleet Bank of Massachusetts, N.A., The Bank of New York, and SunTrust Bank (Central Florida), N.A. (incorporated by reference to Exhibit 10(j)(x) to the Company's Annual Report on Form 10-K for the year ended June 30, 1997). (xi) Revolving Credit Facility Agreement Tenth Amendment -- dated as of March 31, 1997 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank of North Carolina, Mellon Bank, N.A., Nationsbank, N.A., CoreStates Bank, N.A., Fleet National Bank, The Bank of New York, and SunTrust Bank (Central Florida), N.A. (incorporated by reference to Exhibit 10(j)(xi) to the Company's Annual Report on Form 10-K for the year ended June 30, 1997). (xii) Revolving Credit Facility Agreement Eleventh Amendment -- dated as of June 27, 1997 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank of North Carolina, Mellon Bank, N.A., Nationsbank, N.A., CoreStates Bank, N.A., Fleet National Bank, The Bank of New York, SunTrust Bank (Central Florida), N.A., and Bank One (Kentucky), N.A. (incorporated by reference to Exhibit 10(j)(xii) to the Company's Annual Report on Form 10-K for the year ended June 30, 1997). (xiii) Revolving Credit Facility Agreement Twelfth Amendment -- dated as of September 30, 1997 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank, Mellon Bank, N.A., NationsBank, N.A., Corestates Bank, N.A., Fleet Bank, The Bank of New York, SunTrust Bank (Central Florida) N.A., Bank One (Kentucky) N.A., The Fuji Bank, Limited (New York Branch), Crestar Bank, Bank of Tokyo-Mitsubishi Trust Company, and AmSouth Bank (incorporated by reference to Exhibit 10(a) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997). (xiv) Revolving Credit Facility Agreement Thirteenth -- Amendment dated as of November 17, 1997 by and among NovaCare and certain of its subsidiaries and PNC Bank N.A., Corestates Bank, N.A., First Union National Bank, Fleet National Bank, Mellon Bank, N.A., The Bank of New York, SunTrust Bank (Central Florida) N.A., Bank One (Kentucky) N.A., The Fuji Bank, Limited (New York Branch), Crestar Bank, Bank of Tokyo-Mitsubishi Trust Company, AmSouth Bank (incorporated by reference to Exhibit 10(b) to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998).
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EXHIBIT PAGE NUMBER EXHIBIT DESCRIPTION NUMBER - ------- ------------------- ------ (xv) Revolving Credit Facility Agreement Fourteenth -- Amendment dated as of February 24, 1998 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., Corestates Bank, N.A., First Union National Bank, Fleet National Bank, Mellon Bank, N.A., The Bank of New York, SunTrust Bank (Central Florida) N.A., Bank One (Kentucky) N.A., The Fuji Bank, Limited (New York Branch), Crestar Bank, Bank of Tokyo-Mitsubishi Trust Company, AmSouth Bank (incorporated by reference to Exhibit 10(c) to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998). (xvi) Revolving Credit Facility Agreement Fifteenth -- Amendment dated as of February 27, 1998 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., Corestates Bank, N.A., First Union National Bank, Fleet National Bank, Mellon Bank, N.A., The Bank of New York, SunTrust Bank (Central Florida) N.A., Bank One (Kentucky) N.A., The Fuji Bank, Limited (New York Branch), Crestar Bank, Bank of Tokyo-Mitsubishi Trust Company, AmSouth Bank (incorporated by reference to Exhibit 10(d) to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998). (xvii) Revolving Credit Facility Agreement Sixteenth -- Amendment dated as of March 30, 1998 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., Corestates Bank, N.A., First Union National Bank, Fleet National Bank, Mellon Bank, N.A., The Bank of New York, SunTrust Bank (Central Florida) N.A., Bank One (Kentucky) N.A., The Fuji Bank, Limited (New York Branch), Crestar Bank, Bank of Tokyo-Mitsubishi Trust Company, AmSouth Bank (incorporated by reference to Exhibit 10(e) to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998). (xviii) Revolving Credit Facility Agreement Seventeenth Amendment dated as of June 30, 1998 by and among NovaCare and certain of its subsidiaries and PNC Bank, N.A., First Union National Bank, Fleet National Bank, Mellon Bank, N.A., Nations Bank, N.A., The Bank of New York, SunTrust Bank (Central Florida) N.A., Bank One (Kentucky) N.A., The Fuji Bank, Limited (New York Branch), Crestar Bank, Bank of Tokyo-Mitsubishi Trust Company, AmSouth Bank, Bank of America NT & SA, Comerica Bank, Credit Lyonnais (New York Branch), Cooperative Centrale Raiffersen-Boerenleenbank B.A., "Rabobank Nederaland", (New York Branch), The Tokai Bank, Limited (New York Branch), Toronto Dominion (Texas), Inc. 10 (j) Supplemental Benefits Plan as amended to date (incorporated -- by reference to Exhibit 10(k) to the Company's Annual Report on Form 10-K for the year ended June 30, 1997). 13 Annual Report to Shareholders for the fiscal year ended June 30, 1998. 21 Subsidiaries of the Company. 23 Consent of Independent Accountants. 24 Power of Attorney (see "Power of Attorney" in Form 10-K). -- 27 Financial Data Schedules.
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. 62 EX-10.CII 2 AMENDMENT DATED 5/15 TO EMPLOYEEMENT AGREEMENT 1 EXHIBIT 10(c)(ii) AMENDMENT TO EMPLOYMENT AGREEMENT This Amendment to Employment Agreement (the "Amendment") made as of the 15th day of May, 1998, 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 parties have heretofore entered into an Employment Agreement dated as of July 1, 1996 (the "Employment Agreement"); and WHEREAS, the parties now wish to amend the Employment Agreement to modify the manner in which Executive's annual bonus shall be determined for the fiscal years ending June 30, 1999 and thereafter; NOW, THEREFORE, in consideration of the premises and the mutual agreements hereinafter set forth, the parties hereby agree as follows: 1. Effective as of July 1, 1998, the Employment Agreement shall be amended by deleting subsection (a) of Section 3.2 in its entirety, and by replacing such subsection with the following new subsection (a): "(a) In addition to the base salary provided for in Section 3.1, the Executive shall be eligible for an incentive bonus target of 100% of base salary with respect to each fiscal year of the Company ending during the term of this Agreement, payable in accordance with the terms of the Company's Executive Incentive Compensation Plan based on attainment of stated objectives, commencing with the fiscal year ending June 30, 1999." The parties agree that, with respect to the fiscal year ending June 30, 1998, Executive's incentive bonus shall be determined based on the terms and conditions of the Employment Agreement existing as of the date hereof, without regard to the amendment contained herein. 2. Section 6.4(a)(D) is hereby deleted and replaced with the following new subsection (a)(D): "(D) on the date of termination, an amount equal to the product derived by multiplying one and one-half (1.5) times 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 2 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(c). 3. Section 6.7 is hereby amended to provide that, in the event of a termination of employment following a Change of Control as addressed in that Section, the amount referred to in paragraph (D) of Section 6.4 shall be paid on the date of termination (and references in Section 6.7 to the "Payment Date" shall be disregarded). 4. In all other respects the Employment Agreement shall remain in full force and effect without change. IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date first above written. NOVACARE, INC. By: /s/ James W. McLane ______________________________ James W. McLane President /s/ Timothy E. Foster _____________________________ Timothy E. Foster EX-10.EII 3 AMENDMENT TO EMPLOYMENT AGREEMENT/JAMES W. MCLANE 1 EXHIBIT 10(e)(ii) AMENDMENT TO EMPLOYMENT AGREEMENT This Amendment to Employment Agreement (the "Amendment") made this 12th day of May, 1998, by and between NovaCare, Inc., a Delaware corporation (the "Company"), and James W. McLane (the "Executive"), W I T N E S S E T H: WHEREAS, the parties have heretofore entered into an Employment Agreement dated as of April 14, 1997 (the "Employment Agreement"); and WHEREAS, the parties now wish to amend the Employment Agreement to modify the manner in which Executive's annual bonus shall be determined for the fiscal years ending June 30, 1999 and thereafter; NOW, THEREFORE, in consideration of the premises and the mutual agreements hereinafter set forth, the parties hereby agree as follows: Effective as of July 1, 1998, the Employment Agreement shall be amended by deleting subsection (a) of Section 3.2 in its entirety, and by replacing such subsection with the following new subsection (a): "(a) In addition to the base salary provided for in Section 3.1, the Executive shall be eligible for an incentive bonus target of 100% of base salary with respect to each fiscal year of the Company ending during the term of this Agreement, payable in accordance with the terms of the Company's Executive Incentive Compensation Plan based on attainment of stated objectives, commencing with the fiscal year ending June 30, 1999." The parties agree that, with respect to the fiscal year ending June 30, 1998, Executive's incentive bonus shall be determined based on the terms and conditions of the Employment Agreement existing as of the date hereof, without regard to the amendment contained herein. In all other respects the Employment Agreement shall remain in full force and effect without change. 2 IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date first above written. NOVACARE, INC. By: /s/ Timothy E. Foster _______________________________ Timothy E. Foster Chief Executive Officer /s/ James W. McLane ______________________________ James W. McLane EX-10.IXVIII 4 REVOLVING CREDIT FACILITY AGREEENT 17TH AMENDMENT 1 EXHIBIT 10(i)(xviii) NOVACARE, INC. 1016 WEST NINTH AVENUE KING OF PRUSSIA, PA 19406 June 30, 1998 PNC Bank, National Association, as Agent One PNC Plaza Fifth Avenue and Wood Street Pittsburgh, PA 15265 Attn: Marcie Knittel, Vice President RE: Seventeenth Amendment to Credit Agreement and Consent (the "Seventeenth 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 and Restatement. Articles I through XI of the Credit Agreement are hereby amended and restated in their entirety as of the date hereof to read as set forth on Exhibit I hereto. (The cover page, opening paragraph and recitals to the Agreement are also included in Exhibit I for convenience.) Upon the effectiveness of this Seventeenth Amendment and for periods subsequent to such effective date, Bank of America NT & SA, Comerica Bank, Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A., ("Rabobank Nederland") New York Branch, Credit Lyonnais New York Branch, Toronto Dominion (Texas), Inc. and The Tokai Bank, Limited New York Branch shall each be a Bank party to the Credit Agreement. 2 2. Amendment to Exhibits and Schedules. (a) Exhibits. The following Exhibit to the Credit Agreement is hereby amended and restated in its entirety in the form of such Exhibit attached hereto: Exhibit 8.01(m)(iii) Compliance Certificate (b) Schedules. The following Schedules to the Credit Agreement are hereby amended and restated in their entirety in the forms of such Schedules attached hereto:
Schedule 1.01(B) List of Banks and Commitments Schedule 1.01(E) Excluded Entities Schedule 6.01(c) Subsidiaries
3. Closing Fees. The Borrowers jointly and severally agree to reimburse the Agent and the Banks on demand for all costs, expenses and disbursements relating to this Seventeenth Amendment which are payable by the Borrower as provided in Section 10.05 of the Credit Agreement. In addition, the Borrowers shall pay to the Agent for the account of the Agent the fee set forth in that certain agreement between the Borrower and the Agent with respect to this Seventeenth Amendment and shall pay to the Agent for the benefit of the applicable Banks the fees identified in Exhibit II hereto as the "Closing Fee" and as the "Amendment Fee," respectively. 4. Conditions of Effectiveness. The effectiveness of this Seventeenth Amendment is expressly conditioned upon the occurrence and completion of all of the following: (i) receipt by the Agent of the nonrefundable fee set forth in that certain letter agreement among the Agent and the Borrowers with respect to this Seventeenth Amendment; (ii) receipt by the Agent on behalf of the Banks of the nonrefundable fees equal to the aggregate of the amounts set forth on Exhibit II hereto; (iii) the Agent's receipt of counterparts of this Seventeenth Amendment duly executed by the Borrowers, the Guarantors, the Agent and the Banks; (iv) the Agent's receipt of an incumbency certificate signed by the Secretary or Assistant Secretary of the Borrowers and Guarantors, and a certificate certifying as to all action taken by the Borrowers and Guarantors to authorize the execution, delivery and performance of this Seventeenth Amendment; (v) an opinion of Richard S. Binstein, Esquire, Counsel to the Loan Parties, reasonably satisfactory to the Agent regarding this Seventeenth Amendment; (vi) with respect to each new Guarantor or new Borrower (a "Joining Subsidiary") documentation as required under Section 11.18 of the Credit Agreement, including without limitation the completion of the following: (1) executing and delivering to the Agent (A) in the case of a Joining Subsidiary which becomes a Borrower, a Revolving Credit Note in the form of Exhibit 1.01(R) to the Credit Agreement, payable to each Bank, (B) a joinder to the Credit Agreement in form satisfactory to the Agent, (C) a counterpart signature page to the Guaranty Agreement executed by certain Loan Parties which is in the form of Exhibit 1.01 (G)(1) to the Credit Agreement, in the case of a Joining Subsidiary which becomes a Borrower, and Exhibit 1.01(G)(2) to the Credit Agreement, in the case of a Joining Subsidiary which -2- 3 becomes a Guarantor, (D) if it owns stock or other ownership interests in any Qualifying Subsidiary, a joinder to the Pledge Agreement executed by certain Loan Parties which is in the form of Exhibit 1.01(P)(4) to the Credit Agreement, Exhibit 1.01(P)(5) to the Credit Agreement, or Exhibit 1.01(P)(6) to the Credit Agreement, as applicable, and delivering, as applicable, the original certificates evidencing such stock or other ownership interest if it is certificated with appropriate stock powers or other assignments signed in blank and UCC-1 financing statements necessary to perfect the security interests of the Agent for the benefit of the Banks therein, (E) a joinder to the Subordination Agreement (Intercompany) executed by certain Loan Parties which is in the form of Exhibit 1.01(S) to the Credit Agreement, and (F) a joinder to the Agency Agreement executed by certain Loan Parties appointing NovaCare as agent; (2) delivering to the Agent an opinion of Richard S. Binstein, Esquire, Counsel of the Loan Parties, reasonably satisfactory to the Agent regarding such Joining Subsidiary and such joinder; (3) delivering to the Agent certified copies of its organizational documents and other documents as requested by the Agent; (4) the Loan Party which owns the stock or other ownership interest of the Joining Subsidiary shall execute and deliver to the Agent for the benefit of the Banks a Pledge Agreement in the form of Exhibit 1.01(P)(4), 1.01(P)(5) or 1.01(P)(6) to the Credit Agreement, as applicable, and the original certificates evidencing such stock or other ownership interest if it is certificated with appropriate stock powers or other assignments signed in blank and UCC-1 financing statements necessary to perfect the security interests of the Agent for the benefit of the Banks therein; and (5) updated Schedules to the Credit Agreement and the other Loan Documents, if any, to update such schedules with respect to each Joining Subsidiary, such updated Schedules to be in form and substance satisfactory to the Required Banks; (vii) receipt by the Agent of a Certificate signed by the Secretary or Assistant Secretary of each Loan Party confirming that no Event of Default or Potential Default under the Credit Agreement shall have occurred and be continuing or shall exist; and (viii) new Notes to evidence the additional or adjusted Commitments of certain of the Banks. This Seventeenth Amendment shall be dated as of and shall be effective as of the date and year first above written subject to satisfaction of all conditions precedent to effectiveness as set forth in this Section 4, which date shall be the Seventeenth Amendment Effective Date. 5. Consent of All Banks, Approval of Increase in Revolving Credit Commitments. Pursuant to Section 11.01(b) of the Credit Agreement, this Seventeenth Amendment shall require the written consent of all of the Banks. 6. Consent to Acquisition. The Borrower requests the approval of, and the Agent and the Banks by executing this Seventeenth Amendment do hereby consent to, the acquisition by the Borrower or other Loan Party, of the issued and outstanding capital stock of Pro Active Therapy, Inc., for Consideration, not to exceed $45 million (the "Pro Therapy Acquisition"), and for the sole purpose of permitting the Pro Therapy Acquisition do hereby waive the dollar limitation for an individual Permitted Acquisition set forth in Section 8.02 (d)(ii)(g) [Liquidations, Mergers, Consolidations, Acquisitions] of the Credit Agreement. The Borrower acknowledges and agrees -3- 4 that consummation of the Pro Therapy Acquisition shall otherwise be in accordance with the requirements of the Credit Agreement. 7. Full Force and Effect. Each of the following documents, as amended through and including this Seventeenth Amendment, shall remain in full force and effect on and after the date of this Amendment: (a) each of the Schedules attached to the Credit Agreement except for the Schedules which are being amended and restated hereby; (b) each of the Exhibits attached to the Credit Agreement except for the Exhibit which is being amended and restated hereby; and the Notes, the Guaranty Agreements, the Pledge Agreements, the Agent's Fee Letter, the Subordination Agreement (Intercompany), the Borrower Agency Agreement and all other Loan Documents (except for Articles I through XI of the Credit Agreement which is being amended and restated hereby). On and after the date hereof, each reference in the Credit Agreement to "this Agreement", "hereunder" or words of like import shall mean and be a reference to the Credit Agreement, as previously amended and as amended by this Seventeenth Amendment, and each reference in each other Loan Document to the "Credit Agreement" shall mean and be a reference to the Credit Agreement, as previously amended and as amended by this Seventeenth Amendment. No novation is intended by this Seventeenth Amendment. The parties hereto do not amend or waive any provisions of the Agreement or the other Loan Documents except as expressly set forth herein. 8. Counterparts. This Seventeenth Amendment may be executed by different parties hereto in any number of separate counterparts, each of which, when so executed and delivered, shall be an original, and all of such counterparts shall together constitute one and the same instrument. 9. Governing Law. This Seventeenth 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] -4- 5 [Signature Page 1 of 19 to Seventeenth 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 BORROWERS and GUARANTORS listed on Schedule A attached hereto By: /s/ Richard S. Binstein By: /s/ Richard A. McDonald ------------------------------- ------------------------------------- Richard S. Binstein, Secretary Richard A. McDonald, the Vice President of each Borrower and Guarantor listed on Schedule A attached hereto which is a corporation and of each general partner of each Guarantor listed on Schedule A attached hereto which is a partnership [Seal] ATTEST: NOVAFUNDS, INC., a Delaware corporation, and each of the GUARANTORS listed on Schedule B attached hereto By: /s/ Andrew T. Panaccione By: /s/ Robert C. Campbell ------------------------------- ------------------------------------- Andrew T. Panaccione, Secretary Robert C. Campbell, the Vice President of each Borrower and Guarantor listed on Schedule B attached hereto [Seal] 6 [Signature Page 2 of 19 to Seventeenth Amendment] AGENT: PNC BANK, NATIONAL ASSOCIATION, as Agent By: /s/ Justin J. Talgme --------------------------------------- Title: Assistant Vice President ------------------------------------ BANKS: PNC BANK, NATIONAL ASSOCIATION By: /s/ Justin J. Talgme --------------------------------------- Title: Assistant Vice President ------------------------------------ 7 [Signature Page 3 of 19 to Seventeenth Amendment] FIRST UNION NATIONAL BANK By: /s/ Joseph H. Towell ------------------------------------------ Name: Joseph H. Towell ---------------------------------------- Title: Senior Vice President --------------------------------------- 8 [Signature Page 4 of 19 to Seventeenth Amendment] FLEET NATIONAL BANK By: /s/ Maryann S. Smith ------------------------------------------ Name: MARYANN S. SMITH ---------------------------------------- Title: VICE PRESIDENT --------------------------------------- 9 [Signature Page 5 of 19 to Seventeenth Amendment] MELLON BANK, N.A. By: /s/ Colleen McCullum ------------------------------------------ Name: Colleen McCullum ---------------------------------------- Title: ASSISTANT VICE PRESIDENT --------------------------------------- 10 [Signature Page 6 of 19 to Seventeenth Amendment] MELLON BANK, N.A. By: /s/ Kevin Wagley ------------------------------------------ Name: Kevin Wagley ---------------------------------------- Title: VICE PRESIDENT --------------------------------------- 11 [Signature Page 7 of 19 to Seventeenth Amendment] THE BANK OF NEW YORK By: /s/ Peter H. Abdill ------------------------------------------ Name: Peter H. Abdill ---------------------------------------- Title: Vice President --------------------------------------- 12 [Signature Page 8 of 19 to Seventeenth Amendment] SUNTRUST BANK, CENTRAL FLORIDA, N.A. By: /s/ Ronald K. Rueve ------------------------------------------ Name: Ronald K. Rueve ---------------------------------------- Title: Vice President --------------------------------------- 13 STATE OF GEORGIA COUNTY OF FULTON On the 22nd day of June, 1998 personally appeared Ronald K. Rueve, as the Vice President of SunTrust Bank, Central Florida, National Association, and before me executed the attached Seventeenth Amendment Waiver and Consent dated as of June 30, 1998 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/ Mary W. Harrell ---------------------------------------------------------------------- Signature of Notary Public, State of Georgia --------------------------------- Mary W. Harrell ---------------------------------------------------------------------- (Print, Type or Stamp Commissioned Name of Notary Public) Personally known x ; OR Produced Identification -------- ---------------- Type of identification produced: -------------------------------------- ---------------------------------------------------------------------- [SEAL] MARY W. HARRELL NOTARY Notary Public, DeKalb County, Georgia My Commission Expires May 12, 2001 EXPIRES GEORGIA PUBLIC DEKALB COUNTY 14 [Signature Page 9 of 19 to Seventeenth Amendment] BANK ONE, KENTUCKY, NA By: /s/ Todd D. Munson ------------------------------------------ Name: TODD D. MUNSON ---------------------------------------- Title: SENIOR VICE PRESIDENT --------------------------------------- 15 [Signature Page 10 of 19 to Seventeenth Amendment] THE FUJI BANK, LIMITED NEW YORK BRANCH By: /s/ Stephen Chin ------------------------------------------ Name: STEPHEN CHIN ---------------------------------------- Title: Vice President --------------------------------------- 16 [Signature Page 11 of 19 to Seventeenth Amendment] CRESTAR BANK By: /s/ Leesa McSlane ------------------------------------------ Name: Leesa McSlane ---------------------------------------- Title: Vice President --------------------------------------- 17 [Signature Page 12 of 19 to Seventeenth Amendment] BANK OF TOKYO - MITSUBISHI TRUST COMPANY By: /s/ Douglas J. Weir ------------------------------------------ Name: DOUGLAS J. WEIR ---------------------------------------- Title: Vice President --------------------------------------- 18 [Signature Page 13 of 19 to Seventeenth Amendment] AMSOUTH BANK By: /s/ J. Ken Difatta ------------------------------------------ Name: J. KEN DIFATTA ---------------------------------------- Title: ASSISTANT VICE PRESIDENT --------------------------------------- 19 [Signature Page 14 of 19 to Seventeenth Amendment] BANK OF AMERICA NT & SA By: /s/ J. Gregory Seibly ------------------------------------------ Name: J. GREGORY SEIBLY ---------------------------------------- Title: Vice President --------------------------------------- 20 [Signature Page 15 of 19 to Seventeenth Amendment] COMERICA BANK By: /s/ Kimberly S. Reich ------------------------------------------ Name: Kimberly S. Reich ---------------------------------------- Title: Vice President --------------------------------------- 21 [Signature Page 16 of 19 to Seventeenth Amendment] CREDIT LYONNAIS NEW YORK BRANCH By: /s/ Farboud Tavangar ------------------------------------------ Name: Farboud Tavangar ---------------------------------------- Title: First Vice President --------------------------------------- 22 [Signature Page 17 of 19 to Seventeenth Amendment] COOPERATIEVE CENTRALE RAIFFEISEN-BOERENLEENBANK B.A., "RABOBANK NEDERLAND", NEW YORK BRANCH By: /s/ M. Christina Debler ------------------------------------------ Name: M. Christina Debler ---------------------------------------- Title: Vice President /s/ W. Pieter C. Kodde W. Pieter C. Kodde Vice President 23 [Signature Page 18 of 19 to Seventeenth Amendment] THE TOKAI BANK, LIMITED NEW YORK BRANCH By: /s/ Shinichi Nakatani ------------------------------------------ Name: Shinichi Nakatani ---------------------------------------- Title: Assistant General Manager --------------------------------------- 24 [Signature Page 19 of 19 to Seventeenth Amendment] TORONTO DOMINION (TEXAS), INC. By: /s/ Jimmy Simien ------------------------------------------ Name: Jimmy Simien ---------------------------------------- Title: Vice President --------------------------------------- 25 SCHEDULE 1.01(B) (CONTINUED) ADDRESSES FOR NOTICES BORROWERS AND GUARANTORS 1016 West Ninth Avenue King of Prussia, PA 19406 Attention: Chief Financial Officer Telephone No. (610) 992-7200 Telecopier No. (610) 992-3328 AGENT AND BANKS PNC BANK, NATIONAL ASSOCIATION, individually and as Agent One PNC Plaza Fifth Avenue and Wood Street Pittsburgh, PA 15265 Attention: Regional Healthcare Group Telephone No. (412) 762-2190 Telecopier No. (412) 768-5149 FIRST UNION NATIONAL BANK 1 First Union Center TW5 301 S. College Street Charlotte, NC 28288-0735 Attention: Terence Moore, Assistant Vice President Telephone No. (704) 383-5212 Telecopier No. (704) 383-9144 FLEET NATIONAL BANK Health Care and Institutions Group One Federal Street MAOFD07B Boston, MA 02109 Attention: Maryann S. Smith, Vice President Telephone No. (617) 346-1594 Telecopier No. (617) 346-0610 26 MELLON BANK, N.A. Mellon Bank, N.A. One Mellon Bank Center Room 151/0370 Pittsburgh, PA 15258-0001 Attention: Colleen McCullum Telephone No. (412) 236-3984 Telecopier No. (412) 236-0287 NATIONSBANK, N.A. Healthcare Finance Group One NationsBank Plaza 5th Floor Nashville, TN 37239-1697 Attention: Kevin Wagley, Vice President Telephone No. (615) 749-3802 Telecopier No. (615) 749-4640 THE BANK OF NEW YORK Northeast Division One Wall Street 22nd Floor New York, NY 10286 Attention: Peter Abdill, Vice President Telephone No. (212) 635-6987 Telecopier No. (212) 635-7978 SUNTRUST BANK, CENTRAL FLORIDA, N.A. Healthcare Banking Group 0-1101, Tower 10 200 South Orange Avenue Orlando, FL 32801 Attention: Karen M. George, First Vice President Telephone No. (407) 237-4541 Telecopier No. (407) 237-5489 27 BANK ONE, KENTUCKY, NA Internal Zip KY1-2216 416 West Jefferson Street Louisville, KY 40202 Attention: Todd Munson, Sr. Vice President Telephone No. (502) 566-2640 Telecopier No. (502) 566-2367 THE FUJI BANK, LIMITED NEW YORK BRANCH Two World Trade Center New York, New York 10048 Attention: James Grady, Assistant Treasurer Telephone No. (212) 898-2274 Telecopier No. (212) 898-2907 CRESTAR BANK 120 East Baltimore Street 25th Floor Baltimore, MD 21203-7307 Attention: Leesa McShane, Vice President Telephone No. (410) 986-1672 Telecopier No. (410) 986-1670 BANK OF TOKYO - MITSUBISHI TRUST COMPANY US Corp. Banking Division 1251 Avenue of the Americas New York, New York 10020-1104 Attention: Ned Komar, Vice President Telephone No. (212) 782-4584 Telecopier No. (212) 782-4935 AMSOUTH BANK 1900 Fifth Avenue North SONAT - 7th Floor Birmingham, AL 35203 Attention: Ken DiFatta, Commercial Banking Officer Telephone No. (205) 801-0358 Telecopier No. (205) 326-4790 28 CREDIT LYONNAIS NEW YORK BRANCH 1301 Avenue of the Americas New York, NY 10019 Attention: Henry Reukauf, Assistant Treasurer Telephone No. (212) 261-7394 Telecopier No. (212) 261-3440 COOPERATIEVE CENTRALE RAIFFEISEN-BOERENLEEN BANK B.A., "RABOBANK NEDERLAND," NEW YORK BRANCH 245 Park Avenue New York, NY 10167 Attention: Christina Debler, Vice President Telephone No. (212) 916-7967 Telecopier No. (212) 916-7837 BANK OF AMERICA NT & SA 555 S. Flower Street, 11th Floor Los Angeles, CA 90071 Attention: Lucy Nixon Telephone No. (213) 228-9716 Telecopier No. (213) 228-2756 COMERICA BANK 1 Detroit Center 500 Woodward Avenue 9th Floor - Mall Code 3266 Detroit, MI 48226 Attention: Kimberly Reich, Vice President Telephone No. (313) 222-5077 Telecopier No. (313) 222-3420 THE TOKAI BANK, LIMITED NEW YORK BRANCH 55 East 52nd Street 11th Floor New York, NY 10055 Attention: Russell Bohner, Vice President Telephone No. (212) 339-1052 Telecopier No. (212) 832-1428 29 TORONTO DOMINION (TEXAS), INC. 31 West 52nd Street 18th Floor New York, NY 10019 Attention: Bob Maloney, Vice President & Director Telephone No. (212) 827-7750 Telecopier No. (212) 827-7250 30 SCHEDULE A
BORROWER ("B") / ENTITY GUARANTOR ("G") ------ --------------- NovaCare, Inc. (a Delaware corporation) B NovaCare, Inc. (a Pennsylvania corporation) B RehabClinics, Inc. B Rehab Managed Care of Arizona, Inc. B A.D. Craig Company G Advanced Orthopedic Technologies, Inc. (a Nevada corporation) G Advanced Orthopedic Technologies, Inc. (a New York corporation) G Advance Orthotics, Inc. G Advanced Orthotics and Prosthetics, Inc. G Advanced Orthopedic Systems, Inc. G Advanced Orthopedic Technologies (Clayton), Inc. G Advanced Orthopedic Technologies (Lett), Inc. G Advanced Orthopedic Technologies (New Jersey), Inc. G Advanced Orthopedic Technologies (New Mexico), Inc. G Advanced Orthopedic Technologies (New York), Inc. G Advanced Orthopedic Technologies (OTI), Inc. G Advanced Orthopedic Technologies (Parmeco), Inc. G Advanced Orthopedic Technologies (SFV), Inc. G Advanced Orthopedic Technologies (Virginia), Inc. G Advanced Orthopedic Technologies (West Virginia), Inc. G Advanced Orthopedic Technologies Management Corp. G Affiliated Physical Therapists, Ltd. G American Rehabilitation Center, Inc. G American Rehabilitation Clinic, Inc. G Artificial Limb and Brace Center G Athens Sports Medicine Clinic, Inc. G Ather Sports Injury Clinic, Inc. G Atlanta Prosthetics, Inc. G Atlantic Health Group, Inc. G Atlantic Rehabilitation Services, Inc. G
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BORROWER ("B") / ENTITY GUARANTOR ("G") ------ --------------- Boca Rehab Agency, Inc. G Bowman-Shelton Orthopedic Service, Incorporated G Buendel Physical Therapy, Inc. G C.E.R. - West, Inc. G Cahill Orthopedic Laboratory, Inc. G Cannon & Associates, Inc. G Cenla Physical Therapy & Rehabilitation Agency, Inc. G Center for Evaluation & Rehabilitation, Inc. G Center for Physical Therapy and Sports Rehabilitation, Inc. G CenterTherapy, Inc. G Certified Orthopedic Appliance Co., Inc. G Central Valley Prosthetics & Orthotics, Inc. G Champion Physical Therapy, Inc. G CMC Center Corporation G Coplin Physical Therapy Associates, Inc. G Crowley Physical Therapy Clinic, Inc. G Dale Clark Prosthetics, Inc. G Douglas Avery and Associates, Ltd. G Douglas C. Claussen, R.P.T., Physical Therapy, Inc. G E.A. Warnick-Pomeroy Co., Inc. G Elk County Physical Therapy, Inc. G Fine, Bryant & Wah, Inc. G Francis Naselli, Jr. & Stewart Rich Physical Therapists, Inc. G Frank J. Malone & Son, Inc. G Fresno Orthopedic Company G Gallery Physical Therapy Center, Inc. G Georgia Health Group, Inc. G Georgia Physical Therapy of West Georgia, Inc. G Georgia Physical Therapy, Inc. G Greater Sacramento Physical Therapy Associates, Inc. G Grove City Physical Therapy and Sports Medicine, Inc. G Gulf Breeze Physical Therapy, Inc. G
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BORROWER ("B") / ENTITY GUARANTOR ("G") ------ --------------- Gulf Coast Hand Specialists, Inc. G Hand Therapy and Rehabilitation Associates, Inc. G Hand Therapy Associates, Inc. G Hangtown Physical Therapy, Inc. G Hawley Physical Therapy, Inc. G Heartland Rehabilitation, Inc. G High Desert Institute of Prosthetics & Orthotics G Indianapolis Physical Therapy and Sports Medicine, Inc. G Industrial Health Care Company, Inc. G J.E. Hanger, Incorporated G JOYNER SPORTS SCIENCE INSTITUTE, INC. G JOYNER SPORTSMEDICINE INSTITUTE, INC. G Kesinger Physical Therapy, Inc. G Kroll's, Inc. G Lynn M. Carlson, Inc. G McKinney Prosthetics/Orthotics, Inc. G Mark Butler Physical Therapy Center, Inc. G Meadowbrook Orthopedics, Inc. G Medical Arts O&P Services, Inc. G Medical Plaza Physical Therapy, Inc. G Metro Rehabilitation Services, Inc. G Michigan Therapy Centre, Inc. G MidAtlantic Health Group, Inc. G Mill River Management, Inc. G Mitchell Tannenbaum I, Inc. G Mitchell Tannenbaum II, Inc. G Mitchell Tannenbaum III, Inc. G Monmouth Rehabilitation, Inc. G New England Health Group, Inc. G New Mexico Physical Therapists, Inc. G Northland Regional Orthotic and Prosthetic Center, Inc. G Northside Physical Therapy, Inc. G
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BORROWER ("B") / ENTITY GUARANTOR ("G") ------ --------------- NovaCare (Arizona), Inc. G NovaCare (Colorado), Inc. G NovaCare (Texas), Inc. G NovaCare Management Company, Inc. G NovaCare Management Services, Inc. G NovaCare Northside Therapy, Inc. G NovaCare Occupational Health Services, Inc. G NovaCare Orthotics & Prosthetics East, Inc. G NovaCare Orthotics & Prosthetics Holdings, Inc. G NovaCare Orthotics & Prosthetics West, Inc. G NovaCare Orthotics & Prosthetics, Inc. G NovaCare Outpatient Rehabilitation East, Inc. G NovaCare Outpatient Rehabilitation I, Inc. G NovaCare Outpatient Rehabilitation West, Inc. G NovaCare Outpatient Rehabilitation, Inc. G NovaCare Rehab Agency of Alabama, Inc. G NovaCare Rehab Agency of Florida, Inc. G NovaCare Rehab Agency of Georgia, Inc. G NovaCare Rehab Agency of Illinois, Inc. G NovaCare Rehab Agency of Kansas, Inc. G NovaCare Rehab Agency of Missouri, Inc. G NovaCare Rehab Agency of New Jersey, Inc. G NovaCare Rehab Agency of North Carolina, Inc. G NovaCare Rehab Agency of Northern California, Inc. G NovaCare Rehab Agency of Ohio, Inc. G NovaCare Rehab Agency of Oklahoma, Inc. G NovaCare Rehab Agency of Oregon, Inc. G NovaCare Rehab Agency of Pennsylvania, Inc. G NovaCare Rehab Agency of South Carolina, Inc. G NovaCare Rehab Agency of Southern California, Inc. G NovaCare Rehab Agency of Tennessee, Inc. G NovaCare Rehab Agency of Virginia, Inc. G
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BORROWER ("B") / ENTITY GUARANTOR ("G") ------ --------------- NovaCare Rehab Agency of Washington, Inc. G NovaCare Rehab Agency of Wyoming, Inc. G NovaCare Rehabilitation Agency of Wisconsin, Inc. G NovaCare Rehabilitation, Inc. G NovaCare Service Corp. G Opus Care, Inc. G Ortho East, Inc. G Ortho Rehab Associates, Inc. G Ortho-Fab Laboratories, Inc. G Orthopedic Appliances, Inc. G Orthopedic and Sports Physical Therapy of Cupertino, Inc. G Orthopedic Rehabilitative Services, Ltd. G Orthotic & Prosthetic Rehabilitation Technologies, Inc. G Orthotic and Prosthetic Associates, Inc. G Orthotic Specialists, Inc. G Peter Trailov R.P.T. Physical Therapy Clinic, Orthopaedic Rehabilitation & Sports Medicine, Ltd. G Peters, Starkey & Todrank Physical Therapy Corporation G Physical Focus Inc. G Physical Rehabilitation Partners, Inc. G Physical Therapy Enterprises, Inc. G Physical Therapy Institute, Inc. G Professional Orthotics and Prosthetics, Inc. G Professional Orthotics and Prosthetics, Inc. of Santa Fe G Professional Therapeutic Services, Inc. G Progressive Orthopedic G Prosthetics-Orthotics Associates, Inc. G Protech Orthotic and Prosthetic Center, Inc. G Quad City Management, Inc. G RCI (Colorado), Inc. G RCI (Exertec), Inc. G RCI (Illinois), Inc. G
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BORROWER ("B") / ENTITY GUARANTOR ("G") ------ --------------- RCI (Michigan), Inc. G RCI (S.P.O.R.T.), Inc. G RCI (WRS), Inc. G RCI Nevada, Inc. G Rebound Oklahoma, Inc. G Redwood Pacific Therapies, Inc. G Rehab Provider Network of Florida, Inc. G Rehab Provider Network - New Jersey, Inc. G Rehab Provider Network - California, Inc. G Rehab Provider Network - Delaware, Inc. G Rehab Provider Network - Georgia, Inc. G Rehab Provider Network - Illinois, Inc. G Rehab Provider Network - Indiana, Inc. G Rehab Provider Network - Maryland, Inc. G Rehab Provider Network - Michigan, Inc. G Rehab Provider Network - Ohio, Inc. G Rehab Provider Network - Oklahoma, Inc. G Rehab Provider Network - Virginia, Inc. G Rehab Provider Network - Washington, D.C., Inc. G Rehab Provider Network - Pennsylvania, Inc. G Rehab Provider Network of Colorado, Inc. G Rehab Provider Network of Nevada, Inc. G Rehab Provider Network of New Mexico, Inc. G Rehab Provider Network of Texas, Inc. G Rehab Provider Network of Wisconsin, Inc. G Rehab World, Inc. G Rehab/Work Hardening Management Associates, Ltd. G RehabClinics (COAST), Inc. G RehabClinics (GALAXY), Inc. G RehabClinics (New Jersey), Inc. G RehabClinics (PTA), Inc. G RehabClinics (SPT), Inc. G
36
BORROWER ("B") / ENTITY GUARANTOR ("G") ------ --------------- RehabClinics Abilene, Inc. G RehabClinics Dallas, Inc. G RehabClinics Pennsylvania, Inc. G Rehabilitation Fabrication, Inc. G Rehabilitation Management, Inc. G Reid Medical Systems, Inc. G Robert M. Bacci, R.P.T. Physical Therapy, Inc. G Robin Aids Prosthetics, Inc. G S.T.A.R.T., Inc. G Salem Orthopedic & Prosthetic, Inc. G San Joaquin Orthopedic, Inc. G SG Rehabilitation Agency, Inc. G SG Speech Associates, Inc. G South Jersey Physical Therapy Associates, Inc. G South Jersey Rehabilitation and Sports Medicine Center, Inc. G Southern Illinois Prosthetic & Orthotic, Ltd. G Southern Illinois Prosthetic & Orthotic of Missouri, Ltd. G Southpointe Fitness Center, Inc. G Southwest Medical Supply Company G Southwest Physical Therapy, Inc. G Southwest Therapists, Inc. G Sporthopedics Sports and Physical Therapy Centers, Inc. G Sports Therapy and Arthritis Rehabilitation, Inc. G Star Physical Therapy Inc. G Stephenson-Holtz, Inc. G T.D. Rehab Systems, Inc. G Texoma Health Care Center, Inc. G The Center for Physical Therapy and Rehabilitation, Inc. G The Orthopedic Sports and Industrial Rehabilitation Network, Inc. G Theodore Dashnaw Physical Therapy, Inc. G Treister, Inc. G Tucson Limb & Brace, Inc. G
37
BORROWER ("B") / ENTITY GUARANTOR ("G") ------ --------------- Union Square Center for Rehabilitation & Sports Medicine, Inc. G University Orthotic & Prosthetic Consultants, Ltd. G Valley Group Physical Therapists, Inc. G Vanguard Rehabilitation, Inc. G Wayzata Physical Therapy Center, Inc. G West Side Physical Therapy, Inc. G West Suburban Health Partners, Inc. G Western Rehab Services, Inc. G Worker Rehabilitation Services, Inc. G Yuma Rehabilitation Center, Inc. G A.D. Craig (A.D. Craig Company is general partner) G Advanced Orthopedic Services, Ltd. (RehabClinics Dallas, Inc. is general partner) G Craig Weymouth Enterprises (A.D. Craig Company is general partner) G Land Park Physical Therapy (Union Square Center for Rehabilitation & Sports Medicine, Inc. is general partner) G NovaPartners (IND), LP (NovaCare, Inc. (a Pennsylvania corporation) is general partner) G
38 SCHEDULE B
BORROWER ("B") / ENTITY GUARANTOR ("G") ------ --------------- NovaFunds, Inc. B NC Cash Management, Inc. G NC Resources, Inc. G NovaMark, Inc. G NovaStock, Inc. G
39 EXHIBIT I Amended and Restated Credit Agreement 40 EXHIBIT II FEES
Bank Closing Fee Amendment Fee Total Fee ---- ----------- ------------- --------- PNC Bank, National Association First Union National Bank Fleet National Bank Mellon Bank, N.A. NationsBank, N.A. Bank One, Kentucky, NA Credit Lyonnais New York Branch Cooperatieve Centrale Raiffeisen- Boerenleenbank B.A., "Rabobank Nederland", New York Branch Toronto Dominion (Texas), Inc. The Bank of New York SunTrust Bank, Central Florida, N.A. AmSouth Bank Bank of America NT & SA Bank of Tokyo - Mitsubishi Trust Company Comerica Bank Crestar Bank The Fuji Bank, Limited New York Branch The Tokai Bank, Limited New York Branch TOTAL
41 $400,000,000 REVOLVING CREDIT FACILITY CREDIT AGREEMENT by and among NOVACARE, INC., and CERTAIN of its SUBSIDIARIES and THE BANKS PARTY HERETO and PNC BANK, NATIONAL ASSOCIATION, as Agent Dated as of May 27, 1994, as amended 42 TABLE OF CONTENTS
Page ---- LIST OF SCHEDULES AND EXHIBITS....................................................................................V ARTICLE I - CERTAIN DEFINITIONS...................................................................................1 1.01 Certain Definitions.................................................................................1 1.02 Construction.......................................................................................24 1.03 Accounting Principles..............................................................................25 ARTICLE II - REVOLVING CREDIT FACILITY...........................................................................25 2.01 Revolving Credit Borrowing.........................................................................25 2.02 Nature of Banks' Obligations with Respect to Revolving Credit Loans................................25 2.03 Commitment Fees; Closing Fees......................................................................25 2.04 Voluntary Reduction of Commitment..................................................................26 2.05 Revolving Credit Loan Requests.....................................................................27 2.06 Making Revolving Credit Loans......................................................................27 2.07 Revolving Credit Notes.............................................................................28 2.08 Use of Proceeds....................................................................................28 2.09 Letter of Credit Subfacility.......................................................................28 ARTICLE III - [RESERVED].........................................................................................33 ARTICLE IV - INTEREST RATES......................................................................................33 4.01 Interest Rate Options..............................................................................33 (a) Revolving Credit Interest Rate Options.....................................................34 (i) Revolving Credit Base Rate Option.................................................34 (ii) Revolving Credit Euro-Rate Option................................................34 (b) Rate Quotations............................................................................35 4.02 Interest Periods...................................................................................35 4.03 Interest After Default.............................................................................36 4.04 Euro-Rate Unascertainable..........................................................................36 4.05 Selection of Interest Rate Options.................................................................37 ARTICLE V - PAYMENTS.............................................................................................38 5.01 Payments...........................................................................................38 5.02 Pro Rata Treatment of Banks........................................................................38 5.03 Interest Payment Dates.............................................................................38 5.04 Voluntary Prepayments..............................................................................39 (A) Termination of Commitment..................................................................40 (B) Replacement................................................................................41 5.05 [RESERVED..........................................................................................41 5.06 Additional Compensation in Certain Circumstances...................................................41 (a) Increased Costs or Reduced Return Resulting From Taxes, Reserves, Capital Adequacy Requirements, Expenses, Etc...........................................................41 (b) Indemnity..................................................................................42 ARTICLE VI - REPRESENTATIONS AND WARRANTIES......................................................................43 6.01 Representations and Warranties.....................................................................43
(i) 43 (a) Organization and Qualification.............................................................43 (b) Capitalization and Ownership...............................................................43 (c) Subsidiaries; Excluded Entities............................................................43 (d) Power and Authority........................................................................44 (e) Validity and Binding Effect................................................................44 (f) No Conflict................................................................................44 (g) Litigation.................................................................................44 (h) Title to Properties........................................................................45 (i) Financial Statements.......................................................................45 (A) Historical Statements.............................................................45 (B) Financial Projections.............................................................45 (C) Accuracy of Financial Statements..................................................45 (j) Full Disclosure............................................................................45 (k) Taxes......................................................................................45 (l) Consents and Approvals.....................................................................46 (m) No Event of Default; Compliance with Instruments...........................................46 (n) Patents, Trademarks, Copyrights, Etc.......................................................46 (o) Security Interests.........................................................................46 (p) Status of the Pledged Collateral...........................................................47 (q) Insurance..................................................................................47 (r) Compliance with Laws.......................................................................47 (s) Material Contracts, Licenses, Permits and Approvals........................................47 (t) Investment Companies.......................................................................48 (u) Margin Stock...............................................................................48 (v) Plans and Benefit Arrangements.............................................................48 (w) Employment Matters.........................................................................49 (x) Environmental Matters......................................................................50 (y) Senior Debt Status.........................................................................51 (z) Solvency...................................................................................51 (aa) Year 2000.................................................................................51 6.02 Updates to Schedules...............................................................................52 ARTICLE VII - CONDITIONS OF LENDING..............................................................................52 7.02 Each Additional Revolving Credit Loan..............................................................52 ARTICLE VIII - COVENANTS.........................................................................................53 8.01 Affirmative Covenants..............................................................................53 (a) Preservation of Existence, etc.............................................................53 (b) Payment of Liabilities, Including Taxes, etc...............................................53 (c) Maintenance of Insurance...................................................................53 (d) Maintenance of Properties and Leases.......................................................53 (e) Maintenance of Patents, Trademarks, etc....................................................54 (f) Visitation Rights..........................................................................54 (g) Keeping of Records and Books of Account....................................................54 (h) Plans and Benefit Arrangements.............................................................54 (i) Compliance With Laws.......................................................................55 (j) Use of Proceeds............................................................................56 (k) Further Assurances.........................................................................56
(ii) 44 (l) Subordination of Intercompany Indebtedness; Permitted Additional Subordinated Indebtedness.............................................................56 (A) Intercompany Indebtedness.........................................................56 (B) Permitted Additional Subordinated Indebtedness....................................56 (m) Certificate of Borrowers; Other Reports and Information....................................56 (i) Quarterly Financial Statements....................................................56 (ii) Annual Financial Statements......................................................57 (iii) Certificate of the Borrower.....................................................57 (iv) Separate Financial Information for Certain Excluded Entities..............................58 (v) Management Letters.........................................................................58 (vi) Other Reports and Information.............................................................58 8.02 Negative Covenants.................................................................................59 (a) Indebtedness...............................................................................59 (b) Liens......................................................................................61 (c) Guaranties.................................................................................61 (d) Liquidations, Mergers, Consolidations, Acquisitions........................................61 (e) Dispositions of Assets or Subsidiaries.....................................................63 (f) Joinder of Qualifying Subsidiaries; Excluded Entities......................................63 (g) Continuation of or Change in Business......................................................64 (h) Plans and Benefit Arrangements.............................................................64 (i) Loans and Investments......................................................................64 (j) Dividends and Related Distributions........................................................65 (k) [Intentionally Omitted]....................................................................66 (l) Minimum Net Worth..........................................................................66 (m) [Intentionally Omitted]....................................................................66 (n) Funded Debt to Cash Flow From Operations...................................................66 (o) Minimum Fixed Charge Coverage Ratio........................................................66 (p) Changes in Subordinated Indebtedness Documents.............................................66 (q) Affiliate Transactions.....................................................................67 (r) Professional Employment Organizations......................................................67 8.03 Reporting Requirements.............................................................................67 (a) Notice of Default..........................................................................67 (b) Notice of Litigation.......................................................................68 ARTICLE IX - DEFAULT.............................................................................................68 9.01 Events of Default..................................................................................68 9.02 Consequences of Event of Default...................................................................70 9.03 Notice of Sale.....................................................................................73 ARTICLE X - THE AGENT............................................................................................73 10.01 Appointment.......................................................................................73 10.02 Delegation of Duties..............................................................................73 10.03 Nature of Duties; Independent Credit Investigation................................................73 10.04 Actions in Discretion of Agent; Instructions from the Banks.......................................74 10.05 Reimbursement and Indemnification of Agent by the Borrowers.......................................74 10.06 Exculpatory Provisions............................................................................75 10.07 Reimbursement and Indemnification of Agent by Banks...............................................75 10.08 Reliance by Agent.................................................................................76
(iii) 45 10.09 Notice of Default.................................................................................76 10.10 Notices...........................................................................................76 10.11 Banks in Their Individual Capacities..............................................................76 10.12 Holders of Notes..................................................................................76 10.13 Equalization of Banks.............................................................................76 10.14 Successor Agent...................................................................................77 10.15 Agent's Fee.......................................................................................77 10.16 Availability of Funds.............................................................................77 10.17 Calculations......................................................................................78 10.18 Beneficiaries.....................................................................................78 ARTICLE XI - MISCELLANEOUS.......................................................................................78 11.01 Modifications, Amendments or Waivers..............................................................78 11.02 No Implied Waivers; Cumulative Remedies; Writing Required.........................................79 11.03 Reimbursement and Indemnification of Banks by the Borrowers; Taxes................................79 11.04 Holidays..........................................................................................80 11.05 Funding by Branch, Subsidiary or Affiliate........................................................80 (a) Notional Funding...........................................................................80 (b) Actual Funding.............................................................................80 11.06 Notices...........................................................................................80 11.07 Severability......................................................................................81 11.08 Governing Law.....................................................................................81 11.09 Prior Understanding...............................................................................81 11.10 Duration; Survival................................................................................81 11.11 Successors and Assigns............................................................................81 11.12 Confidentiality...................................................................................82 11.13 Counterparts......................................................................................83 11.14 Agent's or Bank's Consent.........................................................................83 11.15 Exceptions........................................................................................83 11.16 CONSENT TO FORUM; WAIVER OF JURY TRIAL............................................................83 11.17 Tax Withholding Clause............................................................................83 11.18 Joinder of Loan Parties...........................................................................84
(iv) 46 LIST OF SCHEDULES AND EXHIBITS SCHEDULES SCHEDULE 1.01(B) LIST OF BANKS AND COMMITMENTS SCHEDULE 1.01(E) EXCLUDED ENTITIES SCHEDULE 1.01(P)(1) PERMITTED INVESTMENTS SCHEDULE 1.01(P)(2) PERMITTED LIENS SCHEDULE 2.09 EXISTING LETTERS OF CREDIT SCHEDULE 6.01(a) ORGANIZATION AND QUALIFICATION SCHEDULE 6.01(c) SUBSIDIARIES SCHEDULE 6.01(l) CONSENTS AND APPROVALS SCHEDULE 6.01(q) INSURANCE SCHEDULE 6.01(s) MATERIAL CONTRACTS SCHEDULE 6.01(v) PLANS AND BENEFIT ARRANGEMENTS SCHEDULE 6.01(x) ENVIRONMENTAL MATTERS SCHEDULE 8.02(a)(ii) EXISTING INDEBTEDNESS SCHEDULE 8.02(q) CERTAIN AFFILIATE TRANSACTIONS EXHIBITS EXHIBIT 1.01(A) ASSIGNMENT AND ASSUMPTION AGREEMENT EXHIBIT 1.01(G)(1) GUARANTY AND SURETYSHIP AGREEMENT (For NovaCare and Borrowing Subsidiaries) EXHIBIT 1.01(G)(2) GUARANTY AND SURETYSHIP AGREEMENT (For Nonborrower Subsidiaries) EXHIBIT 1.01(P)(1) INTENTIONALLY OMITTED EXHIBIT 1.01(P)(2) INTENTIONALLY OMITTED EXHIBIT 1.01(P)(3) TERMS FOR SUBORDINATED DEBT EXHIBIT 1.01(P)(4) PLEDGE AGREEMENT - STOCK (For NovaCare and Borrowing Subsidiaries) EXHIBIT 1.01(P)(5) PLEDGE AGREEMENT - STOCK (For Nonborrower Subsidiaries) EXHIBIT 1.01(P)(6) PLEDGE AGREEMENT - PARTNERSHIP INTERESTS EXHIBIT 1.01(R) REVOLVING CREDIT NOTE EXHIBIT 1.01(S) SUBORDINATION AGREEMENT (INTERCOMPANY) EXHIBIT 1.01(W) EXAMPLE OF WEIGHTED AVERAGE RATING COMPUTATION EXHIBIT 2.05 REVOLVING CREDIT LOAN REQUEST EXHIBIT 7.01(d) FORM OF OPINION OF BORROWERS' COUNSEL EXHIBIT 8.01(m)(iii) COMPLIANCE CERTIFICATE
(v) 47 CREDIT AGREEMENT THIS CREDIT AGREEMENT is dated as of May 27, 1994, and is made by and among NOVACARE, INC., a Delaware corporation ("NovaCare"), each Subsidiary of NovaCare identified on Schedule 6.01(c) hereto as a "Borrower" (collectively, the "Borrowing Subsidiaries" and together with NovaCare sometimes collectively referred to as the "Borrowers" and individually as a "Borrower"), each Subsidiary of NovaCare identified on Schedule 6.01(c) hereto as a "Guarantor" (collectively, the "Guarantors" and, individually, a "Guarantor"), the BANKS (as hereinafter defined), and PNC BANK, NATIONAL ASSOCIATION in its capacity as agent for the Banks under this Agreement (hereinafter referred to in such capacity as the "Agent"). WITNESSETH: WHEREAS, the Loan Parties (as hereinafter defined) have requested the Banks to provide a revolving credit facility in an aggregate principal amount not to exceed $400,000,000; and WHEREAS, the revolving credit facility shall be used for (a) the acquisition and development of health care related businesses and facilities and (b) general corporate purposes; and WHEREAS, the Banks are willing to provide such credit upon the terms and conditions hereinafter set forth. NOW, THEREFORE, 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: ARTICLE I CERTAIN DEFINITIONS 1.01 Certain Definitions. In addition to words and terms defined elsewhere in this Agreement, the following words and terms shall have the following meanings, respectively, unless the context hereof clearly requires otherwise: Affiliate as to any person shall mean any other person (i) which directly or indirectly controls, is controlled by, or is under common control with such person, (ii) which beneficially owns or holds 50% or more of any class of the voting stock of any Loan Party, or (iii) 50% or more of the voting stock (or in the case of a person which is not a corporation, 50% or more of the equity interest) of which is beneficially owned or held, directly or indirectly, by any Loan Party. Control, as used herein, shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management or policies of a person, whether through the ownership of voting securities, by contract or otherwise, including the power to elect a majority of the directors or trustees of a corporation or trust, as the case may be. 48 Agent shall mean PNC Bank, National Association and its successors. Agent's Fee shall mean the fee payable to the Agent by Borrowers described in the Agent's Fee Letter. Agent's Fee Letter shall mean the letter from the Borrowers to the Agent dated the date hereof providing for the payment of fees to the Agent for its services as Agent hereunder, as such letter may be amended, modified or replaced from time to time. Agreement shall mean this Credit Agreement as the same may be supplemented or amended from time to time including all schedules and exhibits hereto. Annual Permitted Acquisition Amount shall have the meaning given to such term in Section 8.02(d)(ii)(g). Applicable Percentage over Euro-Rate shall have the meaning given to such term in Section 4.01(a)(ii). Approvals shall have the meaning given to such term in Section 6.01(s). Assignment and Assumption Agreement shall mean an Assignment and Assumption Agreement by and among a Purchasing Bank, the Transferor Bank and the Agent, as Agent and on behalf of the remaining Banks, substantially in the form of Exhibit 1.01(A) hereto. Authorized Officer shall mean those persons designated by written notice to the Agent from each of the Loan Parties, authorized to execute notices, reports and other documents required hereunder. Any Loan Party may amend such list of persons from time to time by giving written notice of such amendment to the Agent. Available Revolving Credit Commitments for any date of determination, shall mean, as to the Borrowers, an amount equal to the excess, if any, of (A) the Revolving Credit Commitments, over (B) the sum of (i) the aggregate outstanding Revolving Credit Loans and (ii) the aggregate undrawn face amount of outstanding Letters of Credit issued pursuant to Section 2.09 hereof. Bank to be Replaced shall have the meaning set forth in Section 5.04(b). Bank to be Terminated shall have the meaning set forth in Section 5.04(b). Banks shall mean the financial institutions named on Schedule 1.01(B) hereto and their respective successors and assigns as permitted hereunder, each of which is referred to herein as a Bank. Base Rate shall mean the greater of (i) the Federal Funds Effective Rate plus one-half percent (0.5%) per annum, or (ii) the interest rate per annum announced from time - 2 - 49 to time by the Agent at its Principal Office as its then prime rate, which rate may not necessarily be the lowest rate then being charged commercial borrowers by the Agent. Beneficial Interests shall have the meaning set forth in Section 6.01(c). Benefit Arrangement shall mean at any time an "employee benefit plan," within the meaning of Section 3(3) of ERISA, which is neither a Plan or a Multiemployer Plan and which is maintained, sponsored or otherwise contributed to, by any member of the ERISA Group. Borrower Agency Agreement shall mean that certain agreement among the Borrowers, dated as of even date herewith, pursuant to which the Borrowers authorize and appoint NovaCare to act on behalf of the Borrowers to take any and all actions that may be required to be taken by any Borrower or the Borrowers hereunder, including, without limitation, making requests for and borrowing any Revolving Credit Loan. Borrowers shall mean NovaCare and each Subsidiary of NovaCare identified as a "Borrower" on Schedule 6.01(c) hereto and any person subsequently becoming a party to the Loan Documents and assuming the obligations of a Borrower thereunder. Borrowing Date shall mean, with respect to any Revolving Credit Loan, the date for the making thereof or the renewal thereof or conversion thereof to the same or a different Interest Rate Option, which shall be a Business Day. Borrowing Tranche shall mean (i) with respect to the Revolving Credit Euro-Rate Portion of the Revolving Credit Loans, Revolving Credit Loans to which a Revolving Credit Euro-Rate Option applies by reason of the selection of, conversion to or renewal of such Interest Rate Option on the same day and having the same Euro-Rate Interest Period, and (ii) with respect to the Revolving Credit Base Rate Portion of the Revolving Credit Loans, Revolving Credit Loans to which the Revolving Credit Base Rate Option applies by reason of the selection of or conversion to such Interest Rate Option. Business Day shall mean a day on which commercial banks are open for business in Pittsburgh, Pennsylvania and New York, New York. Change in Ownership shall mean if, from and after the Closing Date, any person or group within the meaning of Section 13(d)(3) of the Securities Exchange Act of 1934, as amended (the "1934 Act") and the rules and regulations promulgated thereunder (other than John H. Foster, the current Chairman of the Board and Chief Executive Officer of NovaCare, or a person or group directly or indirectly controlled by said John H. Foster) shall have acquired beneficial ownership (within the meaning of Rule 13d-3 of the 1934 Act), directly or indirectly, of securities of NovaCare (or other securities convertible into such securities) representing 50% or more of combined voting power of all securities of NovaCare entitled to vote in the election of directors (hereinafter called a "Controlling Person"). For purposes of this definition, a person or group shall not be a Controlling Person if such person or group holds voting power in good faith - 3 - 50 and not for the purpose of circumventing this definition as an agent, bank, broker, nominee, trustee, or holder of irrevocable proxies given in response to a solicitation pursuant to the 1934 Act, for one or more beneficial owners who do not individually, or, if they are a group acting in concert, as a group, have the voting power specified in this definition. Closing Date shall mean the Business Day on which the first Revolving Credit Loan shall be made, which shall be May 27, 1994 or such later date on which all requisite conditions have been satisfied. The closing shall take place on the Closing Date at the offices of Buchanan Ingersoll Professional Corporation, Pittsburgh, Pennsylvania, or at such other time and place as the parties agree. Closing Fee shall mean the non-refundable fee paid to the Banks by the Borrowers on the Closing Date, as consideration for each Bank's Revolving Credit Commitment. Commitment Fee shall have the meaning assigned to that term in Section 2.03 hereof. Commitments shall mean Revolving Credit Commitments and Commitment shall mean Revolving Credit Commitment. Consideration shall mean with respect to any Permitted Acquisition, the aggregate of (i) the cash paid by any of the Loan Parties, directly or indirectly, to the seller in connection therewith, (ii) the Indebtedness incurred or assumed by any of the Loan Parties (including, without limitation, Indebtedness of a person becoming a Loan Party in connection with a Permitted Acquisition, which Indebtedness continues to exist following the consummation of such Permitted Acquisition), whether in favor of the seller or otherwise and whether fixed or contingent, in connection therewith, (iii) any Guaranty given or incurred by any Loan Party in connection therewith, (iv) the fair market value of any equity issued by any of the Loan Parties, in connection therewith, and (v) any other consideration given or obligation incurred by any of the Loan Parties in connection therewith, provided, however that the amount of any deferred earn-out payments to any seller not required by GAAP to be disclosed as a liability on the balance sheet of any Loan Party as of the date of consummation of such Permitted Acquisition shall be excluded from the determination under clauses (i) through (v) of this definition. Consolidated Cash Flow from Operations shall mean, for any period of determination, (i) the sum of net income, depreciation, amortization, up to $25 million in any fiscal year of other non-cash charges incurred in the ordinary course of business (if any are deducted in the determination of net income), interest expense and income tax expense, minus (ii) the sum of non-cash credits (if any are included in the determination of net income) and actual cash charges incurred in the period of determination related to the $23.5 million special charge taken by the Loan Parties during their fiscal quarter ended December 31, 1997, 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 attributable to NovaCare Employee Services, Inc. and without regard to net income and the other items described in clauses (i) and (ii) of this sentence attributable to - 4 - 51 Restricted Excluded Entities; 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. Consolidated Earnings Available for Fixed Charges shall mean, for any period of determination, (i) 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, up to $25 million in any fiscal year of other non-cash charges incurred in the ordinary course of business (if any are deducted in the determination of net income), and expenses under operating leases, minus (ii) actual cash charges incurred in the period of determination related to the $23.5 million special charge taken by the Loan Parties during their fiscal quarter ended December 31, 1997, in the case of all the items described under the foregoing clauses (i) and (ii), for NovaCare and its Subsidiaries (other than NovaCare Employee Services, Inc.) for such period determined and consolidated in accordance with GAAP, but without regard to any of the foregoing 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) 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. Consolidated Fixed Charges shall mean, for any period of determination, the sum of interest expense, expenses under operating leases, income tax expense, current maturities of long term Indebtedness (for the twelve (12) month period following the date of determination), 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 Employee Services, Inc.) for such period determined and consolidated in accordance with GAAP. It is expressly agreed that for purposes of calculating the ratio set forth in Section 8.02(o) [Minimum Fixed Charge Coverage Ratio] for the fiscal quarter ended - 5 - 52 March 31, 1999 or any fiscal quarter thereafter, notwithstanding the immediately preceding sentence, Consolidated Fixed Charges for such periods shall not include current maturities of the Subordinated Debentures. 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. Consolidated Funded Debt shall mean, as of any date of determination, all Indebtedness of NovaCare and its Subsidiaries (other than NovaCare Employee Services, Inc.), 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. Consolidated Net Income shall mean, for any period of determination, the net income of NovaCare and its Subsidiaries (other than NovaCare Employee Services, Inc.) for such period determined and consolidated in accordance with GAAP, except that 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. Consolidated Net Worth shall mean, as of any date of determination, total stockholders' equity of NovaCare and its Subsidiaries (other than NovaCare Employee Services, Inc.) as of such date determined and consolidated in accordance with GAAP. Drawing Date shall have the meaning assigned to that term in Section 2.09(d). Delivery Date shall mean the earlier of (A) the date on which NovaCare delivers its consolidated financial statements pursuant to Sections 8.01(m)(i) and (ii) or (B) one Business Day following the date on which such financial statements are due to be delivered pursuant to such Sections. Dollar, Dollars, U.S. Dollars and the symbol $ shall mean lawful money of the United States of America. Environmental Complaint shall mean any written complaint setting forth a cause of action for personal or property damage or equitable relief, order, notice of violation, - 6 - 53 citation, request for information issued pursuant to any Environmental Laws by an Official Body, subpoena or other written notice of any type relating to, arising out of, or issued pursuant to any of the Environmental Laws or any Environmental Conditions, as the case may be, in each case with respect to any violation or alleged violation of Environmental Laws or release or threatened release of a Regulated Substance. Environmental Conditions shall mean any conditions of the environment, including, without limitation, the work place, the ocean, natural resources (including flora or fauna), soil, surface water, ground water, any actual or potential drinking water supply sources, substrata or the ambient air, relating to or arising out of, or caused by the use, handling, storage, treatment, recycling, generation, transportation, release, spilling, leaking, pumping, emptying, discharging, injecting, escaping, leaching, disposal, dumping, threatened release or other management or mismanagement of Regulated Substances resulting from the use of, or operations on, the Property. Environmental Laws shall mean all federal, state, local and foreign laws and regulations, including permits, orders, judgments, and consent decrees issued, or entered into, pursuant thereto, relating to pollution or protection of human health or the environment or employee safety in the work place. ERISA shall mean the Employee Retirement Income Security Act of 1974, as the same may be amended or supplemented from time to time, and any successor statute of similar import, and the rules and regulations thereunder, as from time to time in effect. ERISA Group shall mean, at any time, NovaCare, its Subsidiaries and all members of a controlled group of corporations and all trades or businesses (whether or not incorporated) under common control and all other entities which, together with NovaCare, are treated as a single employer under Section 414 of the Internal Revenue Code. Euro-Rate shall mean with respect to the Revolving Credit Loans comprising any Borrowing Tranche to which the Revolving Credit Euro-Rate Option applies for any Interest Period, the interest rate per annum determined by the Agent by dividing (the resulting quotient rounded upward to the nearest 1/100 of 1% per annum) (i) the rate of interest determined by the Agent (which determination shall be conclusive absent manifest error) to be the average of the London interbank offered rates of interest per annum for U.S. Dollars set forth on Dow Jones Market Service display page 3750 or such other display page on the Dow Jones Market Service System as may replace such page to evidence the average of rates quoted by banks designated by the British Bankers' Association (or appropriate successor or, if the British Bankers' Association or its successor ceases to provide such quotes, a comparable replacement as determined by the Agent) at 11:00 a.m. (London time) two (2) Business Days prior to the first day of such Euro-Rate Interest Period for an amount comparable to such Borrowing Tranche and having a borrowing date and a maturity comparable to such Interest Period by (ii) a number equal to 1.00 minus the Euro-Rate Reserve Percentage. The Euro-Rate may also be expressed by the following formula: - 7 - 54 Dow Jones Market Service page 3750 as quoted by Euro-Rate = British Bankers' Association or appropriate successor 1.00 - Euro-Rate Reserve Percentage
The Euro-Rate shall be adjusted with respect to any Revolving Credit Euro-Rate Option outstanding on the effective date of any change in the Euro-Rate Reserve Percentage as of such effective date. The Agent shall give prompt notice to the Borrowers and the Banks of the Euro-Rate as determined or adjusted in accordance herewith, which determination shall be conclusive absent manifest error. Euro-Rate Interest Period shall have the meaning assigned to that term in Section 4.02 hereof. Euro-Rate Reserve Percentage shall mean the maximum percentage (expressed as a decimal rounded upward to the nearest 1/100 of 1%) as determined by the Agent (which determination shall be conclusive absent manifest error) which is in effect during any relevant period, as prescribed by the Board of Governors of the Federal Reserve System (or any successor) for determining the reserve requirements (including, without limitation, supplemental, marginal and emergency reserve requirements) with respect to eurocurrency funding (currently referred to as "Eurocurrency Liability") of a member bank in such System. Event of Default shall mean any Event of Default described in Section 9.01 of this Agreement. 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), and (ii) the Excluded Qualifying Subsidiaries, and Excluded Entity shall mean separately any of the Excluded Entities. In addition, effective upon the Spin-Off Consummation, NovaCare Employee Services, Inc. shall be deemed to be an Excluded Entity. Excluded Qualifying Subsidiaries shall mean the Qualifying Subsidiaries listed on Schedule 1.01(E) as of the Closing Date under the heading "Excluded Qualifying Subsidiaries," as thereafter amended from time to time with the approval of the Required Banks. Expiration Date shall mean with respect to the Revolving Credit Commitments, June 30, 2003. Federal Funds Effective Rate for any day shall mean the rate per annum (based on a year of 360 days and actual days elapsed and rounded upward to the nearest 1/100 of 1%) announced by the Federal Reserve Bank of New York (or any successor) on such day as being the weighted average of the rates on overnight Federal funds transactions arranged by Federal funds brokers on the previous trading day, as computed and announced by such Federal Reserve Bank (or any successor) in substantially the same manner as such Federal Reserve Bank computes and announces the weighted average it refers to as the "Federal Funds Effective Rate" - 8 - 55 as of the date of this Agreement; provided, if such Federal Reserve Bank (or its successor) does not announce such rate on any day, the "Federal Funds Effective Rate" for such day shall be the Federal Funds Effective Rate for the last day on which such rate was announced. GAAP shall mean generally accepted accounting principles as are in effect from time to time, subject to the provisions of Section 1.03 hereof, and applied on a consistent basis (except for changes in application in which the Borrowers' independent certified public accountants concur) both as to classification of items and amounts. Guarantors shall mean each Subsidiary of NovaCare identified as a "Guarantor" on Schedule 6.01(c) and any person which hereafter becomes a party to the Loan Documents and assumes the obligations of a Guarantor thereunder. Each Qualifying Subsidiary of NovaCare which is not a Borrower or an Excluded Qualifying Subsidiary is required to join the Credit Agreement as a Guarantor. Guaranty of any person shall mean any obligation of such person guaranteeing or in effect guaranteeing any liability or obligation of any other person in any manner, whether directly or indirectly, including, without limiting the generality of the foregoing, any agreement to indemnify or hold harmless any other person, any performance bond or other suretyship arrangement and any other form of assurance against loss, except endorsement of negotiable or other instruments for deposit or collection in the ordinary course of business. Guaranty Agreements shall mean collectively, the Guaranty and Suretyship Agreement in substantially the form attached hereto as Exhibit 1.01(G)(1) executed and delivered by each of the Borrowers to the Agent for the benefit of the Banks and the Guaranty and Suretyship Agreement in substantially the form attached hereto as Exhibit 1.01(G)(2) executed and delivered by each of the Guarantors to the Agent for the benefit of the Banks and Guaranty Agreement shall mean separately any Guaranty Agreement. Indebtedness shall mean as to any person at any time, any and all indebtedness, obligations or liabilities (whether matured or unmatured, liquidated or unliquidated, direct or indirect, absolute or contingent, or joint or several) of such person for or in respect of: (i) borrowed money, (ii) amounts raised under or liabilities in respect of any note purchase or acceptance credit facility, (iii) reimbursement obligations under any letter of credit, currency swap agreement, interest rate swap, cap, collar or floor agreement or other interest rate management device, (iv) any other transaction (including without limitation forward sale or purchase agreements, capitalized leases and conditional sales agreements) having the commercial effect of a borrowing of money entered into by such person to finance its operations or capital requirements (but not including trade payables and accrued expenses incurred in the ordinary course of business which are not represented by a promissory note), or (v) any Guaranty of Indebtedness for borrowed money. - 9 - 56 Indenture shall mean that certain Indenture dated as of January 15, 1993 between NovaCare and PNC Bank, as Trustee, as the same may be amended, modified, supplemented, restated or replaced from time to time. Insolvency Proceedings shall mean, with respect to any Person, (a) a case, action or proceeding with respect to such Person (i) before any court or any other Official Body under any bankruptcy, insolvency, reorganization or other, similar Law now or hereafter in effect, or (ii) for the appointment of a receiver, liquidator, assignee, custodian, trustee, sequestrator, conservator, (or similar official) of any Loan Party or otherwise relating to the liquidation, dissolution, winding-up or relief of such Person, or (b) any general assignment for the benefit of creditors, composition, marshaling of assets for creditors, or other, similar arrangement in respect of such Person's creditors generally or any substantial portion of its creditors; undertaken under any Law. 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 Employee Services, Inc.), 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 Employee Services, Inc. Interest Payment Date shall mean each date specified for the payment of interest in Section 5.03. Interest Rate Option shall mean the Revolving Credit Euro-Rate Option or Revolving Credit Base Rate Option. Internal Revenue Code shall mean the Internal Revenue Code of 1986, as the same may be amended or supplemented from time to time, and any successor statute of similar import, and the rules and regulations thereunder, as from time to time in effect. Investment shall mean all of the following with respect to any Investment Entity (as hereinafter defined): (i) investments or contributions by any other Loan Parties directly or indirectly to the capital of or other payments to the Investment Entity; (ii) loans by any other Loan Parties directly or indirectly to such Investment Entity; (iii) guaranties by any other Loan Parties directly or indirectly of the obligations of the Investment Entity; or (iv) other obligations, contingent or otherwise, of any other Loan Parties, to or for the benefit of such Investment Entity. For purposes of the definition of Investment, "Investment Entity" shall mean a Loan Party with respect to which any of the Investments described in clauses (i) through (iv) inclusive of this definition occurs. Labor Contracts shall have the meaning assigned to that term in Section 6.01(s). - 10 - 57 Law shall mean any law (including common law), constitution, statute, treaty, regulation, rule, ordinance, opinion, release, ruling, order, injunction, writ, decree or award of any Official Body. Letter of Credit shall have the meaning assigned to that term in Section 2.09. Letter of Credit Borrowing shall mean an extension of credit resulting from a drawing under any Letter of Credit which shall not have been reimbursed on the date when made and shall not have been converted into a Revolving Credit Loan under Section 2.09(d). Letter of Credit Fee shall have the meaning assigned to that term in Section 2.09. Letters of Credit Outstanding shall mean at any time the sum of (i) the aggregate undrawn face amount of outstanding Letters of Credit and (ii) the aggregate amount of all unpaid and outstanding Reimbursement Obligations. Lien shall mean any mortgage, deed of trust, pledge, lien, security interest, charge or other encumbrance or security arrangement of any nature whatsoever, whether voluntarily or involuntarily given, including but not limited to any conditional sale or title retention arrangement, and any assignment, deposit arrangement or lease intended as, or having the effect of, security and any filed financing statement or other notice of any of the foregoing (whether or not a lien or other encumbrance is created or exists at the time of the filing). Loan Documents shall mean this Agreement, the Notes, the Guaranty Agreements, the Pledge Agreements, the Agent's Fee Letter, the Subordination Agreement (Intercompany), the Borrower Agency Agreement and any other instruments, certificates or documents delivered or contemplated to be delivered hereunder or thereunder or in connection herewith or therewith, as the same may be supplemented or amended from time to time in accordance herewith or therewith, and Loan Document shall mean any of the Loan Documents. Loan Parties shall mean collectively the Borrowers, the Guarantors, and each person which hereafter becomes a party to the Loan Documents as a Borrower or Guarantor, and Loan Party shall mean any of the Loan Parties. The term Loan Parties shall be deemed also to include all of the Excluded Entities other than the Unaffiliated Managed Companies and the term Loan Party shall be deemed to include any Excluded Entity other than any Unaffiliated Managed Company, in each case, solely for purposes of the representations and warranties contained in Article VI and the covenant contained in Section 8.02(q). Loans shall mean Revolving Credit Loans and Loan shall mean Revolving Credit Loan. - 11 - 58 Material Adverse Change shall mean any set of circumstances or events which (a) has or could reasonably be expected to have any material adverse effect whatsoever upon the validity or enforceability of this Agreement or any other Loan Document, (b) is or could reasonably be expected to be material and adverse to the business, properties, assets, financial condition, results of operations or prospects of the Loan Parties taken as a whole, (c) impairs materially or could reasonably be expected to impair materially the ability of any one or more Loan Parties to duly and punctually pay or perform Indebtedness in principal amount in excess of $1,000,000 in the aggregate, or (d) impairs materially or could reasonably be expected to impair materially the ability of the Agent or any of the Banks, to the extent permitted, to enforce its legal remedies pursuant to this Agreement or any other Loan Document. Member Interests shall have the meaning set forth in Section 6.01(c). Minimum Net Worth Requirement shall mean, for any period of determination, the sum of the amounts under the following clauses (i), (ii), (iii) and (iv) reduced by the amount under the following clause (v): (i) $515,786,000 plus (ii) seventy-five percent (75%) of Consolidated Net Income of NovaCare and its Subsidiaries (other than NovaCare Employee Services, Inc.) for each fiscal quarter after the date of the Spin-Off Consummation 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 NovaCare Employee Services, Inc.) 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, 1997 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 $21,309,699 plus the portion of the Tax Refunds used to repurchase such common stock. Minority Subsidiary of any person at any time shall mean (i) any corporation or trust of which more than 5% and not more than 50% (by number of shares or number of votes) of the outstanding capital stock or shares of beneficial interest normally entitled to vote for the election of one or more directors or trustees (regardless of any contingency which does or may suspend or dilute the voting rights) is at such time owned directly or indirectly by such person or one or more of such person's Subsidiaries, (ii) any partnership (other than a limited partnership of which such person is a general partner) of which more than 5% and not more than 50% of the partnership interests is at the time directly or indirectly owned by such person or one or more of such person's Subsidiaries or (iii) any other entity of which such person owns not more than 50% but more than 5% of the ownership interests directly or indirectly. Month, with respect to a Euro-Rate Interest Period, shall mean the interval between the days in consecutive calendar months numerically corresponding to the first day of - 12 - 59 such Interest Period. The last day of a calendar month shall be deemed to be such numerically corresponding day for such calendar month (i) if there is no such numerically corresponding day in such calendar month, or (ii) if the first day of such Interest Period is the last Business Day of a calendar month. Multiemployer Plan shall mean any employee benefit plan which is a "multiemployer plan" within the meaning of Section 4001(a)(3) of ERISA and to which NovaCare, its Subsidiaries or any member of the ERISA Group is then making or accruing an obligation to make contributions or, within the preceding five Plan years, has made or had an obligation to make such contributions. Multiple Employer Plan shall mean a Plan which has two or more contributing sponsors (including any Borrower or any member of the ERISA Group) at least two of whom are not under common control, as such a plan is described in Sections 4063 and 4064 of ERISA. NC Resources shall mean NC Resources, Inc., a corporation organized and existing under the laws of the State of Delaware, which corporation is a wholly-owned Subsidiary of NovaCare. NCES Credit Facility shall mean that certain Credit Agreement among NovaCare Employee Services, Inc., as borrower, PNC Bank, National Association, as agent, and the lenders party thereto, dated as of November 17, 1997, as the same may be amended, restated, supplemented or modified from time to time. Notes shall mean Revolving Credit Notes and Note shall mean any Revolving Credit Note. NovaCare Employee Services, Inc. shall mean collectively NovaCare Employee Services, Inc., a corporation organized and existing under the laws of the State of Delaware and all of its Subsidiaries (whether now existing or hereafter formed or acquired). Official Body shall mean any national, federal, state, local or other government or political subdivision thereof, or any agency, authority, bureau, central bank, commission, department or instrumentality of any government or political subdivision thereof, or any court, tribunal, grand jury or arbitrator, in each case whether foreign or domestic. Participation Advance shall mean, with respect to any Bank, such Bank's payment in respect of its participation in a Letter of Credit Borrowing according to its Ratable Share pursuant to Section 2.09(g). PBGC shall mean the Pension Benefit Guaranty Corporation established pursuant to Subtitle A of Title IV of ERISA or any successor. - 13 - 60 Permitted Acquisition shall have the meaning assigned to that term in Section 8.02(d)(ii). Permitted Additional Institutional Indebtedness shall mean Indebtedness to a Qualified Lender provided that (A) such Indebtedness is unsecured; (B) the agreements governing such Indebtedness shall not contain any provisions which are more restrictive than the provisions of this Agreement and such Indebtedness shall not be senior in priority of payment to the Indebtedness hereunder; and (C) the Loan Parties shall deliver to the Agent on behalf of the Banks drafts of the agreement described in clause (B) at least five (5) Business Days before they incur such Indebtedness. Permitted Additional Subordinated Indebtedness shall mean Indebtedness which meets each of the following conditions: (A) the documentation governing such Indebtedness shall provide that the rights of the holders thereof shall be subordinate to the rights of the Agent and the Banks with respect to the Indebtedness under the Loan Documents in accordance with the subordination provisions contained in Exhibit 1.01(P)(3) with such revisions thereto as are reasonably satisfactory to the Agent, (B) the agreements governing such Indebtedness shall not contain any provisions which are more restrictive than the provisions of this Agreement, and (C) the Loan Parties shall deliver to the Agent on behalf of the Banks copies of drafts of the agreements described in clauses (A) and (B) at least five (5) Business Days before they incur such Indebtedness if the amount of such Indebtedness shall exceed $5,000,000. Permitted Asset Transfer shall mean any sale, conveyance, assignment, lease, abandonment or other transfer or disposition of assets of any Loan Party, permitted by Sections 8.02(e)(i) or (iv) hereof. Permitted Intercompany Indebtedness shall mean Intercompany Indebtedness, provided that such Indebtedness is subordinated pursuant to the Subordination Agreement (Intercompany). Permitted Investments shall mean investments by the Loan Parties in any of the following: (i) direct obligations of the United States of America ("U.S.A.") or any agency or instrumentality thereof or obligations backed by the full faith and credit of the U.S.A. maturing within two (2) years; (ii) any obligation of any state which is part of the U.S.A. or any obligation of any county or local governmental body of any such state provided that each of the following criteria are met: (A) such obligation matures within five (5) years; (B) the weighted average of the maturities (measured in numbers of years including fractions thereof) of all such obligations held by the Loan Parties is equal to or less than three (3) years; (C) such obligation is rated not lower than Baa-2 by Moody's Investors Service Inc. or BBB by Standard & Poor's Rating Services (or equivalent rating) and so long as the uninsured and unguaranteed general obligation debt of such state, county or local governmental body is rated, at the time of purchase - 14 - 61 and thereafter, not lower than Baa-2 by Moody's Investors Service Inc. or BBB by Standard & Poor's Rating Services (or equivalent rating); (D) the Weighted Average Rating of all such obligations held by the Loan Parties is Aa-2 by Moody's Investors Service Inc. or AA by Standard & Poor's Rating Services (or equivalent rating); and (E) so long as the uninsured and unguaranteed general obligation debt of each state, county or local governmental body relating to each such obligation of the Loan Parties is rated, the Weighted Average Rating of all such debt at the time of purchase and thereafter shall not be lower than Aa-2 by Moody's Investors Service Inc. or AA by Standard & Poor's Rating Services (or equivalent rating); (iii) commercial paper maturing in two hundred and seventy (270) days or less rated not lower than A-1 by Standard & Poor's Rating Services or P-1 by Moody's Investors Service Inc. on the date of acquisition; (iv) demand deposits, time deposits or certificates of deposit maturing within six (6) months in (A) any U.S. financial institution which is a member of the Federal Reserve System, or (B) any non-U.S. financial institution ranked among the fifty (50) largest in the world by assets (as listed by the American Banker Journal) or a non-U.S. financial institution with a net worth of at least $750 million, which institution described in this clause (B) has a credit quality rated at least A-1 or A by Standard & Poor's Rating Services (or equivalent rating); (v) investments in money-market funds rated AAm or AAm-G or higher by Standard & Poor's Rating Services(or equivalent rating) whose net asset value remains a constant $1.00 per share; (vi) in any fiscal year, investments in the aggregate in such fiscal year of up to $5 million in tax advantaged real estate partnerships; and (viii) other investments existing on the Closing Date listed on Schedule 1.01(P)(1) (except for repurchase agreements which are addressed in clause (v) above). 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; and (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 Employee Services, Inc. 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 Consummation, no Restricted Investments shall be made by NovaCare or any Subsidiary of NovaCare in NovaCare Employee Services, Inc. - 15 - 62 Permitted Liens shall mean: (i) Liens for taxes, assessments, or similar charges, incurred in the ordinary course of business and which are not yet due and payable; (ii) Pledges or deposits made in the ordinary course of business to secure payment of workers' compensation, or to participate in any fund in connection with workers' compensation, unemployment insurance, old-age pensions or other social security programs or pledges, deposits or contributions under trust agreements to secure obligations with respect to employee benefit plans; (iii) Liens of mechanics, materialmen, warehousemen, carriers, or other like Liens, securing obligations incurred in the ordinary course of business that are not yet due and payable and Liens of landlords securing obligations to pay lease payments that are not yet due and payable or in default; (iv) Good faith pledges or deposits made in the ordinary course of business to secure performance of bids, tenders, progress or advance payments, contracts (other than for the repayment of borrowed money) or leases, not in excess of the aggregate amount due thereunder, or to secure statutory obligations, or surety, appeal, indemnity, performance or other similar bonds required in the ordinary course of business (except that appeal bonds shall be permitted even if they are required outside of the ordinary course of business); (v) Encumbrances consisting of zoning restrictions, easements, reservations or other restrictions on the use of real property, none of which materially impairs the use of such property as currently used or the present value thereof, and none of which is violated in any material respect by existing or proposed structures or land use; (vi) Liens in favor of the Agent for the benefit of the Banks; (vii) Liens securing obligations under leases permitted in Section 8.02(a)(iii) provided that such Liens are limited to the property under lease; (viii) Any Lien existing on the date of this Agreement, which if securing Indebtedness in excess of $1,000,000 individually or $3,000,000 in the aggregate, is described on Schedule 1.01(P)(2) hereto, provided that the principal amount secured thereby is not hereafter increased and no additional assets become subject to such Lien (other than with respect to after-acquired property clauses in effect on the date hereof); (ix) Liens described in Sections 8.02(a)(v)(A)(2) and 8.02(a)(vi) on assets (A) acquired in Permitted Acquisitions securing Indebtedness assumed in connection therewith or (B) of a person the ownership interests of which are acquired by a Loan Party in a Permitted Acquisition securing Indebtedness of such person existing prior to the date of such acquisition; - 16 - 63 (x) Purchase Money Security Interests securing Indebtedness permitted under Section 8.02(a)(v)(A)(1); and (xi) The following, (A) if the validity or amount thereof is being contested in good faith by appropriate and lawful proceedings diligently conducted so long as levy and execution thereon have been stayed and continue to be stayed or (B) if a final judgment is entered and such judgment is discharged within thirty (30) days of entry, and in either case they do not affect the Pledged Collateral (or, in the event that they do affect the Pledged Collateral, the Loan Parties have provided adequate security satisfactory to the Banks', in the Banks' sole discretion) or, in the aggregate, materially impair the ability of the Loan Parties to perform their obligations hereunder or under the other Loan Documents: (1) Claims or Liens for taxes, assessments or charges due and payable and subject to interest or penalty, provided that the applicable Loan Party maintains such reserves or other appropriate provisions as shall be required by GAAP and pays all such taxes, assessments or charges forthwith upon the commencement of proceedings to foreclose any such Lien; (2) Claims, Liens or encumbrances upon, and defects of title to, real or personal property other than the Pledged Collateral (or, in the event that they do affect the Pledged Collateral, the Loan Parties have provided adequate security satisfactory to the Banks, in the Banks' sole discretion), including any attachment of personal or real property or other legal process prior to adjudication of a dispute on the merits; or (3) Claims or Liens of mechanics, materialmen, warehousemen, carriers, or other statutory nonconsensual Liens; (xii) For periods on or after the Spin-Off Consummation: (1) a pledge by NovaCare (or NC Resources as the transferee of NovaCare) of the issued and outstanding capital stock of NovaCare Employee Services, Inc., a Delaware corporation, owned by NovaCare (or NC Resources as the transferee of NovaCare, as the case may be), such pledge to be in favor of the lenders under the NCES Credit Facility for so long as loans are outstanding or commitments are in effect under such facility, and (2) a pledge by NovaCare Employee Services, Inc., a Delaware corporation and its Subsidiaries of the issued and outstanding capital stock of the Subsidiaries of NovaCare Employee Services, Inc., a Delaware corporation, such pledge to be in favor of the lenders under the NCES Credit Facility for so long as loans are outstanding or commitments are in effect under such facility. Permitted Line of Business shall mean, for any period through but not including the date of the Spin-Off Consummation, the business engaged in by NovaCare and its Subsidiaries as described in the Annual Report, SEC Form 10-K of NovaCare and its Subsidiaries, dated June 30, 1997 (the "Existing Business"), and for periods on and after the date of the Spin-Off Consummation, the Existing Business but expressly excluding and prohibiting the ownership or operation of Professional Employment Organizations, other than the continued - 17 - 64 ownership by NovaCare (or NC Resources as the transferee of NovaCare) of common stock of NovaCare Employee Services, Inc., a Delaware corporation, in accordance with Section 8.02(i). Permitted NovaCare Guaranty shall have the meaning set forth in Section 8.02(a)(vi)(D). Permitted Refinancing of Subordinated Debentures shall mean a refinancing of the Subordinated Debentures, with the cash proceeds from the issuance by NovaCare of common stock or with the proceeds of new Indebtedness of NovaCare as long as, in the case of new Indebtedness, such new Indebtedness satisfies all of the conditions of the following clauses (i), (ii) and (iii): (i) such new Indebtedness is subordinated to the Indebtedness of the Loan Parties to the Banks, (ii) the terms and conditions with respect to such new Indebtedness are satisfactory in form and substance to the Required Banks, and (iii) such new Indebtedness is incurred in accordance with the proviso clauses (x), (y) and (z) of Section 8.02 (a)(iv). Person shall mean any individual, corporation, partnership, association, joint-stock company, trust, unincorporated organization, joint venture, government or political subdivision or agency thereof, or any other entity. Plan shall mean at any time an employee pension benefit plan (including a Multiple Employer Plan but not a Multiemployer Plan) which is covered by Title IV of ERISA or is subject to the minimum funding standards under Section 412 of the Internal Revenue Code and either (i) is maintained by any member of the ERISA Group for employees of any member of the ERISA Group or (ii) has at any time within the preceding five years been maintained by any entity which was at such time a member of the ERISA Group for employees of any entity which was at such time a member of the ERISA Group. Pledge Agreements shall mean the Pledge Agreement in substantially the form attached hereto as Exhibit 1.01(P)(4) executed and delivered by NovaCare and each other Borrower which owns stock in any other Loan Party, Exhibit 1.01(P)(5) executed and delivered by each Guarantor which owns stock in any other Loan Party, Exhibit 1.01(p)(6) executed and delivered by each Borrower or Guarantor which owns any partnership interests in any other Loan Party, and any other form of agreement, in form and substance acceptable to the Agent, pledging any interests in a Loan Party (including, without limitation, ownership interests in any Loan Party which is a limited liability company) or the equity interests in an Excluded Entity owned by any Loan Party executed and delivered by the holders of such interests, in each instance to the Agent for the benefit of the Banks, and Pledge Agreement shall mean separately any Pledge Agreement. Pledged Collateral shall have the meaning assigned to that term in the Pledge Agreements. PNC Bank shall mean PNC Bank, National Association. - 18 - 65 Pooling Consideration shall mean with respect to any Permitted Acquisition which would be accounted for as a "pooling of interests" under GAAP, the sum of: (i) the fair market value (determined as of the date of the signing of the definitive acquisition agreement, provided that such Permitted Acquisition shall close within one hundred and twenty (120) days following such signing) of any stock issued by NovaCare in connection with such merger; and (ii) cash paid in lieu of fractional shares or with respect to dissenters' rights to the extent that the amount thereof can be ascertained on or before the date which is fifteen (15) Business Days prior to the date on which the closing of such Permitted Acquisition is scheduled to occur. Pooling Partner shall mean a person, which is not a Subsidiary or Minority Subsidiary of NovaCare, engaged in a merger or other transaction with a Loan Party which is accounted for under GAAP as a "pooling of interests" and as a result of which a Loan Party acquires all of the assets of such person or at least ninety percent of each class of voting capital stock of such person. Potential Default shall mean any event or condition which with notice, passage of time or a determination by the Agent or the Required Banks, or any combination of the foregoing, would constitute an Event of Default. Principal Office shall mean the main banking office of the Agent, Fifth Avenue and Wood Street, Pittsburgh, Pennsylvania 15265. Prior Security Interest shall mean a valid and enforceable perfected first priority security interest under the Uniform Commercial Code in the Pledged Collateral. Professional Employment Organization shall mean a Person who through contractual arrangements provides the service of payroll and human resource functions to non-affiliated businesses. Prohibited Transaction shall mean any prohibited transaction as defined in Section 4975 of the Internal Revenue Code or Section 406 of ERISA for which neither an individual nor a class exemption has been issued by the United States Department of Labor. Property shall mean all real property, both owned and leased, of the Loan Parties. Purchase Money Security Interest shall mean Liens upon tangible personal property securing loans to any Loan Party or deferred payments by a Loan Party for the purchase of such tangible personal property. - 19 - 66 Purchasing Bank shall mean a Bank which becomes a party to this Agreement by executing an Assignment and Assumption Agreement. Qualified Lender shall mean any person or persons, other than a commercial bank or any other organization which provides revolving credit loans to third parties in the ordinary course of its business. Qualifying Subsidiary at any time shall mean (i) any corporation or trust of which more than 80% (by number of shares or number of votes) of the outstanding capital stock or shares of beneficial interest normally entitled to vote for the election of one or more directors or trustees (regardless of any contingency which does or may suspend or dilute the voting rights) is at such time owned directly or indirectly by NovaCare or one or more of NovaCare's Subsidiaries, (ii) any limited partnership of which NovaCare is a general partner or of which more than 80% of the partnership interests is at the time directly or indirectly owned by NovaCare or one or more of NovaCare's Subsidiaries, (iii) any general partnership of which NovaCare or one or more of NovaCare's Subsidiaries owns directly or indirectly more than 80% of the general partnership interests, or (iv) any other entity of which NovaCare or one or more of its Subsidiaries owns directly or indirectly more than 80% of the ownership interests. Ratable Share shall mean the proportion that a Bank's Revolving Credit Commitment bears to the Revolving Credit Commitments of all of the Banks. Regulated Substances shall mean any substance, including without limitation any solid, liquid, gaseous, thermal or thoriated material, refuse, garbage, wastes, chemicals, petroleum products or by-products, dust, scrap, PCB's, heavy metals, any substances defined as "hazardous substances," "pollutants," "pollution," "contaminant," "hazardous or toxic substances," "toxic wastes," "regulated substances," "industrial waste," "residual waste," "solid wastes," "municipal wastes," "infectious waste," "chemotherapeutic waste," "medical waste" or any related materials or substances as now or hereafter defined pursuant to any Environmental Laws, ordinances, rules or directives of any Official Body, the generation, manufacture, processing, distribution, treatment, storage, disposal, transport, recycling, reclamation, use, reuse or other management or mismanagement of which is regulated by the Environmental Laws. Regulation U shall mean Regulation U, T, G or X as promulgated by the Board of Governors of the Federal Reserve System, as amended from time to time. Remaining Banks shall have the meaning set forth in Section 5.04(b). Reportable Event means a reportable event described in Section 4043 of ERISA and regulations thereunder with respect to a Plan or Multiemployer Plan. Required Banks shall mean (i) if there are no Revolving Credit Loans outstanding, Banks whose Revolving Credit Commitments aggregate at least 51% of the Revolving Credit Commitments of all of the Banks, or (ii) if there are Revolving Credit Loans - 20 - 67 outstanding, Banks whose Revolving Credit Loans outstanding aggregate at least 51% of the total principal amount of the Revolving Credit Loans outstanding hereunder. Restricted Excluded Entities shall mean collectively the Excluded Entities which have incurred Restricted Indebtedness, and Restricted Excluded Entity shall mean separately any of the Restricted Excluded Entities. Restricted Indebtedness shall mean with respect to any Excluded Entity, Indebtedness incurred by such Excluded Entity. Restricted Investments shall mean all of the following with respect to any one or more of the Excluded Entities: (i) investments or contributions by any of the Loan Parties directly or indirectly in or to the capital of or other payments to (except in connection with transactions for fair value in the ordinary course of business) such Excluded Entities, (ii) loans by any of the Loan Parties directly or indirectly to such Excluded Entities, (iii) guaranties by any of the Loan Parties directly or indirectly of the obligations of such Excluded Entities, or (iv) other obligations, contingent or otherwise, of any of the Loan Parties to or for the benefit of such Excluded Entities. If the nature of a Restricted Investment is tangible property then the amount of such Restricted Investment shall be determined by valuing such property at fair value in accordance with the past practice of the Loan Parties and such fair values shall be satisfactory to the Agent, in its sole discretion. Revolving Credit Base Rate Option shall have the meaning assigned to that term in Section 4.01(a)(i). Revolving Credit Base Rate Portion shall mean the portion of the Revolving Credit Loans bearing interest at any time under the Revolving Credit Base Rate Option. Revolving Credit Commitment shall mean as to any Bank at any time, the amount initially set forth opposite its name on Schedule 1.01(B) hereto in the column labeled "Amount of Commitment for Revolving Credit Loans," and thereafter on Schedule 1 to the most recent Assignment and Assumption Agreement, and Revolving Credit Commitments shall mean the aggregate Revolving Credit Commitments of all of the Banks. Revolving Credit Euro-Rate Option shall have the meaning assigned to that term in Section 4.01(a)(ii). Revolving Credit Euro-Rate Portion shall mean the portion of the Revolving Credit Loans bearing interest at any time under the Revolving Credit Euro-Rate Option. Revolving Credit Loan Request shall mean a request for Revolving Credit Loans made in accordance with Section 2.05 hereof. - 21 - 68 Revolving Credit Loans shall mean collectively and Revolving Credit Loan shall mean separately all Revolving Credit Loans or any Revolving Credit Loan made by the Banks or one of the Banks to the Borrowers pursuant to Section 2.01 hereof. Revolving Credit Notes shall mean the Revolving Credit Notes of the Borrowers in the form of Exhibit 1.01(R) hereto evidencing the Revolving Credit Loans together with all amendments, extensions, renewals, replacements, refinancings or refundings thereof in whole or in part. Revolving Facility Usage shall mean at any time the sum of the Revolving Credit Loans outstanding and the Letters of Credit Outstanding. Sale Price shall mean, with respect to any sale by any of the Loan Parties of its assets, the sum of (i) cash paid by the buyer at closing, (ii) the face amount of any deferred payments to be paid by the buyer after closing, (iii) the amount of any debt assumed or guaranteed by the buyer, plus (iv) the fair market value of any other consideration given by the buyer in connection therewith. Selected Banks shall have the meaning given to such term in Section 5.04(b). Solvent shall mean, with respect to any person on a particular date, that on such date (i) the fair value of the property of such person is greater than the total amount of liabilities, including, without limitation, contingent liabilities, of such person, (ii) the present fair saleable value of the assets of such person is not less than the amount that will be required to pay the probable liability of such person on its debts as they become absolute and matured, (iii) such person is able to realize upon its assets and pay its debts and other liabilities, contingent obligations and other commitments as they mature in the normal course of business, (iv) such person does not intend to, and does not believe that it will, incur debts or liabilities beyond such person's ability to pay as such debts and liabilities mature, and (v) such person is not engaged in business or a transaction, and is not about to engage in business or a transaction, for which such person's property would constitute unreasonably small capital after giving due consideration to the prevailing practice in the industry in which such person is engaged. In computing the amount of contingent liabilities at any time, it is intended that such liabilities will be computed at the amount which, in light of all the facts and circumstances existing at such time, represents the amount that can reasonably be expected to become an actual or matured liability. 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 Employee Services, Inc., a Delaware corporation, and as a result of such transaction, NovaCare (or NC Resources as the transferee of NovaCare), after giving effect thereto, shall own at least 65% of all of the issued and outstanding equity interests of NovaCare Employee Services, Inc., a Delaware corporation, and (ii) NovaCare Employee Services, Inc., a Delaware corporation, shall repay all outstanding Indebtedness as of - 22 - 69 the Spin-Off Consummation, together with accrued interest thereon, of NovaCare Employee Services, Inc., a Delaware corporation, to NovaCare. Spin-Off Consummation shall mean November 11, 1997, which is the date of the consummation of the Spin-Off. Subordinated Debentures shall mean the $175 million in original principal amount of 5-1/2% Convertible Subordinated Debentures Due 2000 issued by NovaCare pursuant to the Indenture. Subordinated Indebtedness shall mean the Indebtedness of NovaCare or the other Loan Parties under the Subordinated Indebtedness Documents. Subordinated Indebtedness Documents shall mean the Indenture and other documents evidencing Indebtedness which is subordinated to the Indebtedness of the Loan Parties to the Banks pursuant to Section 8.01(l), and all other instruments, certificates or documents delivered or contemplated to be delivered in connection therewith, as any of the foregoing may be supplemented or amended from time to time in accordance herewith. Subordination Agreement (Intercompany) shall mean the Subordination Agreement in the form of Exhibit 1.01(S) hereto pursuant to which the Loan Parties subordinate their rights to collect loans made to other Loan Parties to the rights of the Banks to collect Indebtedness of the Loan Parties to the Banks under the Loan Documents. Subsidiary of any person at any time shall mean (i) any corporation or trust of which more than 50% (by number of shares or number of votes) of the outstanding capital stock or shares of beneficial interest normally entitled to vote for the election of one or more directors or trustees (regardless of any contingency which does or may suspend or dilute the voting rights) is at such time owned directly or indirectly by such person or one or more of such person's Subsidiaries, or any limited partnership of which such person is a general partner or any partnership of which more than 50% of the partnership interests is at the time directly or indirectly owned by such person or one or more of such person's Subsidiaries or (ii) any other entity of which such person owns more than 50% of the ownership interests, directly or indirectly, and (iii) any corporation, trust, partnership or other entity which is controlled or capable of being controlled by such person or one or more of such person's Subsidiaries. Subsidiary Shares shall have the meaning assigned to that term in Section 6.01(c). Termination Date shall have the meaning set forth in Section 5.04(b). Thirteenth Amendment Effective Date shall mean November 17, 1997. Transferor Bank shall mean the selling Bank pursuant to an Assignment and Assumption Agreement. - 23 - 70 Unaffiliated Managed Company shall mean a person which is not an Affiliate, Subsidiary or Minority Subsidiary of NovaCare and with which any of the Loan Parties have entered into a contract providing for the management by one or more of the Loan Parties of one or more businesses owned by such person; provided that such businesses would be permitted under Section 8.02(g) if they were owned by the Loan Parties. Uniform Commercial Code shall have the meaning assigned to that term in Section 6.01(o). Weighted Average Rating shall mean with respect to obligations of states, counties or local governmental bodies held by the Loan Parties, or with respect to the general obligation debt of each state, county or local government body which issued such obligations, a weighted average determined by (1) first, converting the rating of each such obligation or such debt, as the case may be, to a whole number based on the table set forth below, (2) second, computing a weighted average of such whole numbers, with weighting based on the amount of such obligations, and rounding such average to the next lowest whole number, and (3) third, converting the whole number determined in the second step above back to a rating based on the table.
Number Assigned to Rating Such Rating ------ ----------- Equal to or greater than But less than ------------------------ ------------- Aaa-1 or AAA 4 Aa-2 or AA Aaa-1 or AAA 3 A-2 or A Aa-2 or AA 2 Baa-2 or BBB A-2 or A 1
Exhibit 1.01(W) sets forth an example of such computation. 1.02 Construction. Unless the context of this Agreement otherwise clearly requires, references to the plural include the singular, the singular the plural and the part the whole, "or" has the inclusive meaning represented by the phrase "and/or," and "including" has the meaning represented by the phrase "including without limitation." References in this Agreement to "determination" of or by the Agent or the Banks shall be deemed to include good faith estimates by the Agent or the Banks (in the case of quantitative determinations) and good faith beliefs by the Agent or the Banks (in the case of qualitative determinations). Whenever the Agent or the Banks are granted the right herein to act in its or their sole discretion or to grant or withhold consent such right shall be exercised in good faith. The words "hereof," "herein," "hereunder" and similar terms in this Agreement refer to this Agreement as a whole and not to any particular provision of this Agreement. The section and other headings contained in this Agreement and the Table of Contents preceding this Agreement are for reference purposes only - 24 - 71 and shall not control or affect the construction of this Agreement or the interpretation thereof in any respect. Section, subsection, schedule and exhibit references are to this Agreement unless otherwise specified. 1.03 Accounting Principles. Except as otherwise provided in this Agreement, all computations and determinations as to accounting or financial matters and all financial statements to be delivered pursuant to this Agreement shall be made and prepared in accordance with GAAP (including principles of consolidation where appropriate), and all accounting or financial terms shall have the meanings ascribed to such terms by GAAP. The Loan Parties and the Banks will in good faith attempt to agree upon appropriate changes to the financial covenants hereunder if GAAP changes after the Closing Date and such change materially changes the application of such covenants to the business of NovaCare and its Subsidiaries. ARTICLE II REVOLVING CREDIT FACILITY 2.01 Revolving Credit Borrowing. Subject to the terms and conditions hereof and relying upon the representations and warranties herein set forth, each Bank severally agrees to make revolving credit loans (the "Revolving Credit Loans") to any of the Borrowers at any time or from time to time on or after the date hereof to, but not including, the Expiration Date, in an aggregate principal amount not to exceed at any one time such Bank's Revolving Credit Commitment minus such Bank's Ratable Share of the Letters of Credit Outstanding. Within such limits of time and amount and subject to the other provisions of this Agreement, the Borrowers may borrow, repay and reborrow pursuant to this Section 2.01. In no event shall the aggregate of outstanding Revolving Credit Loans and Letters of Credit Outstanding as of any date exceed the Revolving Credit Commitments as of such date, and the entire outstanding principal amount of the Revolving Credit Loans shall be due and payable on the Expiration Date. 2.02 Nature of Banks' Obligations with Respect to Revolving Credit Loans. Each Bank shall be obligated to participate in each request for Revolving Credit Loans pursuant to Section 2.05 hereof in accordance with its Ratable Share. The aggregate of each Bank's Revolving Credit Loans outstanding hereunder to the Borrowers at any time shall never exceed its Revolving Credit Commitment minus its Ratable Share of the aggregate undrawn face amount of Letters of Credit Outstanding. The obligations of each Bank hereunder are several. The failure of any Bank to perform its obligations hereunder shall not affect the obligations of the Borrowers to any other party nor shall any other party be liable for the failure of such Bank to perform its obligations hereunder. The Banks shall have no obligation to make Revolving Credit Loans hereunder on or after the Expiration Date. 2.03 Commitment Fees; Closing Fees. The Borrowers, jointly and severally, agree to pay to the Agent for the account of each Bank, as consideration for such Bank's Revolving Credit Commitment hereunder, a commitment fee (the "Commitment Fee") equal to the per annum rate (computed on the basis of a year of 365 days or 366 days, as the case may be, and actual days elapsed) set forth below as the "Applicable Commitment Fee", on the average - 25 - 72 daily difference between the unborrowed amount of such Bank's Revolving Credit Commitment as the same may be constituted from time to time and such Bank's Ratable Share of Letters of Credit Outstanding. The Applicable Commitment Fee shall be calculated and determined based upon the ratio of (a) Consolidated Funded Debt to (b) Consolidated Cash Flow from Operations. Such ratio shall be computed as of the end of each quarter. Consolidated Cash Flow from Operations shall be computed at the end of each quarter for the four fiscal quarters then ended. Adjustments to the Commitment Fee attributable to a change in such ratio shall be effective (a) on the Delivery Date for the Borrower's consolidated financial statements for such quarter if the Applicable Commitment Fee is to be increased and (b) on the later of the Delivery Date for such financial statements or the date on which such financial statements are actually delivered to the Agent and the Banks if the Applicable Commitment Fee is to be decreased.
Ratio of Consolidated Applicable Funded Debt to Consolidated Commitment Cash Flow from Operations Fee Per Annum ------------------------- ------------- Greater than 4.0 to 1.0 .325% Greater than 3.50 to 1.0 .30% but less than or equal to 4.0 to 1.0 Greater than 3.00 to 1.0 .275% but less than or equal to 3.50 to 1.0 Greater than 2.50 to 1.0 .25% but less than or equal to 3.00 to 1.0 Greater than 2.00 to 1.0 .225% but less than or equal to 2.50 to 1.0 Less than or equal to 2.00 to 1.0 .20%
The Commitment Fees shall be payable in arrears on the first Business Day of each July, October, January and April after the date hereof and on the Expiration Date or upon acceleration of the Revolving Credit Notes. 2.04 Voluntary Reduction of Commitment. The Borrowers shall have the right at any time and from time to time upon five (5) Business Days' prior written notice to the Agent to permanently reduce, in minimum amount of $5,000,000 and whole multiples of $1,000,000 of principal, or terminate the Revolving Credit Commitments without penalty or premium, except as hereinafter set forth, provided that any such reduction or termination shall be accompanied by (a) the payment in full of any Commitment Fee then accrued on the amount of such reduction or termination and (b) prepayment of the Revolving Credit Notes, together with the full amount of interest accrued on the principal sum to be prepaid (and all amounts referred to in Section 5.06 hereof), to the extent that the aggregate amount thereof then outstanding exceeds the Revolving - 26 - 73 Credit Commitments as so reduced or terminated. Except as provided in Section 5.04(b) each Bank's Revolving Credit Commitment shall be reduced by its Ratable Share of the reduction in the Revolving Credit Commitments. From the effective date of any such reduction or termination, the obligations of the Borrowers to pay the Commitment Fee pursuant to Section 2.03 shall correspondingly be reduced or cease. 2.05 Revolving Credit Loan Requests. Except as otherwise provided herein, the Borrowers, through NovaCare as their agent pursuant to the Borrower Agency Agreement, may from time to time prior to the Expiration Date request the Banks to make Revolving Credit Loans, or renew or convert the Interest Rate Option applicable to existing Revolving Credit Loans, by the delivery to the Agent, not later than 10:00 a.m. Pittsburgh time (i) three (3) Business Days prior to the proposed Borrowing Date with respect to the making of Revolving Credit Loans to which the Revolving Credit Euro-Rate Option applies or the conversion to or the renewal of the Revolving Credit Euro-Rate Option for any Revolving Credit Loans; and (ii) one (1) Business Day prior to either the proposed Borrowing Date with respect to the making of a Revolving Credit Loan to which the Revolving Credit Base Rate Option applies or the last day of the preceding Euro-Rate Interest Period with respect to the conversion to the Revolving Credit Base Rate Option for any Revolving Credit Loan, of a duly completed request therefor substantially in the form of Exhibit 2.05 or a request by telephone immediately confirmed in writing by letter, facsimile or telex in such form (each, a "Revolving Credit Loan Request"), it being understood that the Agent may rely in good faith on the authority of any person making such a telephonic request and purporting to be an Authorized Officer. Each Revolving Credit Loan Request shall be irrevocable and shall (i) specify the proposed Borrowing Date; (ii) specify the aggregate amount of the proposed Revolving Credit Loans comprising the Borrowing Tranche, which shall be in integral multiples of $500,000 and not less than $1,500,000 for Revolving Credit Loans to which the Revolving Credit Euro-Rate Option applies and not less than the lesser of $500,000 or the maximum amount available for Revolving Credit Loans to which the Revolving Credit Base Rate Option applies; (iii) specify whether the Revolving Credit Euro-Rate Option or Revolving Credit Base Rate Option shall apply to the proposed Revolving Credit Loans comprising the Borrowing Tranche; (iv) in the case of Revolving Credit Loans to which the Revolving Credit Euro-Rate Option applies, specify an appropriate Euro-Rate Interest Period for the proposed Revolving Credit Loans comprising the Borrowing Tranche; (v) specify the Borrower to which each Borrowing Tranche is to apply and the amount of such Borrowing Tranche allocable to such Borrower; (vi) certify that the use by the Borrower of the Revolving Credit Loan proceeds is a use permitted by Section 2.08; and (vii) certify that no Event of Default or Potential Default has occurred and is continuing after giving effect to the proposed Revolving Credit Loan. 2.06 Making Revolving Credit Loans. The Agent shall, promptly after receipt by it of a Revolving Credit Loan Request pursuant to Section 2.05, notify the Banks of its receipt of such Revolving Credit Loan Request specifying: (i) the proposed Borrowing Date and the time and method of disbursement of such Revolving Credit Loan; (ii) the amount and type of such Revolving Credit Loan and the applicable Euro-Rate Interest Period (if any); (iii) the apportionment among the Banks of the Revolving Credit Loans as determined by the Agent in - 27 - 74 accordance with Section 2.02 hereof; and (iv) the Borrower to which each Borrowing Tranche is to apply and the amount of such Borrowing Tranche allocable to such Borrower. Each Bank shall remit the principal amount of each Revolving Credit Loan to the Agent such that the Agent is able to, and the Agent shall, to the extent the Banks have made funds available to it for such purpose, fund such Revolving Credit Loan to the Borrower or Borrowers in U.S. Dollars and immediately available funds at the Principal Office prior to 2:00 P.M. Pittsburgh time on the Borrowing Date, provided that if any Bank fails to remit such funds to the Agent in a timely manner the Agent may elect in its sole discretion to fund with its own funds the Revolving Credit Loan of such Bank on the Borrowing Date. 2.07 Revolving Credit Notes. The obligation of each Borrower to repay the aggregate unpaid principal amount of the Revolving Credit Loans made to it by each Bank, together with interest and fees thereon, shall be evidenced by a Revolving Credit Note dated the Closing Date in substantially the form attached hereto as Exhibit 1.01(R) payable to the order of such Bank. Each such note shall be in a face amount equal to the Revolving Credit Commitment of such Bank. Notwithstanding that NovaCare may request Revolving Credit Loans on behalf of a Borrower or Borrowers in accordance with Section 2.05, the Borrowers shall internally account on an individual Borrower basis for the use of the proceeds of the Revolving Credit Loans by each Borrower, and further the Borrowers warrant that they have customary and sufficient accounting procedures in order to accomplish such accounting. 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. 2.09 Letter of Credit Subfacility. (a) NovaCare as agent for any Borrower may request the issuance of, on the terms and conditions hereinafter set forth, standby letters of credit (each a "Letter of Credit" and collectively, "Letters of Credit") by delivering to the Agent a completed application and agreement for letters of credit in such form as the Agent may specify from time to time by no later than 10:00 a.m., Pittsburgh time, at least three (3) Business Days, or such shorter period as may be agreed to by the Agent, in advance of the proposed date of issuance. Subject to the terms and conditions hereof and in reliance on the agreements of the other Banks set forth in this Section 2.09, the Agent will issue a Letter of Credit provided that each Letter of Credit shall (A) have a maximum maturity of twelve (12) months from the date of issuance, and (B) in no event expire later than ten (10) Business Days prior to the Expiration Date and providing that in no event shall (i) the Letters of Credit Outstanding exceed, at any one time, $15,000,000 or (ii) the Revolving Facility Usage exceed, at any one time, the Revolving Credit Commitments. Schedule 2.09 hereto lists letters of credit which PNC Bank issued for the accounts of certain of - 28 - 75 the Loan Parties prior to the date hereof and which shall remain outstanding after the Closing Date (the "Existing Letters of Credit"). Each Existing Letter of Credit shall be a Letter of Credit hereunder on and after the Closing Date and the provisions of this Section 2.09 shall apply to such Existing Letter of Credit. (Schedule 2.09 also lists all amounts of Loans, interest and expenses outstanding under the Prior Credit Agreement.) (b) The Borrower shall pay to the Agent for the ratable account of the Banks a fee (the "Letter of Credit Fee") equal to the Applicable Percentage Over Euro-Rate which is then in effect which fee shall be computed on the face amount of each Letter of Credit and shall be payable quarterly in arrears commencing with the first Business Day of each April, July, October and January following issuance of each Letter of Credit and on the expiration date for each Letter of Credit. The Borrower shall pay to the Agent for its own account a fronting fee equal to 1/16% per annum, which fee shall be computed on the face amount of each Letter of Credit and shall be payable quarterly in arrears commencing with the first business day of each October, January, April and July following issuance of each letter of credit and on the expiration date for each Letter of Credit. The Borrower shall also pay to the Agent the Agent's then in effect customary fees and administrative expenses payable with respect to Letters of Credit as the Agent may generally charge or incur from time to time in connection with the issuance, maintenance, modification (if any), assignment or transfer (if any), negotiation and administration of Letters of Credit. (c) Immediately upon the issuance of each Letter of Credit, each Bank shall be deemed to, and hereby irrevocably and unconditionally agrees to, purchase from the Agent a participation in such Letter of Credit and each drawing thereunder in an amount equal to such Bank's Ratable Share of the maximum amount available to be drawn under such Letter of Credit and the amount of such drawing, respectively. (d) In the event of any request for a drawing under a Letter of Credit by the beneficiary or transferee thereof, the Agent will promptly notify the Borrower. Provided that it shall have received such notice, the Borrower shall reimburse (such obligation to reimburse the Agent shall sometimes be referred to as a "Reimbursement Obligation") the Agent prior to 12:00 noon, Pittsburgh time on each date that an amount is paid by the Agent under any Letter of Credit (each such date, a "Drawing Date") in an amount equal to the amount so paid by the Agent. In the event the Borrower fails to reimburse the Agent for the full amount of any drawing under any Letter of Credit by 12:00 noon, Pittsburgh time, on the Drawing Date, the Agent will promptly notify each Bank thereof, and the Borrower shall be deemed to have requested that Revolving Credit Loans be made by the Banks under the Revolving Credit Base Rate Option to be disbursed on the Drawing Date under such Letter of Credit, subject to the amount of the unutilized portion of the Revolving Credit Commitment and subject to the conditions set forth in Section 7.02 [Each Additional Revolving Credit Loan] other than any notice requirements. Any notice given by the Agent pursuant to this Section 2.09(d) may be oral if immediately confirmed in writing; provided that the lack of such an immediate confirmation shall not affect the conclusiveness or binding effect of such notice. - 29 - 76 (e) Each Bank shall upon any notice pursuant to Section 2.09(d) make available to the Agent an amount in immediately available funds equal to its Ratable Share of the amount of the drawing, whereupon the participating Banks shall (subject to Section 2.09(f)) each be deemed to have made a Revolving Credit Loan under the Revolving Credit Base Rate Option to the Borrower in that amount. If any Bank so notified fails to make available to the Agent for the account of the Agent the amount of such Bank's Ratable Share of such amount by no later than 2:00 p.m., Pittsburgh time on the Drawing Date, then interest shall accrue on such Bank's obligation to make such payment, from the Drawing Date to the date on which such Bank makes such payment (i) at a rate per annum equal to the Federal Funds Effective Rate during the first three days following the Drawing Date and (ii) at a rate per annum equal to the rate applicable to Loans under the Revolving Credit Base Rate Option on and after the fourth day following the Drawing Date. The Agent will promptly give notice of the occurrence of the Drawing Date, but failure of the Agent to give any such notice on the Drawing Date or in sufficient time to enable any Bank to effect such payment on such date shall not relieve such Bank from its obligation under this Section 2.09(e). (f) With respect to any unreimbursed drawing that is not converted into Revolving Credit Loans under the Revolving Credit Base Rate Option to the Borrower in whole or in part as contemplated by Section 2.09(d), because of the Borrower's failure to satisfy the conditions set forth in Section 7.02 [Each Additional Revolving Credit Loan] other than any notice requirements or for any other reason, the Borrower shall be deemed to have incurred from the Agent a Letter of Credit Borrowing in the amount of such drawing. Such Letter of Credit Borrowing shall be due and payable on demand (together with interest) and shall bear interest at the rate per annum applicable to the Revolving Credit Loans under the Revolving Credit Base Rate Option. Each Bank's payment to the Agent pursuant to Section 2.09(e) shall be deemed to be a payment in respect of its participation in such Letter of Credit Borrowing and shall constitute a Participation Advance from such Bank in satisfaction of its participation obligation under this Section 2.09. (g)(i) Upon (and only upon) receipt by the Agent for its account of immediately available funds from the Borrower (i) in reimbursement of any payment made by the Agent under the Letter of Credit with respect to which any Bank has made a Participation Advance to the Agent, or (ii) in payment of interest on such a payment made by the Agent under such a Letter of Credit, the Agent will pay to each Bank, in the same funds as those received by the Agent, the amount of such Bank's Ratable Share of such funds, except the Agent shall retain the amount of the Ratable Share of such funds of any Bank that did not make a Participation Advance in respect of such payment by Agent. (g)(ii) If the Agent is required at any time to return to any Loan Party, or to a trustee, receiver, liquidator, custodian, or any official in any Insolvency Proceeding, any portion of the payments made by any Loan Party to the Agent pursuant to Section 2.09(g)(i) in reimbursement of a payment made under the Letter of Credit or interest or fee thereon, each Bank shall, on demand of the Agent, forthwith return to the Agent the amount of its Ratable Share of any amounts so returned by the Agent plus interest thereon from the date such demand - 30 - 77 is made to the date such amounts are returned by such Bank to the Agent, at a rate per annum equal to the Federal Funds Effective Rate in effect from time to time. (h) Each Loan Party agrees to be bound by the terms of the Agent's application and agreement for letters of credit and the Agent's written regulations and customary practices relating to letters of credit. In the event of a conflict between such application or agreement and this Agreement, this Agreement shall govern. It is understood and agreed that, except in the case of gross negligence or willful misconduct, the Agent shall not be liable for any error, negligence and/or mistakes, whether of omission or commission, in following any Loan Party's instructions or those contained in the Letters of Credit or any modifications, amendments or supplements thereto. (i) In determining whether to honor any request for drawing under any Letter of Credit by the beneficiary thereof, the Agent shall be responsible only to determine that the documents and certificates required to be delivered under such Letter of Credit have been delivered and that they comply on their face with the requirements of such Letter of Credit. (j) Each Bank's obligation in accordance with this Agreement to make the Revolving Credit Loans or Participation Advances, as contemplated by Section 2.09, as a result of a drawing under a Letter of Credit, and the Obligations of the Borrower to reimburse the Agent upon a draw under a Letter of Credit, shall be absolute, unconditional and irrevocable, and shall be performed strictly in accordance with the terms of this Section 2.09 under all circumstances, including the following circumstances: (i) any set-off, counterclaim, recoupment, defense or other right which such Bank may have against the Agent, the Borrower or any other Person for any reason whatsoever; (ii) the failure of any Loan Party or any other Person to comply, in connection with a Letter of Credit Borrowing, with the conditions set forth in Section 2.01 [Revolving Credit Borrowing], 2.05 [Revolving Credit Loan Requests], 2.06 [Making Revolving Credit Loans] or 7.02 [Each Additional Revolving Credit Loan] or as otherwise set forth in this Agreement for the making of a Revolving Credit Loan, it being acknowledged that such conditions are not required for the making of a Letter of Credit Borrowing and the obligation of the Banks to make Participation Advances under Section 2.09; (iii) any lack of validity or enforceability of any Letter of Credit; (iv) the existence of any claim, set-off, defense or other right which any Loan Party or any Bank may have at any time against a beneficiary or any transferee of any Letter of Credit (or any Persons for whom any such transferee may be acting), the Agent or any Bank or any other Person, whether in connection with this Agreement, the transactions contemplated herein or any unrelated transaction (including any underlying transaction between any Loan Party or Subsidiaries of a Loan Party and the beneficiary for which any Letter of Credit was procured); - 31 - 78 (v) any draft, demand, certificate or other document presented under any Letter of Credit proving to be forged, fraudulent, invalid or insufficient in any respect or any statement therein being untrue or inaccurate in any respect even if the Agent has been notified thereof; (vi) payment by the Agent under any Letter of Credit against presentation of a demand, draft or certificate or other document which does not comply with the terms of such Letter of Credit; (vii) any adverse change in the business, operations, properties, assets, condition (financial or otherwise) or prospects of any Loan Party or Subsidiaries of a Loan Party; (viii) any breach of this Agreement or any other Loan Document by any party thereto; (ix) the occurrence or continuance of an Insolvency Proceeding with respect to any Loan Party; (x) the fact that an Event of Default or a Potential Default shall have occurred and be continuing; (xi) the fact that the Expiration Date shall have passed or this Agreement or the Commitments hereunder shall have been terminated; and (xii) any other circumstance or happening whatsoever, whether or not similar to any of the foregoing. (k) In addition to amounts payable as provided in Section 10.05 [Reimbursement and Indemnification of Agent by Borrowers], the Borrower hereby agrees to protect, indemnify, pay and save harmless the Agent from and against any and all claims, demands, liabilities, damages, losses, costs, charges and expenses (including reasonable fees, expenses and disbursements of counsel and allocated costs of internal counsel) which the Agent may incur or be subject to as a consequence, direct or indirect, of (i) the issuance of any Letter of Credit, other than as a result of (A) the gross negligence or willful misconduct of the Agent as determined by a final judgment of a court of competent jurisdiction or (B) subject to the following clause (ii), the wrongful dishonor by the Agent of a proper demand for payment made under any Letter of Credit, or (ii) the failure of the Agent to honor a drawing under any such Letter of Credit as a result of any act or omission, whether rightful or wrongful, of any present or future de jure or de facto government or governmental authority (all such acts or omissions herein called "Governmental Acts"). (l) As between any Loan Party and the Agent, such Loan Party assumes all risks of the acts and omissions of, or misuse of the Letters of Credit by, the respective beneficiaries of such Letters of Credit. In furtherance and not in limitation of the foregoing, the Agent shall not be responsible for: (i) the form, validity, sufficiency, accuracy, genuineness or legal effect of any document submitted by any party in connection with the application for an issuance of any such Letter of Credit, even if it should in fact prove to be in - 32 - 79 any or all respects invalid, insufficient, inaccurate, fraudulent or forged (even if the Agent shall have been notified thereof); (ii) the validity or sufficiency of any instrument transferring or assigning or purporting to transfer or assign any such Letter of Credit or the rights or benefits thereunder or proceeds thereof, in whole or in part, which may prove to be invalid or ineffective for any reason; (iii) the failure of the beneficiary of any such Letter of Credit, or any other party to which such Letter of Credit may be transferred, to comply fully with any conditions required in order to draw upon such Letter of Credit or any other claim of any Loan Party against any beneficiary of such Letter of Credit, or any such transferee, or any dispute between or among any Loan Party and any beneficiary of any Letter of Credit or any such transferee; (iv) errors, omissions, interruptions or delays in transmission or delivery of any messages, by mail, cable, telegraph, telex or otherwise, whether or not they be in cipher; (v) errors in interpretation of technical terms; (vi) any loss or delay in the transmission or otherwise of any document required in order to make a drawing under any such Letter of Credit or of the proceeds thereof; (vii) the misapplication by the beneficiary of any such Letter of Credit of the proceeds of any drawing under such Letter of Credit; or (viii) any consequences arising from causes beyond the control of the Agent, including any Governmental Acts, and none of the above shall affect or impair, or prevent the vesting of, any of the Agent's rights or powers hereunder. Nothing in the preceding sentence shall relieve the Agent from liability for the Agent's gross negligence or willful misconduct in connection with actions or omissions described in such clauses (i) through (viii) of such sentence. In furtherance and extension and not in limitation of the specific provisions set forth above, any action taken or omitted by the Agent under or in connection with the Letters of Credit issued by it or any documents and certificates delivered thereunder, if taken or omitted in good faith, shall not put the Agent under any resulting liability to the Borrower or any Bank. ARTICLE III [RESERVED] ARTICLE IV INTEREST RATES 4.01 Interest Rate Options. Each Borrower shall pay interest in respect of the outstanding unpaid principal amount of the Revolving Credit Loans as selected by NovaCare, as agent for such Borrower, from the Revolving Credit Base Rate Option or Revolving Credit Euro-Rate Option set forth below applicable to the Revolving Credit Loans, it being understood that, subject to the provisions of this Agreement, NovaCare, as such agent, may select different Interest Rate Options and different Euro-Rate Interest Periods to apply simultaneously to the Revolving Credit Loans comprising different Borrowing Tranches and may convert to or renew one or more Interest Rate Options with respect to all or any portion of the Revolving Credit Loans comprising any Borrowing Tranche provided that there shall not be at any one time outstanding more than fifteen (15) Borrowing Tranches in the aggregate among all the Revolving Credit Loans. The Agent's determination of a rate of interest and any change therein shall in the absence of manifest error be conclusive and binding upon all parties hereto. If at any time the - 33 - 80 designated rate applicable to any Revolving Credit Loan made by any Bank exceeds such Bank's highest lawful rate, the rate of interest on such Bank's Revolving Credit Loan shall be limited to such Bank's highest lawful rate. (a) Revolving Credit Interest Rate Options. NovaCare, as agent for the Borrowers, shall have the right to select from the following Interest Rate Options applicable to the Revolving Credit Loans. (i) Revolving Credit Base Rate Option: A fluctuating rate per annum (computed on the basis of a year of 365 or 366 days, as the case may be, and actual days elapsed) equal to the Base Rate, such interest rate to change automatically from time to time effective as of the effective date of each change in the Base Rate. (ii) Revolving Credit Euro-Rate Option: A rate per annum (computed on the basis of a year of 360 days and actual days elapsed), for each period specified below, equal to the Euro-Rate plus the applicable percentage (the "Applicable Percentage Over Euro-Rate") set forth below, based upon the ratio of (a) Consolidated Funded Debt to (b) Consolidated Cash Flow from Operations. Such ratio shall be computed as of the end of each quarter. Consolidated Cash Flow from Operations shall be computed at the end of each quarter for the four fiscal quarters then ended. Adjustments to interest attributable to a change in such ratio shall be effective (a) on the Delivery Date for the Borrower's consolidated financial statements for such quarter if the applicable interest rate is to be increased and (b) on the later of the Delivery Date for such financial statements or the date on which such financial statements are actually delivered to the Agent and the Banks if the applicable interest rate is to be decreased. FOR FISCAL QUARTERS PRIOR TO AND INCLUDING THE FISCAL QUARTER DURING WHICH A PERMITTED REFINANCING OF SUBORDINATED DEBENTURES IN A PRINCIPAL AMOUNT OF AT LEAST $250 MILLION IS CONSUMMATED, THE FOLLOWING TABLE IS APPLICABLE:
Ratio of Consolidated Funded Debt to Consolidated Cash Flow from Operations Applicable Interest Rate ------------------------- ------------------------ Greater than 4.0 to 1.0 Euro-Rate plus 1.50% Greater than 3.5 to 1.0 Euro-Rate plus 1.375% but less than or equal to 4.0 to 1.0 Greater than 3.0 to 1.0 Euro-Rate plus 1.250% but less than or equal to 3.5 to 1.0 Greater than 2.50 to 1.0 Euro-Rate plus 1.125% but less than or equal to 3.00 to 1.0
- 34 - 81 Greater than 2.00 to 1.0 Euro-Rate plus 1.00% but less than or equal to 2.50 to 1.0 Less than or equal to 2.00 to 1.0 Euro-Rate plus .875%
FOR FISCAL QUARTERS AFTER THE CONSUMMATION OF A PERMITTED REFINANCING OF SUBORDINATED DEBENTURES IN A PRINCIPAL AMOUNT OF AT LEAST $250 MILLION, THE FOLLOWING TABLE IS APPLICABLE:
Ratio of Consolidated Funded Debt to Consolidated Cash Flow from Operations Applicable Interest Rate ------------------------- ------------------------ Greater than 4.0 to 1.0 Euro-Rate plus 1.375% Greater than 3.5 to 1.0 Euro-Rate plus 1.250% but less than or equal to 4.0 to 1.0 Greater than 3.0 to 1.0 Euro-Rate plus 1.125% but less than or equal to 3.5 to 1.0 Greater than 2.50 to 1.0 Euro-Rate plus 1.00% but less than or equal to 3.00 to 1.0 Greater than 2.00 to 1.0 Euro-Rate plus .875% but less than or equal to 2.50 to 1.0 Less than or equal to 2.00 to 1.0 Euro-Rate plus .750%
(b) Rate Quotations. NovaCare, as agent for the Borrowers, may call the Agent on or before the date on which a Revolving Credit Loan Request is to be delivered to receive an indication of the rates then in effect, but it is acknowledged that such projection shall not be binding on the Agent or the Banks nor affect the rate of interest which thereafter is actually in effect when the election is made. 4.02 Interest Periods. At any time when NovaCare, as agent for the Borrowers, shall select, convert to or renew a Revolving Credit Euro-Rate Option, NovaCare shall notify the Agent thereof at least three (3) Business Days prior to the effective date of such Revolving Credit Euro-Rate Option by delivering a Revolving Credit Loan Request. The notice shall specify an interest period during which such Interest Rate Option shall apply, such periods to be one, two, three or six months ("Euro-Rate Interest Period"), provided, that: (a) any Euro-Rate Interest Period which would otherwise end on a date which is not a Business Day shall be extended to the next succeeding Business Day unless such - 35 - 82 Business Day falls in the next calendar month, in which case such Euro-Rate Interest Period shall end on the next preceding Business Day; (b) any Euro-Rate Interest Period which begins on the last day of a calendar month for which there is no numerically corresponding day in the subsequent calendar month during which such Interest Period is to end shall end on the last Business Day of such subsequent month; (c) Revolving Credit Euro-Rate Portion for each Euro-Rate Interest Period shall be in integral multiples of $500,000 and not less than $1,500,000; (d) NovaCare shall not select, convert to or renew a Euro-Rate Interest Period for any portion of the Revolving Credit Loans that would end after the Expiration Date; and (e) in the case of the renewal of a Revolving Credit Euro-Rate Option at the end of a Euro-Rate Interest Period, the first day of the new Interest Period shall be the last day of the preceding Interest Period, without duplication in payment of interest for such day. 4.03 Interest After Default. To the extent permitted by Law, upon the occurrence and during the continuation of an Event of Default, any principal, interest, fee or other amount payable hereunder shall bear interest for each day thereafter until paid in full (before and after judgment) at a rate per annum which shall be equal to two hundred (200) basis points (2% per annum) above the Base Rate if no rate of interest is otherwise applicable. Each Borrower acknowledges that such increased interest rate reflects, among other things, the fact that such Revolving Credit Loans or other amounts have become a substantially greater risk given their default status and that the Banks are entitled to additional compensation for such risk. 4.04 Euro-Rate Unascertainable. (a) If on any date on which a Euro-Rate would otherwise be determined, the Agent shall have determined (which determination shall be conclusive absent manifest error) that: (i) adequate and reasonable means do not exist for ascertaining such Euro-Rate, or (ii) a contingency has occurred which materially and adversely affects the secondary market for negotiable certificates of deposit maintained by dealers of recognized standing relating to the London interbank market relating to the Euro-Rate, or (b) if at any time any Bank shall have determined (which determination shall be conclusive absent manifest error) that: (i) the making, maintenance or funding of any Revolving Credit Loan to which a Revolving Credit Euro-Rate Option applies has been made impracticable - 36 - 83 or unlawful by compliance by such Bank in good faith with any Law or any interpretation or application thereof by any Official Body or with any request or directive of any such Official Body (whether or not having the force of Law), or (ii) such Revolving Credit Euro-Rate Option will not adequately and fairly reflect the cost to such Bank of the establishment or maintenance of any such Revolving Credit Loan, or (iii) after making all reasonable efforts, deposits of the relevant amount in Dollars for the relevant Euro-Rate Interest Period for a Revolving Credit Loan to which a Revolving Credit Euro-Rate Option applies are not available to such Bank at the effective cost of funding a proposed Revolving Credit Loan to which the Revolving Credit Euro-Rate Option applies in the London interbank market, then, in the case of any event specified in subsection (a) above, the Agent shall promptly so notify NovaCare, as agent for the Borrowers, and the Banks thereof and in the case of an event specified in subsection (b) above, such Bank shall promptly so notify the Agent in such capacity and endorse a certificate to such notice as to the specific circumstances of such notice and the Agent shall promptly send copies of such notice and certificate to the other Banks and NovaCare, as agent for the Borrowers. Upon such date as shall be specified in such notice (which shall not be earlier than the date such notice is given) the obligation of (A) the Banks in the case of such notice given by the Agent or (B) such Bank in the case of such notice given by such Bank to allow NovaCare, as agent for the Borrowers, to select, convert to or renew a Revolving Credit Euro-Rate Option shall be suspended until the Agent shall have later notified NovaCare, in such capacity, or such Bank shall have later notified the Agent, of the Agent's or such Bank's, as the case may be, determination (which determination shall be conclusive absent manifest error) that the circumstances giving rise to such previous determination no longer exist. If at any time the Agent makes a determination under subsection (a) or (b) of this Section 4.04 and NovaCare has previously notified the Agent of its selection of, conversion to or renewal of a Revolving Credit Euro-Rate Option and such Interest Rate Option has not yet gone into effect, such notification shall be deemed to provide for selection of, conversion to or renewal of the Revolving Credit Base Rate Option otherwise available with respect to such Revolving Credit Loans. If any Bank notifies the Agent of a determination under subsection (b) of this Section 4.04, the Borrowers shall, subject to the Borrowers' indemnification obligations under Section 5.06(b), as to any Revolving Credit Loan of such Bank to which a Revolving Credit Euro-Rate Option applies, on the date specified in such notice either convert such Revolving Credit Loan to the Revolving Credit Base Rate Option otherwise available with respect to such Revolving Credit Loan or prepay such Revolving Credit Loan in accordance with Section 5.04 hereof. Absent due notice from NovaCare of conversion or prepayment, such Revolving Credit Loan shall automatically be converted to the Revolving Credit Base Rate Option otherwise available with respect to such Revolving Credit Loan upon such specified date. 4.05 Selection of Interest Rate Options. If NovaCare, as agent for the Borrowers, fails to select a Euro-Rate Interest Period in accordance with the provisions of Section 4.02 in the case of renewal of the Revolving Credit Euro-Rate Portion, NovaCare shall be deemed to have converted such Revolving Credit Loan or portion thereof to the Revolving - 37 - 84 Credit Base Rate Option otherwise available with respect to such Revolving Credit Loans, commencing upon the last day of that Euro-Rate Interest Period. ARTICLE V PAYMENTS 5.01 Payments. All payments and prepayments to be made in respect of principal, interest, Commitment Fees, Closing Fees, Letter of Credit Fees, Agent's Fee or other fees or amounts due from the Borrowers hereunder shall be payable prior to 11:00 A.M. (Pittsburgh time) on the date when due without presentment, demand, protest or notice of any kind, all of which are hereby expressly waived by the Borrowers, and without setoff, counterclaim or other deduction of any nature, and an action therefor shall immediately accrue. Such payments shall be made to the Agent at its Principal Office for the ratable accounts of the Banks with respect to the Revolving Credit Loans in U.S. Dollars and in immediately available funds and the Agent shall promptly distribute such amounts to the Banks in immediately available funds, provided that in the event payments are received by 11:00 A.M. (Pittsburgh time) by the Agent with respect to the Revolving Credit Loans and such payments are not distributed to the Banks on the same day such payments are received by the Agent, the Agent shall pay the Banks the Federal Funds Effective Rate with respect to the amount of such payments for each day held by the Agent and not distributed to the Banks. The Agent's and each Bank's statement of account, ledger or other relevant record shall, in the absence of manifest error, be conclusive as the statement of the amount of principal of and interest on the Revolving Credit Loans and other amounts owing under this Agreement and shall be deemed an "account stated." 5.02 Pro Rata Treatment of Banks. Each borrowing, and each selection of, conversion to or renewal of any Interest Rate Option and each payment or prepayment by the Borrower with respect to principal, interest, Commitment Fees, Closing Fees, Letter of Credit Fees, or other fees or amounts due from the Borrowers hereunder to the Banks with respect to the Revolving Credit Loans, shall (except as provided in Section 4.04(b) [Euro-Rate Unascertainable], 5.04(b) [Voluntary Prepayments] or 5.06(a) [Additional Compensation in Certain Circumstances] hereof) be made in proportion to the Revolving Credit Loans outstanding from each Bank and if no such Revolving Credit Loans are then outstanding, in proportion to the Ratable Share of each Bank. 5.03 Interest Payment Dates. Interest on Revolving Credit Loans to which the Revolving Credit Base Rate Option applies shall be due and payable in arrears on the first Business Day of each July, October, January and April after the date hereof and on the Expiration Date or upon acceleration of the Revolving Credit Notes. Interest on Revolving Credit Loans to which a Revolving Credit Euro-Rate Option applies shall be due and payable on the last day of each Euro-Rate Interest Period for those Revolving Credit Loans, and if any such Euro-Rate Interest Period is longer than three Months, also on the last day of every third Month during such period. - 38 - 85 5.04 Voluntary Prepayments. (a) Each Borrower shall have the right at its option from time to time to prepay the Revolving Credit Loans in whole or part without premium or penalty (except as provided in subsection (b) below or in Section 5.06 hereof): (i) at any time with respect to any Revolving Credit Loan to which the Revolving Credit Base Rate Option applies, (ii) on the last day of the applicable Euro-Rate Interest Period with respect to any Revolving Credit Loans to which a Revolving Credit Euro-Rate Option applies, or (iii) on the date specified in a notice by any Bank pursuant to Section 4.04(b) [Euro-Rate Unascertainable] hereof with respect to any Revolving Credit Loan to which a Revolving Credit Euro-Rate Option applies. Whenever a Borrower desires to prepay any part of the Revolving Credit Loans, it shall cause NovaCare, as its agent, to provide a prepayment notice to the Agent at least one (1) Business Day prior to the date of prepayment of Revolving Credit Loans setting forth the following information: (x) the date, which shall be a Business Day, on which the proposed prepayment is to be made; and (y) the total principal amount of such prepayment, which shall not be less than $500,000. All prepayment notices shall be irrevocable. The principal amount of the Revolving Credit Loans for which a prepayment notice is given, together with interest on such principal amount except with respect to Revolving Credit Loans to which the Revolving Credit Base Rate Option applies, shall be due and payable on the date specified in such prepayment notice as the date on which the proposed prepayment is to be made. Unless otherwise specified by NovaCare on behalf of such Borrower with respect to prepayments of the Revolving Credit Euro-Rate Portion of the Revolving Credit Loans permitted under (ii) or (iii) above, all prepayments shall be applied first to the Revolving Credit Base Rate Portion of such Revolving Credit Loans, as the case may be, and then to the Revolving Credit Euro-Rate Portion of such Revolving Credit Loans, subject to Section 5.06(b) hereof. (b) In the event (i) any Bank gives notice under Section 4.04(b) [Euro-Rate Unascertainable] or Section 5.06(a) [Additional Compensation in Certain Circumstances] hereof, or (ii) any Bank does not approve any action as to which consent of the Required Banks is requested by the Borrowers and obtained hereunder, NovaCare may request either that such Bank's Revolving Credit Commitment be terminated pursuant to the procedures set forth in clause (A) below or that such Bank be replaced by a new bank pursuant to the procedures set forth in clause (B) below. If NovaCare desires to request that a Bank's Commitment be - 39 - 86 terminated or a Bank be replaced pursuant to this Section 5.04(b), NovaCare shall deliver to the Agent notice of such request within thirty (30) days after NovaCare receives such Bank's notice in the case of clause (i) of this Section 5.04(b), or within thirty (30) days after the Required Banks have consented to a matter with respect to which such Bank has not consented in the case of clause (ii) of this Section 5.04(b). NovaCare may request that the Commitment of a Bank be terminated or a Bank be replaced pursuant to clause (ii) of the first sentence of this Section 5.04(b) only if there exists no Event of Default or Potential Default on the date of such request. (A) Termination of Commitment. If NovaCare requests that the Commitment of a Bank be terminated (the "Bank to be Terminated") pursuant to this Section 5.04(b), such Commitment shall be terminated pursuant to the procedures set forth below if each of the Banks other than the Bank to be Terminated (the "Remaining Banks") agrees to such request. The Remaining Banks shall not unreasonably withhold such consent if NovaCare is requesting a termination pursuant to clause (i) of the first paragraph of Section 5.04(b). If the Remaining Banks agree to such termination, NovaCare shall notify all of the Banks of the date on which such termination shall be effective (the "Termination Date"). Such notice must be delivered at least three Business Days prior to the Termination Date and no more than thirty (30) days following NovaCare's receipt of approval from the Remaining Banks to terminate the Bank to be Terminated. The Borrowers shall repay all outstanding Loans of the Bank to be Terminated on the Termination Date and shall pay any amounts required under Section 5.06 and any accrued Commitment Fees due to such Bank to be Terminated. The Borrowers also shall repay the Loans of the Remaining Banks outstanding on the Termination Date if such reduction is necessary to cause the sum of Loans and Letters of Credit outstanding on such date not to exceed the Commitments (as reduced). The following shall occur upon delivery of the foregoing payment: (1) the Commitment of the Bank to be Terminated and its obligation under outstanding Letters of Credit shall terminate and such Bank shall cease to be a Bank hereunder; (2) the aggregate Commitments of the Banks hereunder shall be reduced by an amount equal to the amount of the Commitment which is being terminated pursuant to clause (1) above; and (3) the contingent obligation of each of the Remaining Banks in outstanding Letters of Credit shall be increased so that its share therein shall equal its Ratable Share of such Letters of Credit after giving effect to the termination of the Commitment of the Bank to be Terminated. It is acknowledged that the effect of the termination of the Commitment of the Bank to be Terminated pursuant to clause (1) above and the reduction of the Commitments pursuant to clause (2) above includes, without limitation, that the Ratable Shares of each of the Remaining Banks shall increase ratably and the aggregate of such increases will equal the Ratable Share of the Bank to be Terminated immediately prior to the Termination Date. PNC Bank may not be terminated under this Section unless on or before the Termination Date all Letters of Credit have been terminated or replaced by an issuing bank other than PNC Bank. If - 40 - 87 PNC Bank is the Bank to be Terminated, PNC Bank may, at its option, require that a successor Agent replace PNC Bank as Agent on or before the Termination Date. (B) Replacement. If NovaCare requests that a Bank be replaced (the "Bank to be Replaced") pursuant to this Section 5.04(b), such request shall be accompanied by a proposed list of banks designated by NovaCare as acceptable replacement Banks. Selection of the proposed replacement bank is subject to the approval of the Agent. If the Agent approves one of the proposed banks (the "Selected Bank"), the Bank to be Replaced shall assign its Commitment and all of its other rights as a Bank hereunder to the Selected Bank, and the Selected Bank shall purchase the Loans and the rights of the Bank to be Replaced and assume such Bank's obligations under Section 2.09 in respect of outstanding Letters of Credit pursuant to an Assignment and Assumption Agreement and subject to the limitations contained in Section 11.11. If the Bank to be Replaced is PNC Bank (1) PNC Bank, may at its option, require that a successor Agent replace PNC Bank as Agent on the date of such replacement, and (2) such replacement shall not be effective until all outstanding Letters of Credit have been replaced or terminated so that such Agent is no longer the issuer of or obligated under such Letters of Credit. 5.05 [RESERVED] 5.06 Additional Compensation in Certain Circumstances. (a) Increased Costs or Reduced Return Resulting From Taxes, Reserves, Capital Adequacy Requirements, Expenses, Etc. If any Law, guideline or interpretation or any change in any Law, guideline or interpretation or application thereof by any Official Body charged with the interpretation or administration thereof or compliance with any request or directive (whether or not having the force of Law) of any central bank or other Official Body: (i) subjects any Bank to any tax or changes the basis of taxation with respect to this Agreement, the Revolving Credit Notes, the Revolving Credit Loans or payments by any Borrower of principal, interest, or other amounts due from any Borrower hereunder or under the Revolving Credit Notes (except for taxes on the net income of such Bank), (ii) imposes, modifies or deems applicable any reserve, special deposit or similar requirement against credits or commitments to extend credit extended by, or assets (funded or contingent) of, deposits with or for the account of, or other acquisitions of funds by, any Bank, or (iii) imposes, modifies or deems applicable any capital adequacy or similar requirement (A) against assets (funded or contingent) of, or letters of credit, other credits or commitments to extend credit extended by, any Bank, or (B) otherwise applicable to the obligations of any Bank under this Agreement, and the result of any of the foregoing is to increase the cost to, reduce the income receivable by, or impose any expense (including loss of margin) upon any Bank or its parent with respect to this - 41 - 88 Agreement, the Revolving Credit Notes or the making, maintenance or funding of any part of the Revolving Credit Loans (or, in the case of any capital adequacy or similar requirement, to have the effect of reducing the rate of return on the capital of any Bank or its parent, taking into consideration such Bank's customary policies with respect to capital adequacy) by an amount which such Bank in its sole discretion deems to be material, such Bank shall from time to time notify the Borrowers and the Agent of the amount determined in good faith (using any averaging and attribution methods employed in good faith) by such Bank (which determination shall be conclusive absent manifest error) to be necessary to compensate such Bank for such increase in cost, reduction of income or additional expense. Such notice shall set forth in reasonable detail the basis for such determination. Such amount shall be due and payable by the Borrowers, jointly and severally, to such Bank ten (10) Business Days after such notice is given. For purposes of this Section 5.06(a), in calculating the amount necessary to compensate such Bank for any such increase in cost, reduction of income or additional expense, such Bank shall calculate the amount payable to it in a manner consistent with the manner in which it shall calculate similar compensation payable to it by other borrowers in the industry of the Borrowers having provisions in their credit agreements comparable to this Section 5.06(a). (b) Indemnity. In addition to the compensation required by subsection (a) of this Section 5.06, the Borrowers, jointly and severally, shall indemnify each Bank against all liabilities, losses or expenses (including loss of margin, any loss or expense incurred in liquidating or employing deposits from third parties and any loss or expense incurred in connection with funds acquired by a Bank to fund or maintain Revolving Credit Loans subject to the Revolving Credit Euro-Rate Option) which such Bank sustains or incurs as a consequence of any (i) payment, prepayment, conversion or renewal of any Revolving Credit Loan to which the Revolving Credit Euro-Rate Option applies on a day other than the last day of the corresponding Euro-Rate Interest Period (whether or not such payment or prepayment is mandatory, voluntary or automatic and whether or not such payment or prepayment is then due), (ii) attempt by the Borrowers to revoke (expressly, by later inconsistent notices or otherwise) in whole or part any notice relating to Revolving Credit Loan Requests under Section 2.05 or Section 4.02 or prepayments under Section 5.04, or (iii) default by any Borrower in the performance or observance of any covenant or condition contained in this Agreement or any other Loan Document, including without limitation any failure of any Borrower to pay when due (by acceleration or otherwise) any principal, interest, or any other amount due hereunder. If any Bank sustains or incurs any such loss or expense it shall from time to time notify the Borrowers of the amount determined in good faith by such Bank (which determination shall be conclusive absent manifest error and may include such assumptions, allocations of costs and expenses and averaging or attribution methods as such Bank shall deem reasonable) to be necessary to indemnify such Bank for such loss or expense. Such notice shall set forth in - 42 - 89 reasonable detail the basis for such determination. Such amount shall be due and payable by the Borrowers, jointly and severally, to such Bank ten (10) Business Days after such notice is given. ARTICLE VI REPRESENTATIONS AND WARRANTIES 6.01 Representations and Warranties. Each Loan Party represents and warrants to the Agent and each of the Banks as follows: (a) Organization and Qualification. Each of the Loan Parties is a corporation, partnership, limited liability company or business trust, duly organized, validly existing and, except as set forth on Schedule 6.01(a), in good standing under the laws of its respective jurisdiction of organization; each Loan Party has the corporate, partnership, limited liability company or trust (as the case may be) power to own or lease its respective properties and to engage in the business it presently conducts or proposes to conduct; and each Loan Party is duly qualified and in good standing in each jurisdiction where the property owned or leased by it or the nature of the business transacted by it or both makes such licensing or qualification necessary, except where the failure to be so licensed or qualified would not constitute a Material Adverse Change. (b) Capitalization and Ownership. All of the issued and outstanding shares of authorized capital stock of NovaCare have been validly issued and are fully paid and nonassessable. (c) Subsidiaries; Excluded Entities. Schedule 6.01(c) attached hereto states the name of each Subsidiary of NovaCare, its jurisdiction of organization, its authorized capital stock and the issued and outstanding shares (referred to herein collectively as the "Subsidiary Shares") and the owners thereof if it is a corporation, its outstanding partnership interests (the "Partnership Interests") and the owners thereof if it is a partnership, its outstanding equity interests (the "Member Interests") and the owners thereof if it is a limited liability company, and the trustee and holders of its beneficial interests (the "Beneficial Interests") if it is a business trust. NovaCare has good and marketable title to all of the Subsidiary Shares, Partnership Interests, Member Interests and Beneficial Interests it purports to own, free and clear in each case of any Lien, except for Liens in favor of the Agent for the benefit of the Banks, and each other Loan Party has good and marketable title to all of the Subsidiary Shares, Partnership Interests, Member Interests and Beneficial Interests it purports to own, free and clear of any Lien, except for Liens in favor of the Agent for the benefit of the Banks. All Subsidiary Shares, Partnership Interests, Member Interests and Beneficial Interests have been validly issued. All Subsidiary Shares are fully paid and nonassessable. All capital contributions and other consideration required to be made or paid in connection with the issuance of the Partnership Interests, Member Interests or Beneficial Interests have been made or paid, as the case may be. Except as set forth on Schedule 6.01(c), there are no options, warrants or other rights outstanding to purchase any such Subsidiary Shares, Partnership Interests, Member Interests or Beneficial Interests. Each Subsidiary, other than the Excluded Qualifying Subsidiaries, is a Loan Party - 43 - 90 hereunder and is listed on the signature lines or Schedule 6.01(c), as the case may be as a Guarantor or a Borrower. Schedule 1.01(E) lists each Subsidiary, Minority Subsidiary or Unaffiliated Managed Company which is not a Loan Party. (d) Power and Authority. Each Loan Party has full corporate, partnership, limited liability company or trust (as the case may be) power to enter into, execute, deliver and carry out this Agreement and the other Loan Documents to which it is a party, to incur the Indebtedness contemplated by the Loan Documents and to perform its obligations under the Loan Documents to which it is a party and all such actions have been duly authorized by all necessary proceedings on its part. (e) Validity and Binding Effect. This Agreement has been duly and validly executed and delivered by each Loan Party (except for Excluded Entities), and each other Loan Document, when duly executed and delivered by each respective Loan Party thereto, will have been duly and validly executed and delivered by such Loan Parties. This Agreement and each other Loan Document delivered by the Loan Parties pursuant to the provisions hereof will constitute legal, valid and binding obligations of the Loan Parties thereto, enforceable against each respective Loan Party in accordance with their respective terms, except to the extent that enforceability of any of the foregoing Loan Documents may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the enforceability of creditors' rights generally or limiting the right of specific performance or by general equitable principles. (f) No Conflict. Neither the execution and delivery of this Agreement or the other Loan Documents by the Loan Parties nor the consummation of the transactions herein or therein contemplated or compliance with the terms and provisions hereof or thereof by them will conflict with, constitute a default under or result in any breach of (i) the terms and conditions of the certificate of incorporation, by-laws or other organizational documents of any Loan Party, or (ii) any Law or any material agreement or instrument or order, writ, judgment, injunction or decree to which any Loan Party is a party or by which it is bound or to which it is subject, or result in the creation or enforcement of any Lien, charge or encumbrance whatsoever upon any property (now or hereafter acquired) of any Loan Party (other than Liens granted under the Loan Documents). (g) Litigation. There are no actions, suits, proceedings or investigations pending or, to the knowledge of any Loan Party, threatened against any Loan Party at law or equity before any Official Body which individually or in the aggregate would constitute a Material Adverse Change including, without limitation, any actions, suits or proceedings by any Official Body to recover any Medicare or Medicaid payments from any Loan Party or to otherwise exclude any Loan Party from participation in any Medicare, Medicaid or similar program. No Loan Party is in violation of any order, writ, injunction or any decree of any Official Body which would constitute a Material Adverse Change. - 44 - 91 (h) Title to Properties. Each of the Loan Parties has good and marketable title to or valid leasehold interest in all properties, assets and other rights which it purports to own or lease or which are reflected as owned or leased on its books and records, free and clear of all Liens and encumbrances except Permitted Liens. All leases of property are in full force and effect without the necessity for any consent which has not previously been obtained upon consummation of the transactions contemplated hereby. (i) Financial Statements. (A) Historical Statements. NovaCare has delivered to the Agent copies of its audited consolidated year-end financial statements for and as of the end of the fiscal year ended June 30, 1997 (the "Annual Statements") and its unaudited consolidated financial statements for and as of the fiscal quarter ended March 31, 1998 (the "Interim Statements" and sometimes collectively with the Annual Statements, the "Historical Statements"). The Historical Statements were compiled from the books and records maintained by NovaCare's management, fairly present the consolidated financial condition of NovaCare and its Subsidiaries as of their dates and the results of operations for the fiscal periods then ended and have been prepared in accordance with GAAP consistently applied, subject (in the case of the Interim Statements) to normal year-end audit adjustments. (B) Financial Projections. NovaCare has delivered to the Agent financial projections of NovaCare and its Subsidiaries through June 30, 2003 derived from various assumptions of NovaCare's management (the "Financial Projections"). The Financial Projections represent a reasonable range of possible results in light of the history of the business, present and reasonably foreseeable conditions and the intentions of NovaCare's management. The Financial Projections reasonably reflect the liabilities of NovaCare and its Subsidiaries upon consummation of the transactions contemplated hereby as of the Closing Date. (C) Accuracy of Financial Statements. Neither NovaCare nor any Subsidiary has any liabilities, contingent or otherwise, or material forward or long-term commitments that are not disclosed in the Historical Statements or in the notes thereto and are required to be disclosed, and except as disclosed therein there are no unrealized or anticipated losses from any commitments of NovaCare or any Subsidiary which would constitute a Material Adverse Change. Since June 30, 1997 no Material Adverse Change has occurred. (j) Full Disclosure. Neither this Agreement nor any other Loan Document, nor any certificate, statement, agreement or other documents furnished to the Agent or any Bank in connection herewith or therewith, contains any untrue statement of a material fact or omits to state a material fact necessary in order to make the statements contained herein and therein, in light of the circumstances under which they were made, not misleading. (k) Taxes. All material federal, state, local and other tax returns required to have been filed with respect to each Loan Party have been filed and payment or adequate provision has been made for the payment of all taxes, fees, assessments and other governmental charges which have or may become due pursuant to said returns or to assessments received except to the extent that such taxes, fees, assessments and other charges are being - 45 - 92 contested in good faith by appropriate proceedings diligently conducted and for which such reserves or other appropriate provisions, if any, as shall be required by GAAP shall have been made. There are no agreements or waivers extending the statutory period of limitations applicable to any federal income tax return of any Loan Party. (l) Consents and Approvals. No consent, approval, exemption, order or authorization of, or a registration or filing with any Official Body or any other person is required by any Law or any agreement in connection with the execution, delivery and carrying out of this Agreement and the other Loan Documents by any Loan Party, except as listed on Schedule 6.01(l) attached hereto, all of which shall have been obtained or made on or prior to the Closing Date except as otherwise indicated on Schedule 6.01(l); provided, however, that it is acknowledged that consent of health care regulatory authorities issuing any licenses or regulating any health care facilities may be required if the Agent on behalf of the Banks exercises the rights and remedies in respect of the Pledged Collateral and such exercise of remedies results in or constitutes an assignment of any health care license issued by a health care regulatory authority or constitutes a change of control with respect to the ownership of a health care facility. (m) No Event of Default; Compliance with Instruments. No event has occurred and is continuing and no condition exists or will exist after giving effect to the borrowings to be made on the Closing Date under the Loan Documents which constitutes an Event of Default or Potential Default. No Loan Party is in violation of (i) any term of its certificate of incorporation, by-laws, or other organizational documents or (ii) any material agreement or instrument to which it is a party or by which it or any of its properties may be subject or bound where such violation would constitute a Material Adverse Change. (n) Patents, Trademarks, Copyrights, Etc. Each Loan Party owns or possesses all the material patents, trademarks, service marks, trade names, copyrights and other intellectual property rights necessary to own and operate its properties and to carry on its business as presently conducted and planned to be conducted by such Loan Party without known conflict with the rights of others. (o) Security Interests. The Liens and security interests granted to the Agent for the benefit of the Banks pursuant to the Pledge Agreements in the Pledged Collateral constitute and the Loan Parties shall not take any action that would cause them not to continue to constitute Prior Security Interests under the Uniform Commercial Code as in effect in each applicable jurisdiction (the "Uniform Commercial Code") or other applicable Law entitled to all the rights, benefits and priorities provided by the Uniform Commercial Code or such Law. Upon taking possession of any stock certificates, certificates of Beneficial Interests or certificates of Member Interests, evidencing the Pledged Collateral which consists of stock, certificated Beneficial Interests or certificated Member Interests, as the case may be, and the filing of UCC-1 financing statements with respect to any Pledged Collateral which consists of Partnership Interests, uncertificated Beneficial Interests or uncertificated Member Interests, all such action as is necessary or advisable to establish such rights of the Agent will have been taken, and there will - 46 - 93 be upon execution and delivery of the Pledge Agreement and such taking of possession and such filing, no necessity for any further action in order to preserve, protect and continue such rights. (p) Status of the Pledged Collateral. All the shares of capital stock, Member Interests, or Beneficial Interests included in the Pledged Collateral to be pledged pursuant to the Pledge Agreements are or will be upon issuance duly authorized, validly issued, fully paid, nonassessable and owned beneficially and of record by the pledgor free and clear of any Lien or restriction on transfer, except as otherwise provided by the Pledge Agreements and except as the right of the Banks or the Agent to dispose of such shares, Member Interests, or Beneficial Interests may be limited by the Securities Act of 1933, as amended, and the regulations promulgated by the Securities and Exchange Commission thereunder and by applicable state securities laws. There are no shareholder or other agreements or understandings with respect to the shares of capital stock, Member Interests, or Beneficial Interests included in the Pledged Collateral. (q) Insurance. Schedule 6.01(q) hereto lists all insurance policies and other bonds to which each Loan Party is a party on the date hereof, all of which are valid and in full force and effect. No notice has been given or claim made and no grounds exist to cancel or avoid any of such policies or bonds or to reduce the coverage provided thereby. Such policies and bonds provide adequate coverage from reputable and financially sound insurers in amounts sufficient to insure the assets and risks of each Loan Party in accordance with prudent business practice in the industry of each Loan Party. (r) Compliance with Laws. Each Loan Party is in compliance in all material respects with all applicable Laws (other than Environmental Laws which are specifically addressed in subsection (x)) in all jurisdictions in which such Loan Party is presently doing business except where the failure to do so would not constitute a Material Adverse Change. (s) Material Contracts, Licenses, Permits and Approvals. (A) All material contracts of each Loan Party are valid, binding and enforceable upon the Loan Party which is a party to such contract, as the case may be, and, to the best knowledge of each Loan Party, each of the other parties thereto in accordance with their respective terms, and there is no material default thereunder, to the knowledge of the Loan Parties, with respect to parties other than the Loan Parties. (B) Except as set forth on Schedule 6.01(s), each Loan Party has all material accreditations, authorizations, approvals, certificates of need, consents, licenses, permits and qualifications (collectively, "Approvals") required (i) for them to construct, acquire, own, manage, lease and/or operate their facilities and provide services, or (ii) for them to receive payment and reimbursement from any patient or third party payor, to the extent in the case of (i) and (ii) such Approvals are presently required. There are no actions, suits, proceedings or investigations pending or, to the knowledge of any Loan Party, threatened against any Loan Party at law or in equity before any Official Body to modify, rescind or revoke any of the Approvals. The Loan Parties have all other material Approvals required for the lawful operation of their - 47 - 94 businesses, except for any violations which would not result in a Material Adverse Change. All material Approvals of the Loan Parties are in full force and effect and have not been amended or otherwise modified (except for modifications which would not constitute a Material Adverse Change), rescinded, revoked or assigned, and no notice has been received of any violation of applicable Laws or any refusal to renew any Approval which could reasonably be expected to cause any of such Approvals to be modified, rescinded or revoked (except for modifications, rescissions or revocations which would not constitute a Material Adverse Change). The continuation, validity and effectiveness of all such Approvals will in no way be adversely affected by the transactions contemplated by this Agreement. No Loan Party knows of any reason why any of them will not be able to maintain, after the Closing Date, all material Approvals necessary or appropriate to construct, own, lease, manage and operate all of their facilities and to otherwise conduct their businesses as now conducted and presently proposed to be conducted. There are no deficiencies to the conditions for participation by any Loan Party in any Medicare, Medicaid or other reimbursement programs which would preclude such participation, nor, other than routine, scheduled audits, is there any pending or, to the knowledge of the Borrowers, threatened investigation, proceeding or other action by Medicare or Medicaid to exclude any Loan Party from participation in such programs. (t) Investment Companies. No Loan Party is an "investment company" registered or required to be registered under the Investment Company Act of 1940 or under the "control" of an "investment company" as such terms are defined in the Investment Company Act of 1940 and shall not become such an "investment company" or under such "control." (u) Margin Stock. Neither NovaCare nor any of its Subsidiaries is engaged or intends to engage principally, or as one of its important activities, in the business of extending credit for the purpose, immediately, incidentally or ultimately, of purchasing or carrying margin stock (within the meaning of Regulation U). No part of the proceeds of any Revolving Credit Loan has been or will be used, immediately, incidentally or ultimately, to purchase or carry any margin stock or to extend credit to others for the purpose of purchasing or carrying any margin stock or to refund Indebtedness originally incurred for such purpose, or for any purpose which entails a violation of or which is inconsistent with the provisions of the regulations of the Board of Governors of the Federal Reserve System. (v) Plans and Benefit Arrangements. Except as set forth on Schedule 6.01(v) hereto: (i) NovaCare, its Subsidiaries and each member of the ERISA Group are in compliance in all material respects with any applicable provisions of ERISA with respect to all Benefit Arrangements, Plans and Multiemployer Plans and each Benefit Arrangement and Plan has been administered in all material respects in accordance with its terms and ERISA. There has been no Prohibited Transaction with respect to any Benefit Arrangement or any Plan or, to the best knowledge of NovaCare and its Subsidiaries, with respect to any Multiemployer Plan or Multiple Employer Plan, which could result in any material liability of NovaCare, its Subsidiaries or any other member of the ERISA Group. NovaCare, its - 48 - 95 Subsidiaries and all members of the ERISA Group have made when due any and all payments required to be made under any agreement relating to a Multiemployer Plan or a Multiple Employer Plan or any Law pertaining thereto. With respect to each Plan and Multiemployer Plan, NovaCare, its Subsidiaries and each member of the ERISA Group (i) have fulfilled in all material respects their obligations under the minimum funding standards of ERISA, (ii) have not incurred any liability to the PBGC other than for the payment of required premiums and (iii) have not had asserted against them any penalty for failure to fulfill the minimum funding requirements of ERISA. (ii) To the best knowledge of each Loan Party, each Multiemployer Plan and Multiple Employer Plan is able to pay benefits thereunder when due. (iii) Neither NovaCare, its Subsidiaries nor any other member of the ERISA Group has instituted or intends to institute proceedings to terminate any Plan, which termination resulted or will directly or indirectly result in any material liability to any Loan Party. (iv) No event requiring notice to the PBGC under Section 302(f)(4)(A) of ERISA has occurred or is reasonably expected to occur with respect to any Plan, and no amendment with respect to which security is required under Section 307 of ERISA has been made or is reasonably expected to be made to any Plan. (v) The aggregate actuarial present value of all benefit liabilities (whether or not vested) under each Plan, determined on a plan termination basis, as disclosed in, and as of the date of, the most recent actuarial report for such Plan, does not exceed the aggregate fair market value of the assets of such Plan by a material amount. (vi) Neither NovaCare, its Subsidiaries nor any other member of the ERISA Group has incurred or reasonably expects to incur any material withdrawal liability under ERISA to any Multiemployer Plan or Multiple Employer Plan. Neither NovaCare, its Subsidiaries nor any other member of the ERISA Group has been notified by any Multiemployer Plan or Multiple Employer Plan that such Multiemployer Plan or Multiple Employer Plan has been terminated within the meaning of Title IV of ERISA and, to the best knowledge of NovaCare and its Subsidiaries, no Multiemployer Plan or Multiple Employer Plan is reasonably expected to be reorganized or terminated, within the meaning of Title IV of ERISA. (vii) To the extent that any Benefit Arrangement is insured, NovaCare, its Subsidiaries and all members of the ERISA Group have paid when due all premiums required to be paid for all periods through and including the Closing Date. To the extent that any Benefit Arrangement is funded other than with insurance, NovaCare, its Subsidiaries and all members of the ERISA Group have made when due all contributions required to be paid for all periods through and including the Closing Date. (w) Employment Matters. Each Loan Party is in compliance with its labor contracts and all applicable federal, state and local labor and employment Laws including, but not limited to, those related to equal employment opportunity and affirmative action, labor relations, minimum wage, overtime, child labor, medical insurance continuation, worker adjustment and relocation notices, immigration controls and worker and unemployment - 49 - 96 compensation, except for any failure to comply which would not constitute a Material Adverse Change. There are no outstanding grievances, arbitration awards or appeals therefrom arising out of any Loan Party's labor contracts or current or threatened strikes, picketing, handbilling or other work stoppages or slowdowns at facilities of any Loan Party which in any case would constitute a Material Adverse Change. NovaCare has delivered to the Agent true and correct copies of each of the Labor Contracts in effect as of the date hereof. (x) Environmental Matters. Except as disclosed on Schedule 6.01(x) hereto: (i) Neither NovaCare nor any of its Subsidiaries has received any Environmental Complaint from any Official Body or private person alleging that NovaCare, any of its Subsidiaries or any prior or subsequent owner of the Property is a potentially responsible party under the Comprehensive Environmental Response, Cleanup and Liability Act, ("CERCLA") 42 U.S.C. Section 9601, et seq., or is potentially liable under the Solid Waste Disposal Act, as amended, ("SWDA") 42 U.S.C. Section 6901, et. seq., or any comparable state or foreign law, statute or regulation of either CERCLA or SWDA and NovaCare has no reason to believe that such an Environmental Complaint might be received. There are no pending or, to any Loan Party's actual knowledge, threatened Environmental Complaints relating to NovaCare, any of its Subsidiaries or, to any Loan Party's knowledge, any prior or subsequent owner of the Property pertaining to, or arising out of, any Environmental Conditions which, individually or in the aggregate, if adversely determined could reasonably be expected to constitute a Material Adverse Change. (ii) Except for conditions, violations or failures which individually and in the aggregate are not reasonably likely to result in a Material Adverse Change, (i) there are no circumstances at, on or, to the best knowledge of each Loan Party, under the Property that constitute a breach of or non-compliance with any of the Environmental Laws, and (ii) there are, to the best knowledge of each Loan Party, no past or present Environmental Conditions at, on or under the Property or, to each Loan Party's actual knowledge, at, on or under adjacent property, that prevent compliance with the Environmental Laws at the Property. (iii) Neither the Property nor any structures, improvements, equipment, fixtures, activities or facilities thereon or thereunder contain or use Regulated Substances except in compliance in all material respects with Environmental Laws (other than any noncompliance which individually and in the aggregate is not reasonably likely to result in a Material Adverse Change). There are no processes, facilities, operations, equipment or any other activities at, on or, to the best knowledge of each Loan Party, under the Property, or, to each Loan Party's actual knowledge, at, on or under adjacent property, that currently result in the release or threatened release of Regulated Substances onto the Property, except to the extent that such releases or threatened releases are not a material breach of or otherwise not a material violation of the Environmental Laws, or are not likely to result in a Material Adverse Change. (iv) There are no above ground storage tanks, underground storage tanks, or underground piping associated with such tanks, used for the management of Regulated Substances at, on or under the Property that (a) do not have, to the extent required by - 50 - 97 applicable Environmental Laws, a full operational secondary containment system in place, and (b) are not otherwise in compliance in all material respects with all Environmental Laws (other than any noncompliance which individually or in the aggregate is not reasonably likely to result in a Material Adverse Change). To the best knowledge of each Loan Party, there are no abandoned underground storage tanks or underground piping associated with such tanks, previously used for the management of Regulated Substances at, on or under the Property that have not been either abandoned in place, or removed, in accordance with the Environmental Laws (other than any noncompliance which individually or in the aggregate is not reasonably likely to result in a Material Adverse Change). (v) Each Loan Party has all material permits, licenses, authorizations, plans and approvals necessary under the Environmental Laws for the conduct of the business of each Loan Party as presently conducted (except where the failure to hold any such permit, license, authorization or approval is not reasonably likely to result in a Material Adverse Change). Each Loan Party has submitted all material notices, reports and other filings required by the Environmental Laws to be submitted to an Official Body which pertain to past and current operations on the Property (except where the failure to make any such submission is not reasonably likely to result in a Material Adverse Change). (vi) Except for violations which individually and in the aggregate are not likely to result in a Material Adverse Change, (i) all present and, to the actual knowledge of each Loan Party, past on-site generation, storage, processing, treatment, recycling, reclamation or disposal of Regulated Substances at, on, or, to the best knowledge of each Loan Party, under the Property and, (ii) to the best knowledge of each Loan Party, all off-site transportation, storage, processing, treatment, recycling, reclamation or disposal of Regulated Substances by any Loan Party, and to the actual knowledge of each Loan Party, by any other party, relating to the activities on the Property has been done in accordance with the Environmental Laws. (y) Senior Debt Status. The obligations of the Loan Parties under this Agreement, the Revolving Credit Notes or the Guaranties, as the case may be, do rank and will rank at least pari passu in priority of payment with all other indebtedness of the Loan Parties except indebtedness of the Loan Parties to the extent secured by Permitted Liens. There is no Lien upon or with respect to any of the properties or income of any Loan Party which secures indebtedness or other obligations of any person except for Permitted Liens. The obligations of the Loan Parties hereunder, under the Revolving Credit Notes, or under the Guaranties constitute and will constitute "Senior Indebtedness" as defined under the Indenture. (z) Solvency. Each Loan Party is Solvent and after giving effect to the transactions contemplated by the Loan Documents, including all Indebtedness incurred thereby, and the payment of all fees related thereto, each Loan Party will be Solvent, determined as of the Closing Date and as of each Borrowing Date, except to the extent that any failure to comply with the foregoing would not result in a Material Adverse Change. (aa) Year 2000. Each Loan Party has reviewed the areas within their business and operations which could be adversely affected by, and have developed or are - 51 - 98 developing a program to address on a timely basis, the risk that certain computer applications used by the Loan Parties (or any of their respective material suppliers, customers or vendors) may be unable to recognize and perform properly date-sensitive functions involving dates prior to and after December 31, 1999 (the "Year 2000 Problem"). The Year 2000 Problem will not result in any Material Adverse Change. 6.02 Updates to Schedules. Should any of the information or disclosures provided on any of the Schedules attached hereto become outdated or incorrect in any material respect, the Loan Parties shall promptly provide the Agent in writing with such revisions or updates to such Schedule as may be necessary or appropriate to update or correct same; provided, however that no Schedule shall be deemed to have been amended, modified or superseded by any such correction or update, nor shall any breach of warranty or representation resulting from the inaccuracy or incompleteness of any such Schedule be deemed to have been cured thereby, unless and until the Required Banks, in their sole and absolute discretion, shall have accepted in writing such revisions or updates to such Schedule. ARTICLE VII CONDITIONS OF LENDING The obligation of each Bank to make Revolving Credit Loans or to issue any Letters of Credit hereunder is subject to the performance by each Loan Party of its obligations to be performed hereunder at or prior to the making of any such Revolving Credit Loans or the issuing of such Letters of Credit and to the satisfaction of the following further conditions: 7.01 [INTENTIONALLY OMITTED] 7.02 Each Additional Revolving Credit Loan. At the time of making any Revolving Credit Loans or issuing any Letters of Credit other than the Revolving Credit Loan made or Letters of Credit issued on the Closing Date hereunder and after giving effect thereto: the representations and warranties of the Loan Parties contained in Article VI hereof shall be true on and as of the date of such additional Revolving Credit Loan or Letter of Credit with the same effect as though such representations and warranties had been made on and as of such date (except representations and warranties which expressly 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) and the Loan Parties shall have performed and complied with all covenants and conditions hereof; no Event of Default or Potential Default shall have occurred and be continuing or shall exist; the making of the Revolving Credit Loans or issuance of the Letters of Credit shall not contravene any Law applicable to any Loan Party or any of the Banks; and NovaCare, for itself or as agent for another Borrower or Borrowers, shall have delivered to the Agent a duly executed and completed Revolving Credit Loan Request or request for Letters of Credit. - 52 - 99 ARTICLE VIII COVENANTS 8.01 Affirmative Covenants. Each Loan Party covenants and agrees that until payment in full of the Revolving Credit Loans and interest thereon, expiration or termination of all Letters of Credit, satisfaction of all of the Loan Parties' other obligations hereunder and termination of the Revolving Credit Commitment, each Loan Party shall comply at all times with the following affirmative covenants: (a) Preservation of Existence, etc. Except as specifically permitted by Section 8.02(d), each Loan Party shall maintain its corporate existence and its qualification and good standing in each jurisdiction in which its ownership or lease of property or the nature of its business makes such license or qualification necessary, except where the failure to be so licensed or qualified would not constitute a Material Adverse Change. (b) Payment of Liabilities, Including Taxes, etc. Each Loan Party shall duly pay and discharge all material liabilities to which it is subject or which are asserted against it, promptly as and when the same shall become due and payable, including all taxes, assessments and governmental charges upon it or any of its properties, assets, income or profits, prior to the date on which penalties attach thereto, except to the extent that such liabilities, including taxes, assessments or charges, are being contested in good faith and by appropriate and lawful proceedings diligently conducted and for which such reserve or other appropriate provisions, if any, as shall be required by GAAP shall have been made, but only to the extent that failure to discharge any such liabilities would not result in any Material Adverse Change or adversely affect the Pledged Collateral, provided that such Loan Party will pay all such liabilities forthwith upon the commencement of proceedings to foreclose any Lien which may have attached as security therefor. (c) Maintenance of Insurance. Each Loan Party shall insure its properties and assets against loss or damage by fire and such other insurable hazards as such assets are commonly insured (including fire, extended coverage, property damage, worker's compensation, public liability and business interruption insurance) and against other risks in such amounts as similar properties and assets are insured by prudent companies in similar circumstances carrying on similar businesses, and with reputable and financially sound insurers, including self-insurance to the extent customary. At the request of the Agent, each Loan Party shall deliver on the Closing Date and annually thereafter a certificate signed by such Loan Party's independent insurance broker certifying as to all insurance then in force with respect to such Loan Party. (d) Maintenance of Properties and Leases. Each Loan Party shall maintain in good repair, working order and condition (ordinary wear and tear excepted) in accordance with the general practice of other businesses of similar character and size, all of those material properties useful or necessary to its business, and from time to time, each Loan Party will make or cause to be made all appropriate repairs, renewals or replacements thereof. -53- 100 (e) Maintenance of Patents, Trademarks, etc. Each Loan Party shall maintain in full force and effect all patents, trademarks, trade names, copyrights, licenses, franchises, permits and other authorizations necessary for the ownership and operation of its properties and business if the failure so to maintain the same would constitute a Material Adverse Change. (f) Visitation Rights. Each Loan Party shall permit any of the officers or authorized employees or representatives of the Agent or any of the Banks to visit and inspect any of its properties and to examine and make excerpts from its books and records or discuss its business affairs, finances and accounts with its officers, all in such detail and at such times during normal business hours and as often as any of the Banks may reasonably request, provided that each Bank shall provide such Loan Party and the Agent with reasonable notice prior to any visit or inspection. In the event that any Bank desires to conduct an inspection of a Loan Party, such Bank shall make a reasonable effort to conduct such audit contemporaneously with any audit to be performed by the Agent. (g) Keeping of Records and Books of Account. The Loan Parties shall maintain and keep proper books of record and account which enable the Loan Parties to issue financial statements in accordance with GAAP and as otherwise required by applicable Laws of any Official Body having jurisdiction over the Loan Parties, and accurately and fairly reflect the transactions and dispositions of the assets of the Loan Parties. (h) Plans and Benefit Arrangements. (i) NovaCare shall, and shall cause each member of the ERISA Group to, comply with ERISA, the Internal Revenue Code and other Laws applicable to Plans and Benefit Arrangements except where such failure, alone or in conjunction with any other failure, would not result in a Material Adverse Change. Without limiting the generality of the foregoing, NovaCare shall cause all of its Plans and all Plans maintained by any member of the ERISA Group to be funded in accordance with the minimum funding requirements of ERISA and shall make, and cause each member of the ERISA Group to make, in a timely manner, all contributions due to Plans, Benefit Arrangements and Multiemployer Plans. (ii) Promptly upon becoming aware of the occurrence thereof, NovaCare shall furnish to the Banks notice (including the nature of the event and, when known, any action taken or threatened by the Internal Revenue Service or the PBGC with respect thereto) of: (A) any Reportable Event with respect to NovaCare or any member of the ERISA Group (regardless of whether the obligation to report said Reportable Event to the PBGC has been waived), (B) any Prohibited Transaction which could subject NovaCare or any member of the ERISA Group to a civil penalty assessed pursuant to Section 502(i) of ERISA or a tax imposed by Section 4975 of the Internal Revenue Code in connection with any Plan, Benefit Arrangement or any trust created thereunder, -54- 101 (C) any assertion of material withdrawal liability with respect to any Multiemployer Plan, (D) any partial or complete withdrawal from a Multiemployer Plan by NovaCare or any member of the ERISA Group under Title IV of ERISA (or assertion thereof), where such withdrawal is likely to result in material withdrawal liability, (E) any cessation of operations (by NovaCare or any member of the ERISA Group) at a facility in the circumstances described in Section 4062(e) of ERISA, (F) withdrawal by NovaCare or any member of the ERISA Group from a Multiple Employer Plan where such withdrawal is likely to result in a material liability, (G) a failure by NovaCare or any member of the ERISA Group to make a payment to a Plan required to avoid imposition of a lien under Section 302(f) of ERISA, (H) the adoption of an amendment to a Plan requiring the provision of security to such Plan pursuant to Section 307 of ERISA, or (I) any change in the actuarial assumptions or funding methods used for any Plan, where the effect of such change is to materially increase or materially reduce the unfunded benefit liability or obligation to make periodic contributions. (iii) Promptly after receipt thereof, NovaCare shall furnish to the Banks copies of (a) all notices received by NovaCare or any member of the ERISA Group of the PBGC's intent to terminate any Plan administered or maintained by NovaCare or any member of the ERISA Group, or to have a trustee appointed to administer any such Plan, and (b) at the request of the Agent or any Bank the three most recent annual reports (IRS Form 5500 series) and all accompanying schedules, the most recent actuarial reports, the most recent financial information concerning the financial status of each Plan administered or maintained by NovaCare or any member of the ERISA Group, and schedules showing the amounts contributed within the last year to each such Plan by or on behalf of NovaCare or any member of the ERISA Group in which any of their personnel participate or from which such personnel may derive a benefit. (iv) Promptly upon the filing thereof, NovaCare shall furnish to the Banks copies of any Form 5310, or any successor or equivalent form to Form 5310, filed with the PBGC in connection with the termination of any Plan. (i) Compliance With Laws. Each Loan Party shall comply with all applicable Laws, including all Environmental Laws, in all respects provided that it shall not be deemed to be a violation of this Section 8.01(i) if any failure to comply with any Law would not result in or constitute a Material Adverse Change. -55- 102 (j) Use of Proceeds. The Borrowers will use the proceeds of the Revolving Credit Loans only for lawful purposes in accordance with Section 2.08 hereof as applicable and such uses shall not contravene any applicable Law or any other provision hereof. (k) Further Assurances. Each Loan Party shall, from time to time, at its expense, faithfully preserve and protect the Agent's Lien on and Prior Security Interest in the Pledged Collateral as a continuing first priority perfected Lien, and shall do such other acts and things as the Agent in its sole discretion reasonably may deem necessary or advisable from time to time in order to preserve, perfect and protect the Liens granted under the Loan Documents and to exercise and enforce its rights and remedies thereunder with respect to the Pledged Collateral. (l) Subordination of Intercompany Indebtedness; Permitted Additional Subordinated Indebtedness. (A) Intercompany Indebtedness. Each Loan Party shall enter into and be bound by the Subordination Agreement (Intercompany) and shall cause all Intercompany Indebtedness to be subordinated to the obligations of the Loan Parties to the Agent and the Banks pursuant to the terms of such Subordination Agreement (Intercompany). (B) Permitted Additional Subordinated Indebtedness. The Loan Parties shall cause to be subordinated pursuant to the provisions of Exhibit 1.01(P)(3) hereof all Indebtedness and Guaranties of Indebtedness of the Loan Parties except for Indebtedness expressly permitted under clauses (i) through (viii) of Section 8.02(a). Without limiting the foregoing, the Loan Parties shall cause to be subordinated pursuant to such provisions all Indebtedness and Guaranties of Indebtedness (i) incurred by any Loan Party in connection with a Permitted Acquisition, or (ii) incurred by a corporation (or its Subsidiaries) whose shares or other equity interests are acquired by a Loan Party in a Permitted Acquisition, unless such Indebtedness is permitted under clauses (i) through (viii) of Section 8.02(a). (m) Certificate of Borrowers; Other Reports and Information. NovaCare shall furnish or cause to be furnished to the Banks: (i) Quarterly Financial Statements. As soon as available and in any event within forty-five (45) calendar days after the end of each of the first three fiscal quarters in each fiscal year, consolidated financial statements of NovaCare and its Subsidiaries and consolidated financial statements of NovaCare and its Subsidiaries (other than NovaCare Employee Services, Inc.) consolidating with NovaCare Employee Services, Inc., in both cases, consisting of a balance sheet as of the end of such fiscal quarter, related statements of income for the fiscal quarter then ended and the fiscal year through such date and related statements of cash flows, for the fiscal year through such date, all in reasonable detail and certified (subject to normal year-end audit adjustments) by the Chief Executive Officer, President or Chief Financial Officer of NovaCare as having been prepared in accordance with GAAP, consistently applied, and setting forth in comparative form the respective financial statements (except for the balance sheets) for the corresponding date and period in the previous fiscal year. NovaCare may comply with this Section 8.01(m)(i) by delivering to the Banks certified copies of its Form 10-Q filed -56- 103 with the Securities and Exchange Commission provided that the financial statements contained therein comply with the foregoing requirements. Without limiting the generality of the foregoing provisions of this subsection, but to further clarify the intent of the Borrower, the Agent and the Banks, for purposes of preparing the financial statements required by this subsection, it is agreed that the Loan Parties shall provide to the Agent and the Banks the required financial statements including the following: the required financial statements for NovaCare and its Subsidiaries (other than NovaCare Employee Services, Inc.) on a consolidated basis, the required financial statements for NovaCare Employee Services, Inc. on a consolidated basis, the required detailed GAAP eliminations with respect to the consolidating of NovaCare and its Subsidiaries (other than NovaCare Employee Services, Inc.) and NovaCare Employee Services, Inc. and the required financial statements for NovaCare and its Subsidiaries on a consolidated basis. (ii) Annual Financial Statements. As soon as available and in any event within ninety (90) days after the end of each fiscal year, consolidated financial statements of NovaCare and its Subsidiaries and consolidated financial statements of NovaCare and its Subsidiaries (other than NovaCare Employee Services, Inc.) consolidating with NovaCare Employee Services, Inc., in both cases consisting of a balance sheet as of the end of such fiscal year, and related statements of income, stockholders' equity and cash flows for the fiscal year then ended, all in reasonable detail and setting forth in comparative form the financial statements as of the end of and for the preceding fiscal year, and certified by Price Waterhouse or other independent certified public accountants of nationally recognized standing reasonably satisfactory to the Agent. The certificate or report of accountants shall be free of qualifications (other than any consistency qualification that may result from a change in the method used to prepare the financial statements as to which such accountants concur) and shall not indicate the occurrence or existence of any event, condition or contingency which would materially impair the prospect of payment or performance of any covenant, agreement or duty of the Loan Parties under any of the Loan Documents. NovaCare may comply with this Section 8.01(m)(ii) by delivering to the Banks copies of its Form 10-K filed with the Securities and Exchange Commission, provided that the financial statements and report of accountants contained therein comply with the foregoing requirements. Without limiting the generality of the foregoing provisions of this subsection, but to further clarify the intent of the Borrower, the Agent and the Banks, for purposes of preparing the financial statements required by this subsection, it is agreed that the Loan Parties shall provide to the Agent and the Banks the required financial statements including the following: the required financial statements for NovaCare and its Subsidiaries (other than NovaCare Employee Services, Inc.) on a consolidated basis, the required financial statements for NovaCare Employee Services, Inc. on a consolidated basis, the required detailed GAAP eliminations with respect to the consolidating of NovaCare and its Subsidiaries (other than NovaCare Employee Services, Inc.) and NovaCare Employee Services, Inc. and the required financial statements for NovaCare and its Subsidiaries on a consolidated basis. (iii) Certificate of the Borrower. No later than ten (10) Business Days following the due date of the financial statements of NovaCare and its Subsidiaries furnished to the Agent and to the Banks pursuant to Sections 8.01(m)(i) and (ii) hereof, a certificate of NovaCare signed by the Chief Executive Officer, President or Chief Financial -57- 104 Officer of NovaCare, in the form of Exhibit 8.01(m)(iii) hereto, to the effect that, except as described pursuant to Section 8.03(a) below, (i) the representations and warranties of the Loan Parties contained in Article VI hereof are true on and as of the date of such certificate with the same effect as though such representations and warranties had been made on and as of such date (except representations and warranties which expressly relate solely to an earlier date or time) and the Loan Parties have performed and complied with all covenants and conditions hereof, and (ii) no Event of Default or Potential Default exists and is continuing on the date of such certificate. The certificate also shall contain calculations in sufficient detail to demonstrate compliance as of the date of the financial statements with all financial covenants contained in Section 8.02 hereof. (iv) Separate Financial Information for Certain Excluded Entities. As soon as available, quarterly and annual financial statements with respect to each Excluded Entity in which a Restricted Investment of more than $1 million has been made by a Loan Party. (v) Management Letters. Concurrently with the annual financial statements described in Section 8.01(m)(ii), any reports including management letters submitted to any Loan Party by independent accountants in connection with any annual, interim or special audit. (vi) Other Reports and Information. Promptly upon their becoming available to NovaCare or as otherwise specified below: (A) the annual consolidated budget and any accompanying forecasts or projections of NovaCare and its Subsidiaries submitted to NovaCare's Board of Directors which shall project the operations of NovaCare and its Subsidiaries on a consolidated basis and separately for each of their lines of business. NovaCare shall deliver such budget, forecasts and projections to the Banks not later than forty-five (45) days following the commencement of the fiscal year to which such budget, forecasts and projections may be applicable. In the event that as a result of a Permitted Acquisition, NovaCare updates any budget, forecasts or projections to give effect to such Permitted Acquisition, NovaCare shall promptly deliver to the Banks such updated budget, forecasts or projections as they become available. (B) any reports, notices or proxy statements generally distributed by NovaCare to its stockholders on a date no later than the date supplied to the stockholders, (C) regular or periodic reports, including Forms 10-K, 10-Q and 8-K, registration statements and prospectuses (except for registration statements on Form S-8), filed by NovaCare with the Securities and Exchange Commission, (D) a copy of any order in any proceeding to which NovaCare or any of its Subsidiaries is a party issued by any Official Body, which order is other than in the ordinary course of business in the case of an order issued by an Official Body other -58- 105 than a court, a tribunal, a grand jury or arbitrator or which order is reasonably likely to result in a Material Adverse Change, (E) a copy of any notice regarding the occurrence of an event of default or event which with the passage of time or giving of notice or both would cause an event of default in respect of any lease to which NovaCare or any of its Subsidiaries is a party or by which NovaCare or any of its Subsidiaries is bound, pursuant to which lease NovaCare or any of its Subsidiaries makes payments equal to or in excess of $250,000 in any fiscal year, such notice to be delivered to the Banks upon receipt thereof by NovaCare or any of its Subsidiaries, (F) upon the request of the Agent or any Bank, a copy of the purchase agreement and all documents and financial statements and information in connection with each Permitted Acquisition, and (G) such other reports and information as the Banks may from time to time reasonably request. NovaCare shall also notify the Banks promptly after it obtains knowledge of the enactment or adoption of any Law which may result in a Material Adverse Change. 8.02 Negative Covenants. NovaCare covenants and agrees that until payment in full of the Revolving Credit Loans and interest thereon, expiration or termination of all Letters of Credit and satisfaction of all of the Borrowers' other obligations hereunder and termination of the Revolving Credit Commitment, NovaCare shall, and shall cause each Loan Party to, comply at all times with the following negative covenants (and insofar as the following are applicable to any Borrower, such Borrower also covenants and agrees as follows): (a) Indebtedness. Each Loan Party shall not at any time create, incur, assume or suffer to exist any Indebtedness, except: (i) Indebtedness under the Loan Documents; (ii) Indebtedness existing on the date hereof as set forth on Schedule 8.02(a)(ii), (other than Indebtedness under the Indenture which is addressed in clause (iv) below), including any extensions or renewals thereof provided there is no increase in the amount thereof or other significant change in the terms thereof adverse to any Loan Party; (iii) Capitalized leases entered into in the ordinary course of business consistent with past practice; (iv) Indebtedness under the Indenture, provided, that the subordination provisions contained in the Indenture shall not be amended after the Closing Date and that the Indenture is not otherwise amended after the Closing Date if the effect thereof would (i) accelerate the due date or increase the amount of any payment due from the Loan Parties thereunder, (ii) change the rate at which interest is charged thereunder, or (iii) impose restrictions or obligations on the Loan Parties which are not imposed thereunder on the Closing Date or add any term thereto which is less favorable in any material respect to the Loan Parties than the terms of the Indenture on the Closing Date or which is more restrictive to any of the Loan Parties than the terms of the Credit Agreement, provided, further that the Indebtedness under the Indenture -59- 106 may be refinanced, in whole or in part, so long as (x) after giving effect to such refinancing the Loan Parties are in pro-forma compliance with the financial covenants set forth in Sections 8.02(l) [Minimum Net Worth], 8.02 (n) [Funded Debt to Cash Flow from Operations], and Section 8.02(o) [Minimum Fixed Charge Coverage Ratio], (y) after giving effect to such refinancing no Event of Default or Potential Default exists, and (z) the terms and conditions of the documents evidencing such refinancing are satisfactory in form and substance to the Required Banks (it being understood and agreed that the Loan Parties shall provide a copy of such documents in substantially final form to the Agent and the Banks at least fifteen (15) Business Days prior such refinancing); (v) (A) Up to $20,000,000 in aggregate principal amount collectively for all Loan Parties, at any one time outstanding, of (1) Indebtedness incurred or assumed on or after the Closing Date secured by Purchase Money Security Interests entered into in the ordinary course of business consistent with past practice; and (2) in connection with a Permitted Acquisition which would be accounted for as a "purchase" transaction under GAAP, Indebtedness assumed by Loan Parties pursuant to mergers of persons into Loan Parties or Indebtedness of persons whose stock (or other ownership interests) or assets are acquired by Loan Parties in a Permitted Acquisition (whether by merger or otherwise and only to the extent the Indebtedness of a person is assumed by Loan Parties in the case of the acquisition of the assets of such person by a Loan Party) provided that with respect to each such Permitted Acquisition such persons referred to above are not Affiliates of any Loan Parties prior to such Permitted Acquisition and provided that such Indebtedness (i) existed before the date of such Permitted Acquisition; (ii) does not exceed the purchase price (determined in accordance with GAAP) in connection with such Permitted Acquisition; and (iii) is secured only by the assets acquired if the Permitted Acquisition is an asset acquisition, or is secured only by the assets of the person whose stock or other ownership interests are being acquired if the Permitted Acquisition is an acquisition of stock or other ownership interests; (B) Any extensions or renewals of Indebtedness described in clause (A) above provided there is no increase in the amount thereof or other significant change in the terms thereof adverse to any Loan Party; (vi) Indebtedness assumed by an acquiring Loan Party in an asset acquisition which would be accounted for as a "pooling of interests" transaction under GAAP, or Indebtedness of a Pooling Partner which remains outstanding following the acquisition, directly or indirectly, of such Pooling Partner's stock or other ownership interests in connection with a stock acquisition (which is accounted for as a "pooling of interests under GAAP"), provided that, in either case: (A) such transaction is a Permitted Acquisition and such Indebtedness existed before the date of such Permitted Acquisition; (B) the aggregate amount of such Indebtedness does not exceed the Pooling Consideration in connection with such Permitted Acquisition; (C) the aggregate amount of such Indebtedness together with all other Indebtedness previously incurred under this Section 8.02(a)(vi) during the then current fiscal year does not exceed $100,000,000; (D) no Loan Party shall issue any Guaranty in respect of, grant any Lien in any of its assets as security for, or otherwise become liable to repay, such Indebtedness except (1) if the Permitted Acquisition is an asset acquisition which would be accounted for as a -60- 107 "pooling of interests" transaction under GAAP, the acquiring Loan Party may assume such Indebtedness and may confirm the continued existence of Liens in the assets which it acquires from the Pooling Partner securing such Indebtedness, provided that such Loan Party shall have been inactive prior to such Permitted Acquisition so that its assets shall consist solely of the assets which it has acquired pursuant to such Permitted Acquisition, (2) if the Permitted Acquisition is a stock acquisition which is accounted for under GAAP as a "pooling of interests", the Pooling Partner may remain liable on such Indebtedness and may confirm its prior grant of Liens in its assets securing such Indebtedness, and (3) NovaCare may execute a Guaranty guaranteeing such Indebtedness provided that such Guaranty shall be subordinated in accordance with the provisions of Exhibit 1.01(P)(3) (a "Permitted NovaCare Guaranty"); (E) the amount of such Indebtedness (or committed amount if the Indebtedness is a revolving credit facility) shall not be increased after such Permitted Acquisition; and (F) the agreements governing such Indebtedness may not be amended or modified in any material respect, extended, renewed or replaced after such Permitted Acquisition; (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 Employee Services, Inc.; (viii) Permitted Additional Institutional Indebtedness; and (ix) Permitted Additional Subordinated Indebtedness. (b) Liens. Each Loan Party shall not at any time create, incur, assume or suffer to exist any Lien on any of its property or assets, tangible or intangible, now owned or hereafter acquired, or agree or become liable to do so, except Permitted Liens. None of the Loan Parties shall enter into any agreement or covenant with any person other than the Agent or the Banks which in any manner limits the right of any of the Loan Parties to permit to exist any Lien on any of their assets, except that the Loan Parties may enter into agreements granting Permitted Liens to third parties. (c) Guaranties. Each Loan Party shall not at any time, directly or indirectly, become or be liable in respect of any Guaranty, or assume, guarantee, become surety for, endorse or otherwise agree, become or remain directly or contingently liable upon or with respect to any obligation or liability of any other person which obligation or liability would be required to be reported or noted in the financial statements of such Loan Party in accordance with GAAP, except pursuant to (u) Guaranties of contractual obligations of the Loan Parties not constituting Indebtedness; (v) Permitted NovaCare Guaranties; (w) Guaranties listed on Schedule 8.02(a)(ii); (x) the Guaranty Agreements; (y) guaranties subordinated in accordance with the provisions of Exhibit 1.01(P)(3) guaranteeing Permitted Additional Subordinated Indebtedness or (z) guaranties of the obligations described in Sections 8.02(a)(iii), (v) and (viii). (d) Liquidations, Mergers, Consolidations, Acquisitions. Each of the Loan Parties shall not, and shall not permit any of its Subsidiaries to, dissolve, liquidate or wind-up its affairs, or become a party to any merger or consolidation, or acquire by purchase, lease or -61- 108 otherwise all or substantially all of the assets or capital stock or other ownership interests of any other person, provided that (i) any wholly-owned Subsidiary of NovaCare may consolidate or merge into another Loan Party which is wholly-owned by one or more of the other Loan Parties, and (ii) any Loan Party may acquire, 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 a fiscal year of the Loan Parties shall not exceed the amount specified below for such fiscal year (the amount specified below for an individual fiscal year of the Borrower is hereinafter the "Annual Permitted Acquisition Amount"): -62- 109
Annual Permitted Fiscal Year Ended Acquisition Amount ----------------- ------------------ June 30, 1999 $250,000,000 June 20, 2000 $200,000,000 June 30, 2001 $200,000,000 June 30, 2002 $150,000,000 June 30, 2003 $150,000,000
Notwithstanding anything in this Agreement to the contrary, for periods on or after March 31, 1997, no portion of the Annual Permitted Acquisition Amount shall be utilized to make Permitted Acquisitions of Professional Employment Organizations. (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: (i) transactions involving 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) transactions involving 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) transactions involving any sale, abandonment, transfer or lease of assets in the ordinary course of business which are replaced by substitute assets; or (iv) transactions involving 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. (f) Joinder of Qualifying Subsidiaries; Excluded Entities. NovaCare shall not, and shall not permit any other Loan Party to, own, create or acquire any Qualifying Subsidiary except for the Excluded Qualifying Subsidiaries unless such Qualifying Subsidiary joins this Agreement as either a Borrower or Guarantor pursuant to Section 11.18 hereof. The Loan Parties shall not permit their Restricted Investments in Excluded Entities to exceed the Permitted Investment in Excluded Entities. -63- 110 (g) Continuation of or Change in Business. Each Loan Party shall not engage in any business other than a Permitted Line of Business. NovaCare shall not change its business materially after the Closing Date. (h) Plans and Benefit Arrangements. Each Loan Party shall not: (i) fail to satisfy the minimum funding requirements of ERISA and the Internal Revenue Code with respect to any Plan; (ii) request a minimum funding waiver from the Internal Revenue Service with respect to any Plan; (iii) engage in a Prohibited Transaction with any Plan, Benefit Arrangement or Multiemployer Plan which, alone or in conjunction with any other circumstances or set of circumstances resulting in liability under ERISA, would constitute a Material Adverse Change; (iv) permit the aggregate actuarial present value of all benefit liabilities (whether or not vested) under each Plan, determined on a plan termination basis, as disclosed in the most recent actuarial report completed with respect to such Plan, to exceed, as of any actuarial valuation date, the fair market value of the assets of such Plan; (v) fail to make when due any contribution to any Multiemployer Plan that NovaCare or any member of the ERISA Group may be required to make under any agreement relating to such Multiemployer Plan, or any Law pertaining thereto; (vi) withdraw (completely or partially) from any Multiemployer Plan or withdraw (or be deemed under Section 4062(e) of ERISA to withdraw) from any Multiple Employer Plan, where any such withdrawal is likely to result in a material liability of NovaCare or any member of the ERISA Group; (vii) terminate, or institute proceedings to terminate, any Plan, where such termination is likely to result in a material liability to NovaCare or any member of the ERISA Group; (viii) make any amendment to any Plan with respect to which security is required under Section 307 of ERISA; or (ix) fail to give any and all notices and make all disclosures and governmental filings required under ERISA or the Internal Revenue Code, where such failure is likely to result in a Material Adverse Change. (i) Loans and Investments. The Loan Parties shall not, and shall not permit any of their Subsidiaries to, at any time make or suffer to remain outstanding any loan or advance to, or purchase, acquire or own any stock, bonds, notes or securities of, or any partnership interest (whether general or limited) in or any other investment or interest in, or make any capital contribution to, any other person, or agree, become or remain liable to do any of the foregoing, except: -64- 111 (i) trade credit extended on usual and customary terms in the ordinary course of business including any such credit which may be evidenced from time to time by promissory notes; (ii) advances to employees to meet expenses incurred by such employees in the ordinary course of their employment and short-term or relocation loans to new executives to induce them to enter into the employ of NovaCare or any of its Subsidiaries, consistent with past practices; (iii) Permitted Investments; (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 Employee Services, Inc.; and (v) the Permitted Investment in Excluded Entities so long as: (a) the Excluded Entity in which the Restricted Investment is made is engaged in either a Permitted Line of Business, the ownership of real property, or operation of a physician practice group; (b) if a Loan Party is a general partner of an Excluded Entity in which a Restricted Investment is made, the Restricted Investment in such general partner shall not exceed the amount of the Permitted Investment in Excluded Entity for such Excluded Entity; (c) the Loan Party making a Restricted Investment in an Excluded Entity gives notice to the Agent, including a brief description of the nature, type and amount of the Restricted Investment, description of the Excluded Entity, and if the nature of a Restricted Investment is tangible property then the fair value of such tangible property (including a detailed calculation and summary of the method of such valuation) together with such other information regarding the Restricted Investment as the Agent or any Bank may reasonably request, such notice to be delivered to the Agent no later than ten (10) Business Days prior to the making of such Restricted Investment, (d) the Loan Party making the Permitted Investment in Excluded Entities is a Loan Party other than NovaCare, and (e) a Prior Security Interest in the stock, partnership interests or other equity interests of the Excluded Entity owned by any Loan Party are pledged to the Agent, for the benefit of the Banks, pursuant to a Pledge Agreement in form and substance satisfactory to the Agent. Notwithstanding anything contained in this Section 8.02(i) to the contrary, neither NovaCare, nor any other Loan Party, nor any Subsidiary of any 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 Employee Services, Inc., a Delaware corporation, other than the continued ownership of NovaCare's (or NC Resources' as transferee of NovaCare) equity interest of common stock of NovaCare Employee Services, Inc., a Delaware corporation, as owned as of the Spin-Off Consummation. (j) Dividends and Related Distributions. The Loan Parties shall not make or pay, or agree to become or remain liable to make or pay, any dividend or other distribution of any nature (whether in cash, property, securities or otherwise) on account of or in respect of its shares of capital stock or on account of the purchase, redemption, retirement or -65- 112 acquisition of its shares of capital stock (or warrants, options or rights therefor), except (i) dividends payable by any Subsidiary of NovaCare to NovaCare or to any other Loan Party, or (ii) dividends paid by NovaCare or payments by NovaCare for stock repurchases or redemptions not exceeding twenty-five percent (25%) of consolidated net income earned in respect of any fiscal year provided that such dividends (A) may not be made until at least four (4) Business Days have elapsed following the delivery by NovaCare of its financial statements to the Banks pursuant to Section 8.01(m)(ii) hereof for such fiscal year, and (B) may be made in subsequent fiscal years if they are not made during the fiscal year in which such financial statements are delivered. (k) [Intentionally Omitted] (l) Minimum Net Worth. The Loan Parties shall not permit Consolidated Net Worth, calculated as of the end of each fiscal quarter, to be less than the Minimum Net Worth Requirement. (m) [Intentionally Omitted] (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 4.25 to 1.0 for the fiscal quarter ending on or after the Thirteenth Amendment Effective Date through the period ending on or before June 30, 2000 or 3.75 to 1.0 for any fiscal quarter ending after July 1, 2000. (o) Minimum Fixed Charge Coverage Ratio. The Loan Parties shall not permit the ratio of Consolidated Earnings Available for Fixed Charges to Consolidated Fixed Charges, calculated as of the end of each fiscal quarter for the four fiscal quarters then ended, to be less than 1.30 to 1.0. (p) Changes in Subordinated Indebtedness Documents. NovaCare shall not, and shall not permit any Subsidiary to, amend or modify any provisions of the Subordinated Indebtedness Documents without providing, in the case of an amendment or modification in connection with a refinancing of the Subordinated Debentures permitted by Section 8.02(a)(iv), at least fifteen (15) Business Days' prior written notice to the Agent and the Banks, and obtaining the prior written consent of the Required Banks, and in the case of any other amendment or modification to provisions of the Subordinated Indebtedness Documents at least five (5) Business Days' prior written notice to the Agent and the Banks, and obtaining the prior written consent of the Required Banks. The Loan Parties shall not directly or indirectly make any payment or other distribution directly or indirectly to the obligees under the Subordinated Indebtedness, except for (i) regularly scheduled mandatory payments under the Subordinated Indebtedness Documents excluding any mandatory payments required by reason of acceleration, (ii) prepayments of Indebtedness of the type described in Section 8.02(a)(v)(A)(2), or (iii) prepayments of the Subordinated Debentures with the cash proceeds of a Permitted Refinancing of Subordinated Debentures so long as after giving effect to the prepayment of the -66- 113 Subordinated Debentures, no Event of Default or Potential Default shall have occurred or shall exist; provided that in the event that proceeds of a Permitted Refinancing of Subordinated Indebtedness are used to repay Revolving Credit Loans (the "Repaid Amount"), then proceeds of Revolving Credit Loans, not to exceed the Repaid Amount, may be used to prepay the Subordinated Debentures, but it is expressly agreed that no other proceeds of the Revolving Credit Loans shall be used directly or indirectly for the purpose of repaying or redeeming the Subordinated Indebtedness. (q) Affiliate Transactions. NovaCare shall not, and shall not permit any of its Subsidiaries to, enter into or carry out any transaction (including, without limitation, purchasing property or services or selling property or services) with any Affiliate (other than the Loan Parties) unless such transaction is not otherwise prohibited by this Agreement, is entered into in the ordinary course of business upon fair and reasonable arm's-length terms and conditions which are fully disclosed to the Agent and is in accordance with all applicable Law. It is agreed that the transactions set forth on Schedule 8.02(q) between NovaCare and NovaCare Employee Services, Inc. shall be deemed to comply with the requirements of this Section 8.02(q). (r) Professional Employment Organizations. NovaCare shall not, and shall not permit any of its Subsidiaries, to on or after March 31, 1997, at any time (x) 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, or (y) make or suffer to remain outstanding any loan or advance to, or purchase, acquire or own any stock, bonds, notes or securities of, or any partnership interests (whether general or limited) in or any other investment or interest in, or make any capital contribution to, any other entity or Person which engages in the business of a Professional Employment Organization, other than the continued ownership of NovaCare's (or NC Resources' as the transferee of NovaCare) equity interest of common stock of NovaCare Employee Services, Inc. otherwise permitted by this Agreement. 8.03 Reporting Requirements. The Borrowers jointly and severally covenant and agree that until payment in full of the Revolving Credit Loans and interest thereon, and termination of the Revolving Credit Commitment and satisfaction of all of the Borrowers' other obligations hereunder, the Borrowers shall furnish or cause to be furnished to the Agent and each of the Banks: (a) Notice of Default. Promptly after any officer of any Loan Party has learned of the occurrence of an Event of Default or Potential Default, a certificate signed by the Chief Executive Officer, President or Chief Financial Officer of NovaCare setting forth the details of such Event of Default or Potential Default and the action which such Loan Party proposes to take with respect thereto. -67- 114 (b) Notice of Litigation. Promptly after the commencement thereof, notice of all actions, suits, proceedings or investigations before or by any Official Body or any other person against any Loan Party involving a claim or series of claims in excess of $2,500,000 or which if adversely determined would constitute a Material Adverse Change. ARTICLE IX DEFAULT 9.01 Events of Default. An Event of Default shall mean the occurrence or existence of any one or more of the following events or conditions (whatever the reason therefor and whether voluntary, involuntary or effected by operation of Law): (a) Any Loan Party shall fail to pay any principal of any Revolving Credit Loan (including scheduled installments, mandatory prepayments or the payment due at maturity), fees or any other amount owing hereunder or under the other Loan Documents after such principal, fees or other amount becomes due in accordance with the terms hereof or thereof or shall fail to pay any interest on any Revolving Credit Loan within five (5) days of the due date for payment of interest; (b) Any representation or warranty made at any time by any Loan Party herein or in any other Loan Document, or in any certificate, other instrument or statement furnished pursuant to the provisions hereof or thereof, shall prove to have been false or misleading in any material respect as of the time it was made or furnished; (c) Any Loan Party shall breach or default in the observance or performance of any covenant contained in (i) Section 8.01(f), (ii) Section 8.02 (except for breaches of covenants contained in Sections 8.02(b), (h) and (i); such breaches are addressed in clause (iii) below), or (iii) Section 8.02(b), (h) or (i) when the performance or observance of such covenant is within the control of such Loan Party; (d) Any Loan Party shall default in the observance or performance of any other covenant, condition or provision hereof or of any other Loan Document and such default shall continue unremedied for a period of twenty (20) Business Days after any officer of such Loan Party becomes aware of the occurrence thereof (such grace period to be applicable only in the event such default can be remedied by corrective action of NovaCare or such Loan Party as determined by the Agent in its sole discretion); (e) A default or event of default shall occur at any time under the terms of (i) Subordinated Indebtedness Documents evidencing Subordinated Indebtedness in excess of $1,000,000 (or any agreement to subordinate the right of payment in respect of Subordinated Indebtedness in excess of $1,000,000 to the Indebtedness arising out of or under the Loan Documents, at any time and for any reason, ceases to be in full force and effect or is declared to be null and void or unenforceable in part); (ii) any lease by a Loan Party under which such Loan Party may be obligated as lessee or sublessee in excess of $1,000,000 in the aggregate over the lease term and such Loan Party fails to make a payment thereunder when due or a -68- 115 default thereunder shall occur which permits the lessor or sublessor to terminate the lease, retake possession of the leased property or assert a claim for damages; or (iii) any other agreement involving borrowed money or the extension of credit or any other Indebtedness under which any Loan Party may be obligated as borrower or guarantor in excess of $1,000,000 in the aggregate, and with respect to such other agreement described in this clause (iii) either (A) such breach, default or event of default consists of the failure to pay (beyond any period of grace permitted with respect thereto, whether waived or not) any indebtedness when due (whether at stated maturity, by acceleration or otherwise) or (B) such breach or default permits or causes the acceleration of any indebtedness (whether or not such right shall have been waived) or the termination of any commitment to lend; (f) Any final judgments or orders for the payment of money in excess of $2,500,000 in the aggregate shall be entered against any Loan Party by a court having jurisdiction in the premises which judgment is not discharged, vacated, bonded or stayed pending appeal within a period of thirty (30) days from the date of entry; (g) Any of the Loan Documents shall cease to be legal, valid and binding agreements enforceable against the Loan Party executing the same or such party's successors and assigns (as permitted under the Loan Documents) in accordance with the respective terms thereof or shall in any way be terminated (except in accordance with its terms) or become or be declared ineffective or inoperative or shall cease to give or provide the respective Liens, security interests, rights, titles, interests, remedies, powers or privileges intended to be created thereby; (h) There shall occur any material uninsured (except to the extent of self-insurance for which adequate reserves have been made) damage to or loss, theft or destruction of any of the Property in excess of $2,500,000 or any other of any Loan Party's assets are attached, seized, levied upon or subjected to a writ or distress warrant; or such come within the possession of any receiver, trustee, custodian or assignee for the benefit of creditors and the same is not cured within thirty (30) days thereafter; (i) A notice of lien or assessment in excess of $2,500,000 is filed of record with respect to all or any part of any Loan Party's assets by the United States, or any department, agency or instrumentality thereof, or by any state, county, municipal or other governmental agency, including, without limitation, the PBGC, or if any taxes or debts owing at any time or times hereafter to any one of these become payable and the same are not paid within thirty (30) days after the same become payable unless the same are being contested in good faith and either a stay of execution is in effect or the Banks are provided with adequate security satisfactory to the Banks in their sole discretion; (j) Any Loan Party is enjoined, restrained or in any way prevented by court order from conducting all or any material part of its business and such injunction, restraint or other preventive order is not dismissed within thirty (30) days after the entry thereof; (k) A Change in Ownership occurs; -69- 116 (l) A proceeding shall have been instituted in a court having jurisdiction in the premises seeking a decree or order for relief in respect of any Loan Party in an involuntary case under any applicable bankruptcy, insolvency, reorganization or other similar law now or hereafter in effect, or for the appointment or the taking possession by a receiver, liquidator, assignee, custodian, trustee, sequestrator, conservator (or similar official) of any Loan Party or for any substantial part of any Loan Party's property, or for the winding-up or liquidation of its affairs, and such proceeding shall remain undismissed or unstayed and in effect for a period of thirty (30) consecutive days or such court shall enter a decree or order granting any of the relief sought in such proceeding; (m) Any Loan Party shall commence a voluntary case under any applicable bankruptcy, insolvency, reorganization or other similar law now or hereafter in effect, shall consent to the entry of an order for relief in an involuntary case under any such law, or shall consent to the appointment or taking possession by a receiver, liquidator, assignee, custodian, trustee, sequestrator, conservator (or other similar official) of itself or for any substantial part of its property or shall make a general assignment for the benefit of creditors, or shall fail generally to pay its debts as they become due, or shall take any action in furtherance of any of the foregoing; or (n) Any event, condition, violation, failure or circumstance shall occur or exist of which the Loan Parties are not aware but which would constitute a breach of Section 6.01(x) if one or more of the Loan Parties were aware of such event, condition, violation, failure or circumstance. 9.02 Consequences of Event of Default. (a) If an Event of Default specified under subsections (a) through (k) or (n) of Section 9.01 hereof shall occur and be continuing, the Banks shall be under no further obligation to make Revolving Credit Loans or issue any Letters of Credit hereunder and the Agent may, and upon written request of the Required Banks shall, (i) by written notice to the Loan Parties, declare the unpaid principal amount of the Revolving Credit Notes then outstanding and all interest accrued thereon, any unpaid fees and all other Indebtedness of the Loan Parties to the Banks hereunder and thereunder to be forthwith due and payable, and the same shall thereupon become and be immediately due and payable to the Agent for the benefit of each Bank without presentment, demand, protest or any other notice of any kind, all of which are hereby expressly waived; and (ii) require each Borrower to, and each Borrower shall thereupon, deposit in a non- interest bearing account with the Agent, as cash collateral for its obligations under the Loan Documents, an amount equal to the maximum amount currently or at any time thereafter available to be drawn on all outstanding Letters of Credit issued on its account, and each Borrower hereby pledges to the Agent and the Banks, and grants to the Agent and the Banks a security interest in, all such cash as security for such obligations. Upon the curing of all existing Events of Default to the satisfaction of the Required Banks, the Agent shall return such cash collateral to the applicable Borrower. It is acknowledged that the authority given to the Agent to take the actions set forth in clauses (i) and (ii) above without first obtaining the written -70- 117 request of the Required Banks is intended primarily to enable the Agent to act on behalf of the Banks when obtaining such written request is not feasible or practical or would result in unacceptable delays as determined by the Agent in its sole discretion; and (b) If an Event of Default specified under subsections (l) or (m) of Section 9.01 hereof shall occur, the Banks shall be under no further obligations to make Revolving Credit Loans or issue any Letters of Credit hereunder and the unpaid principal amount of the Revolving Credit Notes then outstanding and all interest accrued thereon, any unpaid fees and all other Indebtedness of the Loan Parties to the Banks hereunder and thereunder shall be immediately due and payable, without presentment, demand, protest or notice of any kind, all of which are hereby expressly waived; and (c) If an Event of Default shall occur and be continuing, any Bank to whom any obligation is owed by any Loan Party hereunder or under any other Loan Document or any participant of such Bank which has agreed in writing to be bound by the provisions of Section 10.13 hereof and any branch, subsidiary or affiliate of such Bank or participant anywhere in the world shall have the right, in addition to all other rights and remedies available to it, without notice to the Loan Parties, to set-off against and apply to the then unpaid balance of all the Revolving Credit Loans and all other obligations of such Loan Party hereunder or under any other Loan Document any debt owing to, and any other funds held in any manner for the account of, such Loan Party by such Bank or participant or by such branch, subsidiary or affiliate, including, without limitation, all funds in all deposit accounts (whether time or demand, general or special, provisionally credited or finally credited, or otherwise) now or hereafter maintained by such Loan Party for its own account (but not including funds held in custodian or trust accounts) with such Bank or participant or such branch, subsidiary or affiliate. Such Bank agrees promptly to notify NovaCare on behalf of the Loan Parties after any such set-off and application made by such Bank; provided, however, that the failure to give such notice shall not affect the validity of such set-off and application. Such right shall exist whether or not any Bank or the Agent shall have made any demand under this Agreement or any other Loan Document, whether or not such debt owing to or funds held for the account of such Loan Party is or are matured or unmatured and regardless of the existence or adequacy of any collateral, Guaranty or any other security, right or remedy available to any Bank or the Agent; and (d) If an Event of Default shall occur and be continuing, and provided that the Agent shall have accelerated the maturity of Revolving Credit Loans of the Borrowers or such Loans otherwise shall have been accelerated or come due pursuant to any of the foregoing provisions of this Section 9.02, the Agent or any Bank, if owed any amount with respect to the Revolving Credit Notes, may proceed to protect and enforce its rights by suit in equity, action at law and/or other appropriate proceeding, whether for the specific performance of any covenant or agreement contained in this Agreement or the Revolving Credit Notes, including as permitted by applicable Law the obtaining of the ex parte appointment of a receiver, and, if such amount shall have become due, by declaration or otherwise, proceed to enforce the payment thereof or any other legal or equitable right of the Agent or such Bank; and -71- 118 (e) Following the occurrence and during the continuance of an Event of Default, each Loan Party, at the cost and expense of the Loan Parties (including the cost and expense of obtaining any of the following referenced consents, approvals, etc.) will promptly execute and deliver or cause the execution and delivery of all applications, certificates, instruments, registration statements, and all other documents and papers the Agent or any Bank may request in connection with the obtaining of any consent, approval, registration, qualification, permit, license, accreditation, or authorization of any Official Body or other person necessary or appropriate for the effective exercise of any rights hereunder or under the other Loan Documents. Without limiting the generality of the foregoing, each Loan Party agrees that in the event the Agent or any Bank shall exercise its rights, hereunder or pursuant to the other Loan Documents, to sell, transfer, or otherwise dispose of, or vote, consent, operate, or take any other action in connection with any of the Pledged Collateral, each Loan Party shall execute and deliver (or cause to be executed and delivered) all applications, certificates, assignments, and other documents that the Agent or any Bank requests to facilitate such actions and shall otherwise promptly, fully, and diligently cooperate with the Agent or any Bank and any other necessary persons in making any application for the prior consent or approval of any Official Body or any other person to the exercise by the Agent or any Bank of any of such rights relating to all or any of the Pledged Collateral. Furthermore, because the Loan Parties agree that the remedies of the Agent and the Banks at law for failure of the Loan Parties to comply with the provisions of this Section 9.02(e) would be inadequate and that any such failure would not be adequately compensable in damages, the Loan Parties agree that the covenants of this Section 9.02(e) may be specifically enforced; and (f) [RESERVED] (g) From and after the date on which the Agent has taken any action pursuant to this Section 9.02 and until all obligations of the Loan Parties have been paid in full, any and all proceeds received by the Agent from any sale or other disposition of the Pledged Collateral, or any part thereof, or the exercise of any other remedy by the Agent, shall be applied as follows: (i) first, to reimburse the Agent and the Banks for out-of-pocket costs, expenses and disbursements, including without limitation reasonable attorneys' fees and legal expenses, incurred by the Agent or the Banks in connection with realizing on the Pledged Collateral or collection of any obligations of the Loan Parties under any of the Loan Documents, including advances made by the Banks or any one of them or the Agent for the reasonable maintenance, preservation, protection or enforcement of, or realization upon, the Pledged Collateral, including without limitation, advances for taxes, insurance, repairs and the like and reasonable expenses incurred to sell or otherwise realize on, or prepare for sale or other realization on, any of the Pledged Collateral; (ii) second, to the repayment of all Indebtedness then due and unpaid of the Loan Parties to the Banks incurred under this Agreement or any of the Loan Documents, provided that such proceeds shall be applied first to interest, fees, expenses and -72- 119 other Indebtedness other than principal, in such manner as the Agent may reasonably determine, and then to principal; (iii) the balance, if any, as required by Law; and (h) In addition to all of the rights and remedies contained in this Agreement or in any of the other Loan Documents, the Agent shall have all of the rights and remedies of a secured party under the Uniform Commercial Code or other applicable Law, all of which rights and remedies shall be cumulative and nonexclusive, to the extent permitted by Law. The Agent may exercise all post-default rights granted to the Agent and the Banks under the Loan Documents or applicable Law. 9.03 Notice of Sale. Any notice required to be given by the Agent of a sale, lease, or other disposition of the Pledged Collateral or any other intended action by the Agent, if given ten (10) days prior to such proposed action, shall constitute commercially reasonable and fair notice thereof to the Loan Parties. ARTICLE X THE AGENT 10.01 Appointment. Each Bank hereby irrevocably designates, appoints and authorizes PNC Bank to act as Agent for such Bank under this Agreement to execute and deliver or accept on behalf of each of the Banks the other Loan Documents. Each Bank hereby irrevocably authorizes, and each holder of any Note by the acceptance of a Note shall be deemed irrevocably to authorize, the Agent to take such action on its behalf under the provisions of this Agreement and the other Loan Documents and any other instruments and agreements referred to herein, and to exercise such powers and to perform such duties hereunder as are specifically delegated to or required of the Agent by the terms hereof, together with such powers as are reasonably incidental thereto. PNC Bank agrees to act as the Agent on behalf of the Banks to the extent provided in this Agreement. 10.02 Delegation of Duties. The Agent may perform any of its duties hereunder by or through agents or employees (provided such delegation does not constitute a relinquishment of its duties as Agent) and, subject to Sections 10.05 and 10.06 hereof, shall be entitled to engage and pay for the advice or services of any attorneys, accountants or other experts concerning all matters pertaining to its duties hereunder and to rely upon any advice so obtained. 10.03 Nature of Duties; Independent Credit Investigation. The Agent shall have no duties or responsibilities except those expressly set forth in this Agreement and no implied covenants, functions, responsibilities, duties, obligations, or liabilities shall be read into this Agreement or otherwise exist. The duties of the Agent shall be mechanical and administrative in nature; the Agent shall not have by reason of this Agreement a fiduciary or trust relationship in respect of any Bank; and nothing in this Agreement, expressed or implied, is intended to or shall be so construed as to impose upon the Agent any obligations in respect of this Agreement except as expressly set forth herein. Each Bank expressly acknowledges (i) that the Agent has not made -73- 120 any representations or warranties to it and that no act by the Agent hereafter taken, including any review of the affairs of the Loan Parties, shall be deemed to constitute any representation or warranty by the Agent to any Bank; (ii) that it has made and will continue to make, without reliance upon the Agent, its own independent investigation of the financial condition and affairs and its own appraisal of the creditworthiness of the Loan Parties in connection with this Agreement and the making and continuance of the Loans hereunder; and (iii) except as expressly provided herein, that the Agent shall have no duty or responsibility, either initially or on a continuing basis, to provide any Bank with any credit or other information with respect thereto, whether coming into its possession before the making of any Loan or at any time or times thereafter. 10.04 Actions in Discretion of Agent; Instructions from the Banks. The Agent agrees, upon the written request of the Required Banks, to take or refrain from taking any action of the type specified as being within the Agent's rights, powers or discretion herein, provided that the Agent shall not be required to take any action which exposes the Agent to personal liability or which is contrary to this Agreement or any other Loan Document or applicable Law. In the absence of a request by the Required Banks, the Agent shall have authority, in its sole discretion, to take or not to take any such action, unless this Agreement specifically requires the consent of the Required Banks or all of the Banks. Any action taken or failure to act pursuant to such instructions or discretion shall be binding on the Banks, subject to Section 10.06 hereof. Subject to the provisions of Section 10.06, no Bank shall have any right of action whatsoever against the Agent as a result of the Agent acting or refraining from acting hereunder in accordance with the instructions of the Required Banks, or in the absence of such instructions, in the absolute discretion of the Agent. 10.05 Reimbursement and Indemnification of Agent by the Borrowers. The Borrowers, jointly and severally, unconditionally agree to pay or reimburse the Agent and save the Agent harmless against (a) liability for the payment of all reasonable out-of-pocket costs, expenses and disbursements, including but not limited to fees and expenses of counsel, appraisers and environmental consultants, incurred by the Agent (i) in connection with the development, negotiation, preparation, printing, execution, administration, syndication, interpretation and performance of this Agreement and the other Loan Documents, (ii) relating to any requested amendments, waivers or consents pursuant to the provisions hereof, (iii) in connection with the enforcement of this Agreement or any other Loan Document or collection of amounts due hereunder or thereunder or the proof and allowability of any claim arising under this Agreement or any other Loan Document, whether in bankruptcy or receivership proceedings or otherwise, and (iv) in any workout, restructuring or in connection with the protection, preservation, exercise or enforcement of any of the terms hereof or of any rights hereunder or under any other Loan Document or in connection with any foreclosure, collection or bankruptcy proceedings, and (b) all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever which may be imposed on, incurred by or asserted against the Agent, in its capacity as such, in any way relating to or arising out of this Agreement or any other Loan Documents or any action taken or omitted by the Agent hereunder or thereunder, provided that the Borrowers shall not be liable for any portion of -74- 121 such liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements if the same results from the Agent's gross negligence or willful misconduct, or if NovaCare was not given notice of the subject claim and the opportunity to participate in the defense thereof, at its expense, or if the same results from a compromise or settlement agreement entered into without the consent of NovaCare. In addition, the Borrowers agree to reimburse and pay all reasonable out-of-pocket expenses of the Agent's regular employees and agents engaged periodically to perform audits or inspection of NovaCare and its Subsidiaries' books, records and business properties. 10.06 Exculpatory Provisions. Neither the Agent nor any of its directors, officers, employees, agents, attorneys or affiliates shall (a) be liable to any Bank for any action taken or omitted to be taken by it or them hereunder, or in connection herewith including without limitation pursuant to any Loan Document, unless caused by its or their own gross negligence or willful misconduct, (b) be responsible in any manner to any of the Banks for the effectiveness, enforceability, genuineness, validity or the due execution of this Agreement or any other Loan Documents or for any recital, representation, warranty, document, certificate, report or statement herein or made or furnished under or in connection with this Agreement or any other Loan Documents, or (c) be under any obligation to any of the Banks to ascertain or to inquire as to the performance or observance of any of the terms, covenants or conditions hereof or thereof on the part of the Loan Parties, or the financial condition of NovaCare and its Subsidiaries, or the existence or possible existence of any Event of Default or Potential Default. Neither the Agent nor any Bank nor any of their respective directors, officers, employees, agents, attorneys or affiliates shall be liable to the Loan Parties or their Subsidiaries for consequential damages resulting from any breach of contract, tort or other wrong in connection with the negotiation, documentation, administration or collection of the Loans or any of the Loan Documents. 10.07 Reimbursement and Indemnification of Agent by Banks. Each Bank agrees to reimburse and indemnify the Agent (to the extent not reimbursed by the Borrowers and without limiting the obligation of the Borrowers to do so) in proportion to its Ratable Share from and against all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever which may be imposed on, incurred by or asserted against the Agent, in its capacity as such, in any way relating to or arising out of this Agreement or any other Loan Documents or any action taken or omitted by the Agent hereunder or thereunder, provided that no Bank shall be liable for any portion of such liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements (a) if the same results from the Agent's gross negligence or willful misconduct, or (b) if such Bank was not given notice of the subject claim and the opportunity to participate in the defense thereof, at its expense, or (c) if the same results from a compromise and settlement agreement entered into without the consent of such Bank. In addition, each Bank agrees promptly upon demand to reimburse the Agent (to the extent not reimbursed by the Borrowers and without limiting the obligation of the Borrowers to do so) in proportion to its Ratable Share for all amounts due and payable by the Borrowers to the Agent in connection with the Agent's periodic audit of books, records and business properties of NovaCare and its Subsidiaries. -75- 122 10.08 Reliance by Agent. The Agent shall be entitled to rely upon any writing, telegram, telex or teletype message, resolution, notice, consent, certificate, letter, cablegram, statement, order or other document or conversation by telephone or otherwise believed by it to be genuine and correct and to have been signed, sent or made by the proper person or persons, and upon the advice and opinions of counsel and other professional advisers selected by the Agent. The Agent shall be fully justified in failing or refusing to take any action hereunder unless it shall first be indemnified to its satisfaction by the Banks against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any such action. 10.09 Notice of Default. The Agent shall not be deemed to have knowledge or notice of the occurrence of any Potential Default or Event of Default unless the Agent has received written notice from a Bank or NovaCare referring to this Agreement, describing such Potential Default or Event of Default and stating that such notice is a "notice of default." 10.10 Notices. The Agent shall promptly send to each Bank a copy of all notices received from the Loan Parties pursuant to the provisions of this Agreement or the other Loan Documents promptly upon receipt thereof. The Agent shall promptly notify NovaCare and the other Banks of each change in the Base Rate and the effective date thereof. 10.11 Banks in Their Individual Capacities. With respect to its Revolving Credit Commitments and the Revolving Credit Loans made by it, the Agent shall have the same rights and powers hereunder as any other Bank and may exercise the same as though it were not the Agent, and the term "Banks" shall, unless the context otherwise indicates, include the Agent in its individual capacity. PNC Bank and its affiliates and each of the Banks and their respective affiliates may, without liability to account, except as prohibited herein, make loans to, accept deposits from, discount drafts for, act as trustee under indentures of, and generally engage in any kind of banking or trust business with, the Loan Parties and their Subsidiaries, in the case of the Agent, as though it were not acting as Agent hereunder and in the case of each Bank, as though such Bank were not a Bank hereunder. 10.12 Holders of Notes. The Agent may deem and treat any payee of any Note as the owner thereof for all purposes hereof unless and until written notice of the assignment or transfer thereof shall have been filed with the Agent. Any request, authority or consent of any person who at the time of making such request or giving such authority or consent is the holder of any Note shall be conclusive and binding on any subsequent holder, transferee or assignee of such Note or of any Note or Notes issued in exchange therefor. 10.13 Equalization of Banks. The Banks and the holders of any participations in any Notes agree among themselves that, with respect to all amounts received by any Bank or any such holder for application on any obligation hereunder or under any Note or under any such participation, whether received by voluntary payment, by realization upon security, by the exercise of the right of set-off or banker's lien, by counterclaim or by any other non-pro rata source, equitable adjustment will be made in the manner stated in the following sentence so that, in effect, all such excess amounts will be shared ratably among the Banks and such holders in -76- 123 proportion to their interests in payments under the Notes, except as otherwise provided in Sections 4.04(b), 5.04(b) or 5.06(a) hereof. The Banks or any such holder receiving any such amount shall purchase for cash from each of the other Banks a participation in such Bank's Loans in such amount as shall result in a ratable participation by the Banks and each such holder in the aggregate unpaid amount under the Notes, provided that if all or any portion of such excess amount is thereafter recovered from the Bank or the holder making such purchase, such purchase shall be rescinded and the purchase price restored to the extent of such recovery, together with interest or other amounts, if any, required by law (including court order) to be paid by the Bank or the holder making such purchase. 10.14 Successor Agent. The Agent may resign as Agent upon not less than thirty (30) days' prior written notice to NovaCare for the benefit of the Loan Parties and the Banks. If the Agent shall resign under this Agreement, then either (a) the Required Banks shall appoint from among the Banks a successor agent for the Banks, or (b) if a successor agent shall not be so appointed and approved within the thirty (30) day period following the Agent's notice to the Banks of its resignation, then the Agent shall appoint, with the consent of NovaCare on behalf of the Loan Parties, such consent not to be unreasonably withheld, a successor agent who shall serve as Agent until such time as the Required Banks appoint a successor agent. Upon its appointment pursuant to either clause (a) or (b) above, such successor agent shall succeed to the rights, powers and duties of the Agent and the term "Agent" shall mean such successor agent, effective upon its appointment, and the former Agent's rights, powers and duties as Agent shall be terminated without any other or further act or deed on the part of such former Agent or any of the parties to this Agreement. After the resignation of any Agent hereunder, the provisions of this Article X shall inure to the benefit of such former Agent and such former Agent shall not by reason of such resignation be deemed to be released from liability for any actions taken or not taken by it while it was an Agent under this Agreement. 10.15 Agent's Fee. The Borrowers shall pay the Agent's Fee to Agent until the Commitments have terminated and the Loans have been paid in full or until the Agent shall have resigned. 10.16 Availability of Funds. Unless the Agent shall have been notified by a Bank prior to the date upon which a Loan is to be made that such Bank does not intend to make available to the Agent such Bank's portion of such Loan, the Agent may assume that such Bank has made or will make such proceeds available to the Agent on such date and the Agent may, in reliance upon such assumption (but shall not be required to), make available to the applicable Borrowers a corresponding amount. If such corresponding amount is not in fact made available to the Agent by such Bank, the Agent shall be entitled to recover such amount on demand from such Bank (or, if such Bank fails to pay such amount forthwith upon such demand from NovaCare as agent for such Borrowers) together with interest thereon, in respect of each day during the period commencing on the date such amount was made available to such Borrowers and ending on the date the Agent recovers such amount, at a rate per annum equal to (i) the Federal Funds Effective Rate for the first Business Day during which such interest shall accrue, and (ii) the applicable interest rate in respect of the Loan for each day thereafter. -77- 124 10.17 Calculations. In the absence of gross negligence or willful misconduct, the Agent shall not be liable for any error in computing the amount payable to any Bank whether in respect of the Loans, fees or any other amounts due to the Banks under this Agreement. In the event an error in computing any amount payable to any Bank is made, the Agent, the Borrowers and each affected Bank shall, forthwith upon discovery of such error, make such adjustments as shall be required to correct such error, and any compensation therefor will be calculated at the Federal Funds Effective Rate. 10.18 Beneficiaries. Except as expressly provided herein, the provisions of this Article X are solely for the benefit of the Agent and the Banks, and the Loan Parties shall not have any rights to rely on or enforce any of the provisions hereof. In performing its functions and duties under this Agreement, the Agent shall act solely as agent of the Banks and does not assume and shall not be deemed to have assumed any obligation toward or relationship of agency or trust with or for the Loan Parties. ARTICLE XI MISCELLANEOUS 11.01 Modifications, Amendments or Waivers. With the written consent of the Required Banks, the Agent, acting on behalf of all the Banks, and the Loan Parties (or NovaCare on behalf of the Loan Parties) may from time to time enter into written agreements amending or changing any provision of this Agreement or any other Loan Document or the rights of the Banks or the Loan Parties hereunder or thereunder, or may grant written waivers or consents to a departure from the due performance of the obligations of the Loan Parties hereunder or thereunder. Any such agreement, waiver or consent made with such written consent shall be effective to bind all the Banks; provided, that, without the written consent of all the Banks, no such agreement, waiver or consent may be made which will do any of the following, except if this Agreement expressly provides that the consent of a fraction of the Banks which is less than 100% may bind all of the Banks with respect thereto: (a) Reduce the amount of the Commitment Fee, Letter of Credit Fee or any other fees payable to any Bank hereunder, or amend Sections 5.02 [Pro Rata Treatment of Banks], 10.06 [Exculpatory Provisions] and 10.13 [Equalization of Banks] hereof; (b) Increase or reduce the amount of the Commitments or of any Commitment, increase the dollar limitation set forth in Section 2.09(a)(i) or whether or not any Revolving Credit Loans are outstanding, extend the time for payment of principal or interest of any Revolving Credit Loan, or reduce the principal amount of or the rate of interest borne by any Revolving Credit Loan, or otherwise affect the terms of payment of the principal of or interest of any Revolving Credit Loan or the obligation in Section 2.09 to reimburse the Agent pursuant to advances under Letters of Credit; (c) Except for sales of assets permitted by Section 8.02(e), release any collateral or other security, including, without limitation, the Guaranties, if any, for the Borrowers' obligations hereunder; or -78- 125 (d) Amend this Section 11.01, change the definition of Required Banks, or change any requirement providing for the Banks or the Required Banks to authorize the taking of any action hereunder. 11.02 No Implied Waivers; Cumulative Remedies; Writing Required. No course of dealing and no delay or failure of the Agent or any Bank in exercising any right, power, remedy or privilege under this Agreement or any other Loan Document shall affect any other or future exercise thereof or operate as a waiver thereof; nor shall any single or partial exercise thereof or any abandonment or discontinuance of steps to enforce such a right, power, remedy or privilege preclude any further exercise thereof or of any other right, power, remedy or privilege. The rights and remedies of the Agent and the Banks under this Agreement and any other Loan Documents are cumulative and not exclusive of any rights or remedies which they would otherwise have. Any waiver, permit, consent or approval of any kind or character on the part of any Bank of any breach or default under this Agreement or any such waiver of any provision or condition of this Agreement must be in writing and shall be effective only to the extent specifically set forth in such writing. 11.03 Reimbursement and Indemnification of Banks by the Borrowers; Taxes. The Borrowers jointly and severally agree unconditionally upon demand to pay or reimburse to each Bank (other than the Agent as to which the Borrowers' obligations are set forth in Section 10.05) and to save such Bank harmless against (i) liability for the payment of all reasonable out-of-pocket costs, expenses and disbursements (including fees and expenses of counsel for such Bank), incurred by such Bank (a) in connection with the administration and interpretation of this Agreement, the other Loan Documents and other instruments and documents to be delivered hereunder, (b) relating to any amendments, waivers or consents pursuant to the provisions hereof or thereof, (c) in connection with the enforcement of this Agreement or any other Loan Document, or collection of amounts due hereunder or thereunder or the proof and allowability of any claim arising under this Agreement or any other Loan Document, whether in bankruptcy or receivership proceedings or otherwise, and (d) in any workout, restructuring or in connection with the protection, preservation, exercise or enforcement of any of the terms hereof or of any rights hereunder or under any other Loan Document or in connection with any foreclosure, collection or bankruptcy proceedings, or (ii) all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever which may be imposed on, incurred by or asserted against such Bank in any way relating to or arising out of this Agreement or any other Loan Documents or any action taken or omitted by such Bank hereunder or thereunder, provided that the Borrowers shall not be liable for any portion of such liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements (A) if the same results from such Bank's gross negligence or willful misconduct, or (B) if the Borrowers were not given notice of the subject claim and the opportunity to participate in the defense thereof, at their expense, or (C) if the same results from a compromise or settlement agreement entered into without the consent of the Borrowers. The Borrowers jointly and severally agree unconditionally to pay all stamp, document, transfer, recording or filing taxes or fees and similar impositions now or hereafter determined by the Agent or any Bank to be payable in connection with this Agreement or any other Loan -79- 126 Document, and the Borrowers jointly and severally agree unconditionally to save the Agent and the Banks harmless from and against any and all present or future claims, liabilities or losses with respect to or resulting from any omission to pay or delay in paying any such taxes, fees or impositions. 11.04 Holidays. Whenever any payment or action to be made or taken hereunder shall be stated to be due on a day which is not a Business Day, such payment or action shall be made or taken on the next following Business Day (except as provided in Section 4.02(a)), and such extension of time shall be included in computing interest or fees, if any, in connection with such payment or action. 11.05 Funding by Branch, Subsidiary or Affiliate. (a) Notional Funding. Each Bank shall have the right from time to time, without notice to the Loan Parties, to deem any branch, subsidiary or affiliate (which for the purposes of this Section 11.05 shall mean any corporation or association which is directly or indirectly controlled by or is under direct or indirect common control with any corporation or association which directly or indirectly controls such Bank) of such Bank to have made, maintained or funded any Revolving Credit Loan to which the Revolving Credit Euro-Rate Option applies at any time, provided that immediately following (on the assumption that a payment were then due from the Borrowers to such other office) and as a result of such change the Borrowers would not be under any greater financial obligation pursuant to Section 5.06 hereof than they would have been in the absence of such change. Notional funding offices may be selected by each Bank without regard to the Bank's actual methods of making, maintaining or funding the Loans or any sources of funding actually used by or available to such Bank. (b) Actual Funding. Each Bank shall have the right from time to time to make or maintain any Loan by arranging for a branch, subsidiary or affiliate of such Bank to make or maintain such Loan subject to the last sentence of this Section 11.05(b). If any Bank causes a branch, subsidiary or affiliate to make or maintain any part of the Loans hereunder, all terms and conditions of this Agreement shall, except where the context clearly requires otherwise, be applicable to such part of the Revolving Credit Loans to the same extent as if such Revolving Credit Loans were made or maintained by such Bank but in no event shall any Bank's use of such a branch, subsidiary or affiliate to make or maintain any part of the Revolving Credit Loans hereunder cause such Bank or such branch, subsidiary or affiliate to incur any cost or expenses payable by any Borrower hereunder or require any Borrower to pay any other compensation to any Bank (including, without limitation, any expenses incurred or payable pursuant to Section 5.06 hereof) which would otherwise not be incurred. 11.06 Notices. All notices, requests, demands, directions and other communications (collectively "notices") given to or made upon any party hereto under the provisions of this Agreement shall be by telephone, in person or in writing (including telex or facsimile communication) unless otherwise expressly permitted hereunder and shall be delivered or sent by telex or facsimile to the respective parties at the addresses and numbers set forth under -80- 127 their respective names on Schedule 1.01(B) [List of Banks and Commitments] hereof, provided, that, all notices to the Loan Parties shall be sent in care of NovaCare, unless written direction is given by a Borrower to the Banks to send notices to a different party and address. All notices shall, except as otherwise expressly herein provided, be effective (a) in the case of telex or facsimile, when received, (b) in the case of hand-delivered notice, when hand delivered, (c) in the case of telephone, when telephoned, provided, however, that in order to be effective, telephonic notices must be confirmed in writing no later than the next day by letter, facsimile or telex, and (d) if given by any other means (including by air courier), when delivered; provided, that notices to the Agent shall not be effective until received. Any Bank giving any notice to the Loan Parties (or to NovaCare on their behalf) shall simultaneously send a copy thereof to the Agent, and the Agent shall promptly notify the other Banks of the receipt by it of any such notice. 11.07 Severability. The provisions of this Agreement are intended to be severable. If any provision of this Agreement shall be held invalid or unenforceable in whole or in part in any jurisdiction such provision shall, as to such jurisdiction, be ineffective to the extent of such invalidity or unenforceability without in any manner affecting the validity or enforceability thereof in any other jurisdiction or the remaining provisions hereof in any jurisdiction. 11.08 Governing Law. This Agreement 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 laws of the Commonwealth of Pennsylvania without regard to its conflict of laws principles. 11.09 Prior Understanding. This Agreement supersedes all prior understandings and agreements, whether written or oral, between the parties hereto relating to the transactions provided for herein, including any prior confidentiality agreements and commitments. 11.10 Duration; Survival. All representations and warranties of the Borrowers contained herein or made in connection herewith shall survive the making of Revolving Credit Loans and shall not be waived by the execution and delivery of this Agreement, any investigation by the Agent or the Banks, the making of Revolving Credit Loans, or payment in full of the Revolving Credit Loans. All covenants and agreements of the Borrowers contained in Sections 8.01, 8.02 and 8.03 herein shall continue in full force and effect from and after the date hereof so long as the Borrowers may borrow hereunder and until termination of the Revolving Credit Commitment. All covenants and agreements of the Borrowers contained herein relating to the payment of principal, interest, premiums, additional compensation or expenses and indemnification, including those set forth in the Revolving Credit Notes, Article V and Sections 10.05, 10.07 and 11.03 hereof, and relating to confidentiality shall survive payment in full of the Revolving Credit Loans, termination or expiration of all Letters of Credit and termination of the Revolving Credit Commitment. 11.11 Successors and Assigns. This Agreement shall be binding upon and shall inure to the benefit of the Banks, the Agent, the Loan Parties and their respective successors and -81- 128 assigns, except that the Loan Parties may not assign or transfer any of their rights and obligations hereunder or any interest herein. Each Bank may, at its own cost, make assignments of or sell participations in all or any part of its Revolving Credit Commitment and the Loans made by it to one or more banks or other entities, subject to the consent of NovaCare on behalf of the Loan Parties and the Agent with respect to any assignee (but not with respect to a participant), such consent not to be unreasonably withheld; provided that assignments may not be made in amounts less than $5,000,000 and provided that participations may be sold only to banks or other financial institutions. In the case of an assignment, upon receipt by the Agent of the Assignment and Assumption Agreement, the assignee shall have, to the extent of such assignment (unless otherwise provided therein), the same rights, benefits and obligations as it would have if it had been a signatory Bank hereunder, the Revolving Credit Commitments in Section 2.01 shall be adjusted accordingly, and upon surrender of any Revolving Credit Note subject to such assignment, the Borrowers shall execute and deliver new Notes to the assignee in an amount equal to the amount of the Revolving Credit Commitment assumed by it and a new Revolving Credit Note to the assigning Bank in an amount equal to the Revolving Credit Commitment retained by it hereunder. The assigning Bank shall pay to Agent a service fee of $3,500. In the case of a participation, the participant shall only have the rights specified in Section 9.02(c) (the participant's rights against such Bank in respect of such participation to be those set forth in the agreement executed by such Bank in favor of the participant relating thereto and not to include any voting rights except with respect to changes of the type referenced in clauses (a), (b), or (c) under Section 11.01 hereof), all of such Bank's obligations under this Agreement or any other Loan Document shall remain unchanged and all amounts payable by the Borrowers hereunder or thereunder shall be determined as if such Bank had not sold such participation. Each Bank may furnish any publicly available information concerning the Borrowers and any other information concerning the Borrowers in the possession of such Bank from time to time to assignees and participants (including prospective assignees or participants) provided such assignees and participants agree to be bound by the provisions of Section 11.12 hereof. 11.12 Confidentiality. The Agent and the Banks each agree to keep confidential all information obtained from the Borrowers which is nonpublic and confidential or proprietary in nature (including any information the Borrowers specifically designate as confidential), except as provided below, and to use such information only in connection with its capacity under this Agreement and for the purposes contemplated hereby. The Agent and the Banks shall be permitted to disclose such information (i) to outside legal counsel, accountants and other professional advisors who need to know such information in connection with the administration and enforcement of this Agreement, subject to agreement of such persons to maintain the confidentiality thereof, (ii) to assignees and participants as contemplated by Section 11.11 (subject to the agreement of such persons to maintain the confidentiality thereof), (iii) to the extent requested by any bank regulatory authority or, with notice to the Borrowers, as otherwise required by applicable Law or by any subpoena or similar legal process, or in connection with any investigation or proceeding arising out of the transactions contemplated by this Agreement, (iv) if it becomes publicly available other than as a result of a breach of this Agreement or becomes available from a source not subject to confidentiality restrictions, or (v) if NovaCare shall have consented to such disclosure. -82- 129 11.13 Counterparts. This Agreement may be executed by different parties hereto on any number of separate counterparts, each of which, when so executed and delivered, shall be an original, and all such counterparts shall together constitute one and the same instrument. 11.14 Agent's or Bank's Consent. Whenever the Agent's or any Bank's consent is required to be obtained under this Agreement or any of the other Loan Documents as a condition to any action, inaction, condition or event, the Agent and each Bank shall be authorized to give or withhold such consent in its sole and absolute discretion (unless otherwise specifically provided herein) and to condition its consent upon the giving of additional collateral, the payment of money or any other matter. 11.15 Exceptions. The representations, warranties and covenants contained herein shall be independent of each other and no exception to any representation, warranty or covenant shall be deemed to be an exception to any other representation, warranty or covenant contained herein unless expressly provided, nor shall any such exceptions be deemed to permit any action or omission that would be in contravention of applicable Law. 11.16 CONSENT TO FORUM; WAIVER OF JURY TRIAL. EACH BORROWER HEREBY IRREVOCABLY CONSENTS TO THE NONEXCLUSIVE JURISDICTION OF THE COURT OF COMMON PLEAS OF ALLEGHENY COUNTY, PENNSYLVANIA AND THE UNITED STATES DISTRICT COURT FOR THE WESTERN DISTRICT OF PENNSYLVANIA, AND WAIVES PERSONAL SERVICE OF ANY AND ALL PROCESS UPON IT AND CONSENTS THAT ALL SUCH SERVICE OF PROCESS BE MADE BY CERTIFIED OR REGISTERED MAIL DIRECTED TO SUCH BORROWER AT THE ADDRESSES PROVIDED FOR IN SECTION 11.06 HEREOF AND SERVICE SO MADE SHALL BE DEEMED TO BE COMPLETED UPON ACTUAL RECEIPT THEREOF. EACH BORROWER WAIVES ANY OBJECTION TO JURISDICTION AND VENUE OF ANY ACTION INSTITUTED AGAINST IT AS PROVIDED HEREIN AND AGREES NOT TO ASSERT ANY DEFENSE BASED ON LACK OF JURISDICTION OR VENUE. EACH BORROWER AND THE BANKS HEREBY WAIVE TRIAL BY JURY IN ANY ACTION, SUIT, PROCEEDING OR COUNTERCLAIM OF ANY KIND ARISING OUT OF OR RELATED TO THIS AGREEMENT, ANY OTHER LOAN DOCUMENT OR THE PLEDGED COLLATERAL TO THE FULL EXTENT PERMITTED BY LAW. 11.17 Tax Withholding Clause. At least five (5) Business Days prior to the first date on which interest or fees are payable hereunder for the account of any Bank, each Bank that is not incorporated under the laws of the United States of America or a state thereof agrees that it will deliver to the Borrowers and to the Agent two (2) duly completed copies of (i) Internal Revenue Service Form W-9, 4224 or 1001, or other applicable form prescribed by the Internal Revenue Service, certifying in either case that such Bank is entitled to receive payments under this Agreement and the other Loan Documents without deduction or withholding of any United States federal income taxes, or is subject to such tax at a reduced rate under an applicable tax treaty, or (ii) Form W-8 or other applicable form or a certificate of such Bank indicating that no -83- 130 such exemption or reduced rate is allowable with respect to such payments. Each Bank which so delivers a Form W-8, W-9, 4224 or 1001 further undertakes to deliver to the Borrowers and to the Agent two (2) additional copies of such form (or a successor form) on or before the date that such form expires or becomes obsolete or after the occurrence of any event requiring a change in the most recent form so delivered by it, and such amendments thereto or extensions or renewals thereof as may be reasonably requested by the Borrowers or the Agent, either certifying that such Bank is entitled to receive payments under this Agreement and the other Loan Documents without deduction or withholding of any United States federal income taxes or is subject to such tax at a reduced rate under an applicable tax treaty or stating that no such exemption or reduced rate is allowable. The Agent shall be entitled to withhold United States federal income taxes at the full withholding rate unless a Bank establishes an exemption or that it is subject to a reduced rate as established pursuant to the above provisions. 11.18 Joinder of Loan Parties. (i) All Subsidiaries (other than those which are Excluded Qualifying Subsidiaries) of NovaCare acquired or created on or after the Closing Date shall join this Agreement as a Guarantor or a Borrower (a "Joining Subsidiary") on the date of their acquisition or creation by completing all of the following by such date: (1) executing and delivering to the Agent (A) in the case of a Joining Subsidiary which becomes a Borrower, a Revolving Credit Note in the form of Exhibit 1.01(R) payable to each Bank, (B) a joinder to this Agreement in form satisfactory to the Agent, (C) a Guaranty Agreement in the form of Exhibit 1.01(G)(1), in the case of a Joining Subsidiary which becomes a Borrower and Exhibit 1.01(G)(2), in the case of a Joining Subsidiary which becomes a Guarantor, and (D) if it owns stock or other ownership interests in any Subsidiary, a Pledge Agreement in the form of Exhibit 1.01(P)(4), 1.01(P)(5) or 1.01(P)(6) or other appropriate form acceptable to the Agent if such Subsidiary is not a partnership or corporation, as applicable, and delivering, as applicable, the original certificates evidencing such stock or other ownership interest if it is certificated with appropriate stock powers or other assignments signed in blank and UCC-1 financing statements necessary to perfect the security interests of the Agent for the benefit of the Banks therein; (2) delivering to the Agent an opinion of counsel reasonably satisfactory to the Agent regarding such Joining Subsidiary and such joinder; and (3) delivering to the Agent certified copies of its organizational documents and other documents as requested by the Agent. The Loan Party which owns the stock or other ownership interest of the Joining Subsidiary shall execute and deliver to the Agent for the benefit of the Banks a Pledge Agreement in the form of Exhibit 1.01(P)(4), 1.01(P)(5) or 1.01(P)(6) or other appropriate form acceptable to the Agent if such Subsidiary is not a partnership or corporation, as applicable, and the original certificates evidencing such stock or other ownership interest if it is certificated with appropriate stock powers or other assignments signed in blank and UCC-1 financing statements necessary to perfect the security interests of the Agent for the benefit of the Banks therein. Notwithstanding the provisions of this Section 11.18(i) to the contrary, for periods after the Spin-Off Consummation, NovaCare Employee Services, Inc. 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 Employee -84- 131 Services, Inc. owned by NovaCare or any Subsidiary of NovaCare shall not be required to be pledged to the Agent for the benefit of the Banks. (ii) The Agent shall acknowledge any joinders delivered pursuant to this Section 11.18 and provide copies thereof to the Banks and the Loan Parties. All joinders by a new Loan Party shall be effective and binding upon all Banks and each of the other Loan Parties without any requirement that the Banks or such other Loan Parties execute such joinder. [SIGNATURE PAGES FOLLOW] -85- 132 [Signature Page 1 of 10 to Credit Agreement] IN WITNESS WHEREOF, the parties hereto, by their officers thereunto duly authorized, have executed this Agreement 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) and each of the GUARANTORS listed on Schedule 6.01(c) By:_______________________ By:______________________________ __________________________[Name], [Seal] the ________________________[Title] of each Borrower and Guarantor listed on Schedule 6.01(c), 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 133 [Signature Page 2 of 10 to Credit Agreement] AGENT: PNC BANK, NATIONAL ASSOCIATION, as Agent By:________________________________ Title:_____________________________ Address for Notices: One PNC Plaza 249 Fifth Avenue Pittsburgh, PA 15222-2707 Telecopier No. (412) 768-5149 Attention: Regional Healthcare Group Telephone No. (412) 762-8343 BANKS: PNC BANK, NATIONAL ASSOCIATION By:________________________________ Title:_____________________________ Address for Notices: One PNC Plaza 249 Fifth Avenue Pittsburgh, PA 15222-2707 Telecopier No. (412) 768-5149 Attention: Regional Healthcare Group Telephone No. (412) 762-8343 134 [Signature Page 3 of 10 to Credit Agreement] CORESTATES BANK, N.A. By:________________________________ Name:______________________________ 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: Lisa Rothenberger Telephone No. _______________ 135 [Signature Page 4 of 10 to Credit Agreement] FIRST UNION NATIONAL BANK By:________________________________ Name: Terence Moore Title: Assistant 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 136 [Signature Page 5 of 10 to Credit Agreement] FLEET NATIONAL BANK By:________________________________ Name:______________________________ Title:_____________________________ Address for Notices: Health Care and Institutions 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 137 [Signature Page 6 of 10 to Credit Agreement] MELLON BANK, N.A. By:________________________________ Name:______________________________ 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 Cunniffe Assistant Vice President Telephone No. (610) 941-8426 138 [Signature Page 7 of 10 to Credit Agreement] NATIONSBANK N.A. By:________________________________ Name:______________________________ Title:_____________________________ Address for Notices: Healthcare Finance Group One NationsBank Plaza, 5th Floor Nashville, TN 37239-1697 Telecopier No. (615)749-4640 Attention: Kevin Wagley Vice President Telephone No. (615) 749-3802 139 [Signature Page 8 of 10 to Credit Agreement] THE BANK OF NEW YORK By:________________________________ Name:______________________________ Title:_____________________________ Address for Notices: Northeastern Division One Wall Street 22nd Floor New York, NY 10286 Telecopier No. (212) 635-7978 Attention: Peter Abdill Vice President Telephone No. (212) 635-6987 140 [Signature Page 9 of 10 to Credit Agreement] SUNTRUST BANK, CENTRAL FLORIDA, N.A. By:________________________________ Name:______________________________ Title:_____________________________ Address for Notices: Healthcare Banking Group 0-1106, Tower 10 200 South Orange Avenue Orlando, FL 32801 Telecopier No. (407) 237-5489 Attention: Jeffrey R. Dickson First Vice President Telephone No. (407) 237-4541 141 [Signature Page 10 of 10 to Credit Agreement] BANK ONE, KENTUCKY, N.A. By:________________________________ Name:______________________________ Title:_____________________________ 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 [ADD NEW BANKS] 142 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 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. ___________________________________________________ Signature of Notary Public, State of_______________ ___________________________________________________ (Print, Type or Stamp Commissioned Name of Notary Public) Personally known _________; OR Produced Identification _____________ Type of identification produced:__________________________________________ ___________________________________________________ 143 SCHEDULE 1.01(E) REVISED JUNE 30, 1998 EXCLUDED ENTITIES 1. Excluded Qualifying Subsidiaries NAME JURISDICTION Jim All, Inc. Texas McFarlen & Associates, Inc. Texas OSI Midwest, Inc. Nebraska 2. Other Excluded Entities NAME JURISDICTION ASK Colorado Health Care Services, P.C. Colorado CMC Occupational Medical Center, California Professional Corporation C.O.A.S.T. Institute Physical Therapy, Inc. California ConsulTemps, Inc. Virginia Employee Benefits Management, Inc. Florida Employers' Risk Management, Inc. Florida GP Therapy, L.L.C. Georgia Gill/Balsano Consulting, L.L.C. Delaware Joyner Sportsmedicine, P.C. Pennsylvania Langhorne, P.C. Pennsylvania Lester OSM, P.C. Pennsylvania Medstat, P.C. Illinois NC (Wisconsin), S.C. Wisconsin NC Occupational Therapy, P.C. New York NC Physical Therapy, P.C. New York NCES Finance, Inc. Delaware NCES Holdings, Inc. Delaware NCES Licensing, Inc. Delaware NCES Partners (IND), L.P. Indiana Northeast Physical Therapy, P.C. Massachusetts NovaCare Administrative Employee Services of New York New York, Inc. NovaCare Administrative Employee Services, Inc. Florida NovaCare Employee Services Club Staff, Inc. Florida NovaCare Employee Services Easy Staff, Inc. Florida NovaCare Employee Services Northeast, Inc. New York NovaCare Employee Services of America, Inc. Florida 144 NovaCare Employee Services of Boston, Inc. Delaware NovaCare Employee Services of Florida, Inc. Florida NovaCare Employee Services of New York, Inc. New York NovaCare Employee Services of Orlando, Inc. Florida NovaCare Employee Services Resource One, Inc. Florida NovaCare Employee Services TPI, Inc. New York NovaCare Employee Services West, Inc. Arizona NovaCare Employee Services, Inc. Delaware NovaCare Speech Therapy & Audiology, Inc. California Orthomedics - Voner (Rancho) California Orthomedics - Voner (Whittier) California Paralign Staffing Technologies, Inc. Arizona Penn Therapy, P.C. Pennsylvania Philadelphia Occupational Health, P.C. Pennsylvania Professional Insurance Planners of Florida, Inc. Florida Quad City Regional Spine Institute, P.C. Iowa Rx One, Inc. Florida South Philadelphia, P.C. Pennsylvania Sprint Physical Therapy, P.C. Colorado Staffing Technologies, Inc. New York TJ Corporation I, L.L.C. Delaware T.J. Partnership I Delaware Therex, P.C. Colorado 145 SCHEDULE 6.01(c) REVISED JUNE 30, 1998 SUBSIDIARIES I. SUBSIDIARY CORPORATIONS
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ A.D. Craig Company California G 20,000 common 666.66 NovaCare Orthotics & shares, no par Prosthetics West, value Inc. Advanced Orthopedic Technologies, Nevada G 1,000 common 1,000 NovaCare Orthotics & Inc. shares, $.01 par Prosthetics, Inc. value Advanced Orthopedic Technologies, New York G 5,500,000 Class A 1,662,500 Advanced Orthopedic Inc. Voting common Technologies, Inc., shares, $.01 par a Nevada corporation value 500,000 Class B 40,320 Advanced Orthopedic Non-Voting common Technologies, Inc., shares, $.01 par a Nevada corporation value 400,000 Series C 139,811.2548 Advanced Orthopedic Preferred Stock, Technologies, Inc., $.01 par value a Nevada corporation 1,000 Series D 10 Advanced Orthopedic Preferred Stock, Technologies, Inc., $.01 par value a Nevada corporation Advance Orthotics, Inc. Texas G 50,000 common 50,000 NovaCare Orthotics & shares, no par Prosthetics West, value Inc. Advanced Orthotics and Prosthetics, Washington G 50,000 common 100 NovaCare Orthotics & Inc. shares, no par Prosthetics West, value Inc.
146
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Advanced Orthopedic Systems, Inc. California G 7,500 common 1,000 NovaCare Orthotics & shares, no par value Prosthetics West, Inc. Advanced Orthopedic Technologies New Jersey G 1,000 common 200 Advanced Orthopedic (Clayton), Inc. shares, no par value Technologies, Inc., a New York corporation Advanced Orthopedic Technologies West Virginia G 200 common shares, 125 Advanced Orthopedic (Lett), Inc. $.01 par value Technologies, Inc., a New York corporation Advanced Orthopedic Technologies New Jersey G 200 common shares, 200 Advanced Orthopedic (New Jersey), Inc. no par value Technologies, Inc., a New York corporation Advanced Orthopedic Technologies New Mexico G 200 common shares, 100 Advanced Orthopedic (New Mexico), Inc. $1.00 par value Technologies, Inc., a New York corporation Advanced Orthopedic Technologies New York G 600 Class A Voting 475 Advanced Orthopedic (New York), Inc. dividend bearing Technologies, Inc., common shares, no a New York par value corporation 400 Class B 25 Advanced Orthopedic Non-Voting dividend Technologies, Inc., bearing common a New York shares, no par value corporation
2 147
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Advanced Orthopedic Technologies New York G 200 common shares, 100 Advanced Orthopedic (OTI), Inc. no par value Technologies, Inc., a New York corporation Advanced Orthopedic Technologies West Virginia G 200 common shares, 100 Advanced Orthopedic (Parmeco), Inc. $.01 par value Technologies, Inc., a New York corporation Advanced Orthopedic Technologies California G 200 common shares, 100 Advanced Orthopedic (SFV), Inc. $1.00 par value Technologies, Inc., a New York corporation Advanced Orthopedic Technologies Virginia G 50,000 common 100 Advanced Orthopedic (Virginia), Inc. shares, $1.00 par Technologies, Inc., value a New York corporation Advanced Orthopedic Technologies West Virginia G 600 Class A Voting 600 Advanced Orthopedic (West Virginia), Inc. dividend bearing Technologies, Inc., common shares, a New York $5.00 par value corporation 400 Class B Voting 0 non-dividend bearing common shares, $5.00 par value Advanced Orthopedic Technologies New York G 200 common shares, 100 Advanced Orthopedic Management Corp. $1.00 par value Technologies, Inc., a New York corporation
3 148
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Affiliated Physical Therapists, Ltd. Arizona G 120,091 common 35,600 RehabClinics, Inc. shares, $1.00 par value 83,067 preferred shares, $1.00 par value American Rehabilitation Center, Inc. Missouri G 30,000 common 2,500 Rehabilitation shares, $1.00 par Management, Inc. value American Rehabilitation Clinic, Inc. Missouri G 30,000 common 1,000 Rehabilitation shares, $1.00 par Management, Inc. value Artificial Limb and Brace Center Arizona G 1,000,000 common 1,066 NovaCare Orthotics & shares, $1.00 par Prosthetics West, value Inc. Athens Sports Medicine Clinic, Inc. Georgia G 200,000 common 100 NovaCare Outpatient shares, $1.00 par Rehabilitation East, value Inc. Ather Sports Injury Clinic, Inc. California G 10,000 common 2,000 NovaCare Outpatient shares, no par value Rehabilitation West, Inc. Atlanta Prosthetics, Inc. Georgia G 25,000 common 2,784 NovaCare Orthotics & shares, $1.00 par Prosthetics East, value Inc. Atlantic Health Group, Inc. Delaware G 1,000 common 1,000 NovaCare shares, $.01 par Occupational Health value Services, Inc. Atlantic Rehabilitation Services, New Jersey G 1,000 common 20 RehabClinics, Inc. Inc. shares, no par value Boca Rehab Agency, Inc. Delaware G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value Bowman-Shelton Orthopedic Oklahoma G 3,000 common 3,000 NovaCare Orthotics Service, Incorporated shares, $1.00 par & Prosthetics value East, Inc.
4 149
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Buendel Physical Therapy, Inc. Florida G 750 common shares, 100 RehabClinics, Inc. $10.00 par value C.E.R. - West, Inc. Michigan G 60,000 common 1,000 NovaCare Outpatient shares, no par value Rehabilitation East, Inc. Cahill Orthopedic Laboratory, Inc. New York G 200 common shares, 50 NovaCare Orthotics & no par value Prosthetics East, Inc. Cannon & Associates, Inc. Delaware G 10,000 common 3,000 NovaCare, Inc. (PA) shares, no par value 1,286 cumulative redeemable preferred shares, $.01 par value Cenla Physical Therapy & Louisiana G 10,000 common 2,000 RehabClinics, Inc. Rehabilitation Agency, Inc. shares, no par value Center for Evaluation & Michigan G 25,000 Class A 12,375 NovaCare Outpatient Rehabilitation, Inc. common shares, Rehabilitation East, $1.00 par value, Inc. 25,000 Class B 4,125 common shares, $1.00 par value Center for Physical Therapy and New Mexico G 500,000 common 1,000 RehabClinics, Inc. Sports Rehabilitation, Inc. shares, no par value CenterTherapy, Inc. Minnesota G 50,000 Class A 475 Class A RehabClinics, Inc. voting shares, $.01 voting par value, 50,000 Class B non-voting shares, $.01 par value
5 150
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Certified Orthopedic Appliance Co., Arizona G 10,000 common 150 NovaCare Orthotics & Inc. shares, $100 par Prosthetics West, value Inc. Central Valley Prosthetics & California G 100,000 common 9,000 NovaCare Orthotics & Orthotics, Inc. shares, no par value Prosthetics West, Inc. Champion Physical Therapy, Inc. Pennsylvania G 100,000 common 6,660 NovaCare Outpatient shares, $1.00 par Rehabilitation East, value Inc. CMC Center Corporation California G 750,000 common 1,111 NC Resources, Inc. shares, no par value ConsulTemps, Inc. Virginia E 5,000 common 1,000 NovaCare Employee shares, $1.00 par Services Easy Staff, value Inc. Coplin Physical Therapy Associates, Minnesota G 2,500 common 100 RehabClinics, Inc. Inc. shares, no par value Crowley Physical Therapy Clinic, Louisiana G 10,000 common 500 RehabClinics, Inc. Inc. shares, no par value Dale Clark Prosthetics, Inc. Iowa G 1,000 common 20 NovaCare Orthotics & shares, $100 par Prosthetics East, value Inc. Douglas Avery and Associates, Ltd. Virginia G 500 Series A Voting 100 RehabClinics, Inc. Common Shares, $10.00 par value 300 Series B Non-Voting Common Shares, $.01 par value Douglas C. Claussen, R.P.T., California G 50,000 common 10,187 RehabClinics, Inc. Physical Therapy, Inc. shares, no par value
6 151
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ E.A. Warnick-Pomeroy Co., Inc. Pennsylvania G 300 common shares, 16 NovaCare Orthotics & $100 par value Prosthetics East, Inc. Elk County Physical Therapy, Inc. Pennsylvania G 100,000 common 2,000 NovaCare Outpatient shares, no par value Rehabilitation East, Inc. Employee Benefits Management, Inc. Florida E 800,000 common 428,747 NovaCare Employee shares, $.01 par Services of America, value Inc. Employers' Risk Management, Inc. Florida E 800,000 common 428,747 NovaCare Employee shares, $.01 par Services of America, value Inc. Fine, Bryant & Wah, Inc. Maryland G 50,000 Class A 2,000 NovaCare Outpatient voting common Rehabilitation East, shares, $1.00 par Inc. value NovaCare Outpatient 50,000 Class B 106 Rehabilitation East, non-voting common Inc. shares, $1.00 par value Francis Naselli, Jr. & Stewart Rich Pennsylvania G 1,000 common 1,000 RehabClinics, Inc. Physical Therapists, Inc. shares, no par value Frank J. Malone & Son, Inc. Pennsylvania G 100,000 common 2 NovaCare Orthotics & shares, $.10 par Prosthetics East, value Inc. Fresno Orthopedic Company California G 50,000 common 6,000 NovaCare Orthotics & shares, $10.00 par Prosthetics West, value Inc. Gallery Physical Therapy Center, Minnesota G 1,048.85 common 1,048.85 RehabClinics, Inc. Inc. shares, no par value
7 152
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Georgia Health Group, Inc. Georgia G 1,000 common 1,000 Atlantic Health shares, $.01 par Group, Inc. value Georgia Physical Therapy of West Georgia G 5,000,000 common 1,000,200 RehabClinics, Inc. Georgia, Inc. shares, $.01 par value Georgia Physical Therapy, Inc. Georgia G 100,000 common 1,000 RehabClinics, Inc. shares, $.50 par value Greater Sacramento Physical Therapy California G 100,000 common 38,250 RehabClinics, Inc. Associates, Inc. shares, no par value 11,250 Peters, Starkey & Todrank Physical Therapy Corporation Grove City Physical Therapy and Pennsylvania G 100,000 common 10 NovaCare Outpatient Sports Medicine, Inc. shares, $10.00 par Rehabilitation East, value Inc. Gulf Breeze Physical Therapy, Inc. Florida G 7,500 common 200 RehabClinics, Inc. shares, $1.00 par value Gulf Coast Hand Specialists, Inc. Florida G 7,500 common 100 RehabClinics, Inc. shares, $1.00 par value Hand Therapy and Rehabilitation California G 10,000 common 6,000 RehabClinics, Inc. Associates, Inc. shares, no par value Hand Therapy Associates, Inc. Arizona G 1,000,000 common 250 RehabClinics, Inc. shares, $10 par value Hangtown Physical Therapy, Inc. California G 100,000 common 86 NovaCare Outpatient shares, no par value Rehabilitation West, Inc.
8 153
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Hawley Physical Therapy, Inc. California G 100,000 common 20,000 RehabClinics, Inc. shares, no par value Heartland Rehabilitation, Inc. Indiana G 1,000 common 100 NovaCare, Inc. (PA) shares, no par value High Desert Institute of California G 1,000,000 common 2,074 NovaCare Orthotics & Prosthetics & Orthotics shares, no par value Prosthetics West, Inc. Indianapolis Physical Therapy and Indiana G 400,000 common 267,808 RehabClinics, Inc. Sports Medicine, Inc. shares, no par value Industrial Health Care Company, Inc. Connecticut G 20,000 common 919 NC Resources, Inc. shares, $1.00 par value J.E. Hanger, Incorporated Missouri G 10,000 common 6,545 NovaCare Orthotics & shares, $10.00 par Prosthetics East, value Inc. Jim All, Inc. Texas E 1,000,000 common 1,000 NovaCare Orthotics & shares, $1.00 par Prosthetics West, value Inc. JOYNER SPORTS SCIENCE INSTITUTE, Pennsylvania G 1,000 common 100 JOYNER Inc. shares, $.01 par SPORTSMEDICINE value INSTITUTE, INC. JOYNER SPORTSMEDICINE INSTITUTE, Pennsylvania G 5,000,000 common 1,209,697 NovaCare Outpatient INC. shares, no par value Rehabilitation East, Inc. Kesinger Physical Therapy, Inc. California G 10,000 common 1,000 RehabClinics, Inc. shares, no par value Kroll's, Inc. Minnesota G 2,500 common 150 NovaCare Orthotics & shares, $10.00 par Prosthetics East, value Inc.
9 154
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Lynn M. Carlson, Inc. Arizona G 1,000,000 common 6,400 RehabClinics, Inc. shares, $1.00 par value McFarlen & Associates, Inc. Texas E 100,000 common 1,000 NovaCare Orthotics & shares, $.10 par Prosthetics West, value Inc. McKinney Prosthetics/Orthotics, Inc. Illinois G 1,000 Class A voting 1,000 NovaCare Orthotics & common shares, $1.00 Prosthetics East, par value Inc. 50,000 Class B 10,000 non-voting common shares, $1.00 par value Mark Butler Physical Therapy New Jersey G 2,500 Common 100 NovaCare Outpatient Center, Inc. shares, no par value Rehabilitation East, Inc. Meadowbrook Orthopedics, Inc. Michigan G 50,000 common 2,000 NovaCare Orthotics & shares, no par value Prosthetics East, Inc. Medical Arts O&P Services, Inc. Wisconsin G 100,000 common 800 NovaCare Orthotics & shares, $.01 par Prosthetics East, value Inc. Medical Plaza Physical Therapy, Inc. Missouri G 6,000 common 510 NovaCare Outpatient shares, $5.00 par Rehabilitation East, value Inc. Metro Rehabilitation Services, Inc. Michigan G 50,000 common 1,000 NovaCare Outpatient shares, $1.00 par Rehabilitation East, value Inc. Michigan Therapy Centre, Inc. Michigan G 50,000 common 11,765 RehabClinics, Inc. shares, $.01 par value MidAtlantic Health Group, Inc. Delaware G 1,000 common 1,000 Atlantic Health shares, $.01 par Group, Inc. value
10 155
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Mill River Management, Inc. Delaware G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value Mitchell Tannenbaum I, Inc. Illinois G 1,000 common 100 RCI (S.P.O.R.T.), shares, no par value Inc. Mitchell Tannenbaum II, Inc. Illinois G 1,000 common 100 RCI (S.P.O.R.T.), shares, no par value Inc. Mitchell Tannenbaum III, Inc. Illinois G 1,000 common 100 RCI (S.P.O.R.T.), shares, no par value Inc. Monmouth Rehabilitation, Inc. New Jersey G 100 common 80 RehabClinics, Inc. shares, no par value NC Cash Management, Inc. Delaware G 1,000 common 100 NC Resources, Inc. shares, $.01 par value NC Resources, Inc. Delaware G 1,000 common 100 NovaCare, Inc. (DE) shares, $.01 par value NCES Finance, Inc. Delaware E 3,000 common 100 NCES Holdings, Inc. shares, $.01 par value NCES Holdings, Inc. Delaware E 3,000 common 100 NovaCare Employee shares, $.01 par Services, Inc. value NCES Licensing, Inc. Delaware E 3,000 common 100 NCES Finance, Inc. shares, $.01 par value New England Health Group, Inc. Massachusetts G 1,000 common 1,000 Atlantic Health shares, $.01 par Group, Inc. value
11 156
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ New Mexico Physical Therapists, Inc. New Mexico G 50,000 common 559 RehabClinics, Inc. shares, $1.00 par value Northland Regional Orthotic and Minnesota G 25,000 common 12 NovaCare Orthotics & Prosthetic Center, Inc. shares, no par Prosthetics East, value Inc. Northside Physical Therapy, Inc. Ohio G 500 common shares, 100 RehabClinics, Inc. without par value NovaCare (Arizona), Inc. Arizona G 1,000 common 1,000 NovaCare, Inc. (PA) shares, no par value NovaCare (Colorado), Inc. Delaware G 1,000 common 1,000 NovaCare, Inc. (PA) shares, $.01 par value NovaCare (Texas), Inc. Texas G 100 common 100 NovaCare, Inc. (PA) shares, $.01 par value NovaCare Administrative Employee Florida E 800,000 common 428,747 NovaCare Employee Services, Inc. shares, $.01 par Services of America, value Inc. NovaCare Administrative Employee New York E 200 common shares, 1 NovaCare Employee Services of New York, Inc. no par value Services TPI, Inc. NovaCare Employee Services, Inc. Delaware E 60,000,000 common 19,400,000 NC Resources, Inc. shares, $.01 par value 1,000,000 preferred shares, $.01 par value
12 157
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ NovaCare Employee Services Club Florida E 800,000 common 428,747 NovaCare Employee Staff, Inc. shares, $.01 par Services of America, value Inc. NovaCare Employee Services Easy Florida E 800,000 common 428,747 NovaCare Employee Staff, Inc. shares, $.01 par Services of America, value Inc. NovaCare Employee Services New York E 200 common shares, 1 NovaCare Employee Northeast, Inc. no par value Services TPI, Inc. NovaCare Employee Services West, Arizona E 1,000,000 common 98,069 NovaCare Employee Inc. shares, no par value Services, Inc. NovaCare Employee Services of Florida E 800,000 common 428,747 NovaCare Employee America, Inc. shares, $.01 par Services, Inc. value 500,000 preferred 0 shares, no par value NovaCare Employee Services of Delaware E 200 common shares, 1 NovaCare Employee Boston, Inc. $1.00 par value Services TPI, Inc. NovaCare Employee Services of Florida E 800,000 common 428,747 NovaCare Employee Florida, Inc. shares, $.01 par Services of America, value Inc. NovaCare Employee Services of New New York E 200 common shares, 1 NovaCare Employee York, Inc. no par value Services TPI, Inc. NovaCare Employee Services of Florida E 1,000,000 common 50,000 NovaCare Employee Orlando, Inc. shares, $.01 par Services Resource value One, Inc.
13 158
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ NovaCare Employee Services Resource Florida E 1,000,000 common 100,000 NovaCare Employee One, Inc. shares, $.01 par Services, Inc. value NovaCare Employee Services TPI, Inc. New York E 11,111 common 6,261 NovaCare Employee shares, $.01 par common Services, Inc. value 4,850 preferred 4,850 NovaCare Employee shares, $.01 par preferred Services, Inc. value NovaCare Management Company, Inc. Delaware G 1,000 common 100 NovaCare Orthotics & shares, $.01 par Prosthetics, Inc. value NovaCare Management Services, Inc. Delaware G 1,000 common 100 NovaCare, Inc. (DE) shares, $.01 par value NovaCare Northside Therapy, Inc. Minnesota G 2,500 common 100 NovaCare, Inc. (PA) shares, $10.00 par value NovaCare Occupational Health Delaware G 1,000 common 1,000 NC Resources, Inc. Services, Inc. shares, $.01 par value NovaCare Orthotics & Prosthetics Delaware G 1,000 common 1,000 NovaCare Orthotics & East, Inc. shares, $.01 par Prosthetics value Holdings, Inc. NovaCare Orthotics & Prosthetics Delaware G 1,000 common 1,000 NovaCare Orthotics & Holdings, Inc. shares, $.01 par Prosthetics, Inc. value NovaCare Orthotics & Prosthetics California G 5,000,000 common 689,681 NovaCare Orthotics & West, Inc. shares, $.10 par Prosthetics value Holdings, Inc.
14 159
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ NovaCare Orthotics & Prosthetics, Delaware G 1,000 common 1,000 NC Resources, Inc. Inc. shares, $.01 par value NovaCare Outpatient Rehabilitation Delaware G 1,000 common 1,000 RehabClinics, Inc. East, Inc. shares, $.01 par value NovaCare Outpatient Rehabilitation Kansas G 100,000 common 1,250 RehabClinics, Inc. I, Inc. shares, no par value NovaCare Outpatient Rehabilitation Delaware G 1,000 common 1,000 RehabClinics, Inc. West, Inc. shares, $.01 par value NovaCare Outpatient Rehabilitation, Kansas G 500,000 common 10,851 RehabClinics, Inc. Inc. shares, $1.00 par value NovaCare Rehab Agency of Alabama, Alabama G 1,000 common 1,000 NovaCare, Inc. (PA) Inc. shares, $.01 par value NovaCare Rehab Agency of Florida, Florida G 1,000 common 1,000 NovaCare, Inc. (PA) Inc. shares, $.01 par value NovaCare Rehab Agency of Georgia, Georgia G 1,000 common 1,000 NovaCare, Inc. (PA) Inc. shares, $.01 par value NovaCare Rehab Agency of Illinois, Illinois G 1,000 common 1,000 NovaCare, Inc. (PA) Inc. shares, $.01 par value NovaCare Rehab Agency of Kansas, Kansas G 1,000 common 1,000 NovaCare, Inc. (PA) Inc. shares, $.01 par value NovaCare Rehab Agency of Missouri, Missouri G 1,000 common 1,000 NovaCare, Inc. (PA) Inc. shares, $.01 par value
15 160
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ NovaCare Rehab Agency of New New Jersey G 1,000 common 1,000 NovaCare, Inc. (PA) Jersey, Inc. shares, $.01 par value NovaCare Rehab Agency of North North G 1,000 common 1,000 NovaCare, Inc. (PA) Carolina, Inc. Carolina shares, $.01 par value NovaCare Rehab Agency of Northern California G 9,000 common 100 NovaCare, Inc. (PA) California, Inc. shares, $1.00 par value NovaCare Rehab Agency of Ohio, Inc. Ohio G 1,000 common 1,000 NovaCare, Inc. (PA) shares, $.01 par value NovaCare Rehab Agency of Oklahoma, Oklahoma G 1,000 common 1,000 NovaCare, Inc. (PA) Inc. shares, $.01 par value NovaCare Rehab Agency of Oregon, Oregon G 1,000 common 1,000 NovaCare, Inc. (PA) Inc. shares, $.01 par value NovaCare Rehab Agency of Pennsylvania G 1,000 common 1,000 NovaCare, Inc. (PA) Pennsylvania, Inc. shares, $.01 par value NovaCare Rehab Agency of South South G 1,000 common 1,000 NovaCare, Inc. (PA) Carolina, Inc. Carolina shares, $.01 par value NovaCare Rehab Agency of Southern California G 9,000 common 100 NovaCare, Inc. (PA) California, Inc. shares, $1.00 par value NovaCare Rehab Agency of Tennessee, Tennessee G 1,000 common 1,000 NovaCare, Inc. (PA) Inc. shares, $.01 par value NovaCare Rehab Agency of Virginia, Virginia G 1,000 common 1,000 NovaCare, Inc. (PA) Inc. shares, $.01 par value
16 161
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ NovaCare Rehab Agency of Washington G 1,000 common 1,000 NovaCare, Inc. (PA) Washington, Inc. shares, $.01 par value NovaCare Rehab Agency of Wyoming, Wyoming G 1,000 common 1,000 NovaCare, Inc. (PA) Inc. shares, no par value NovaCare Rehabilitation Agency of Wisconsin G 9,000 common 10 NovaCare, Inc. (PA) Wisconsin, Inc. shares, $1.00 par value NovaCare Rehabilitation, Inc. Minnesota G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value NovaCare Service Corp. Delaware G 1,000 common 1,000 NovaCare, Inc. (DE) shares, $.01 par value NovaCare, Inc. Pennsylvania B 5,000 common 1,000 NC Resources, Inc. shares, no par value NovaFunds, Inc. Delaware B 3,000 common 100 NC Resources, Inc. shares, $.01 par value NovaMark, Inc. Delaware G 3,000 common 100 NovaFunds, Inc. shares, $.01 par value NovaStock, Inc. Delaware G 3,000 common 100 NovaFunds, Inc. shares, $.01 par value Opus Care, Inc. Illinois G 50,000 common 1,000 NovaCare Orthotics & shares, no par value Prosthetics East, Inc. Ortho East, Inc. Massachusetts G 12,500 common 100 NovaCare Orthotics & shares, no par value Prosthetics East, Inc.
17 162
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Ortho Rehab Associates, Inc. Florida G 1,000 common 100 RehabClinics, Inc. shares, $1.00 par value Ortho-Fab Laboratories, Inc. Illinois G 500 common shares, 500 NovaCare Orthotics & no par value Prosthetics East, Inc. Orthopedic Appliances, Inc. Iowa G 200,000 common 335 NovaCare Orthotics & shares, $10.00 par Prosthetics East, value Inc. Orthopedic and Sports Physical California G 100,000 common 3,000 RehabClinics, Inc. Therapy of Cupertino, Inc. shares, no par value Orthopedic Rehabilitative Services, Illinois G 5,000 common 1,000 NovaCare Orthotics & Ltd. shares, no par value Prosthetics East, Inc. Orthotic & Prosthetic Florida G 1,000 common 500 NovaCare Orthotics & Rehabilitation Technologies, Inc. shares, $1.00 par Prosthetics East, value Inc. Orthotic and Prosthetic Associates, Massachusetts G 300,000 common 200,000 NovaCare Orthotics & Inc. shares, $.01 par Prosthetics East, value Inc. Orthotic Specialists, Inc. Michigan G 60,000 shares, no 500 NovaCare Orthotics & par value Prosthetics East, Inc. OSI Midwest, Inc. Nebraska E 10,000 common 7,651 NovaCare Orthotics & shares, $1.00 par Prosthetics value Holdings, Inc. Paralign Staffing Technologies, Inc. Arizona E 10,000 common 1,000 NovaCare Employee shares, $1.00 par Services West, Inc. value
18 163
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Peter Trailov R.P.T. Physical Illinois G 10,000 common 300 NovaCare Outpatient Therapy Clinic, Orthopaedic shares, $10.00 par Rehabilitation East, Rehabilitation & Sports Medicine, value Inc. Ltd. Peters, Starkey & Todrank Physical California G 50,000 common 91 RehabClinics, Inc. Therapy Corporation shares, no par value Physical Focus Inc. Delaware G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value Physical Rehabilitation Partners, Louisiana G 5,000 common 106.12 RehabClinics, Inc. Inc. shares, no par value Physical Therapy Enterprises, Inc. Arizona G 1,000,000 common 1,000 NovaCare Outpatient shares, $1.00 par Rehabilitation West, value Inc. Physical Therapy Institute, Inc. Louisiana G 500 common shares, 500 RehabClinics, Inc. no par value Professional Insurance Planners of Florida E 5,000 common 250 NovaCare Employee Florida, Inc. shares, $.10 par Services Resource value One, Inc. Professional Orthotics and New Mexico G 50,000 common 40,000 NovaCare Orthotics & Prosthetics, Inc. shares, $1.00 par Prosthetics West, value Inc. Professional Orthotics and New Mexico G 50,000 common 30,000 NovaCare Orthotics & Prosthetics, Inc. of Santa Fe shares, $1.00 par Prosthetics West, value Inc. Professional Therapeutic Services, Ohio G 500 common shares, 150 NovaCare Outpatient Inc. no par value Rehabilitation East, Inc.
19 164
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Progressive Orthopedic California G 20,000 common 2,618 NovaCare Orthotics & shares, $10.00 par Prosthetics West, value Inc. Prosthetics-Orthotics Associates, Illinois G 1.000 common 500 NovaCare Orthotics & Inc. shares, no par value Prosthetics East, Inc. Protech Orthotic and Prosthetic Illinois G 15,000 common 3,000 NovaCare Orthotics & Center, Inc. shares, no par value Prosthetics East, Inc. Quad City Management, Inc. Iowa G 100,000 common 1,000 RehabClinics, Inc. shares, no par value RCI (Colorado), Inc. Delaware G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value RCI (Exertec), Inc. Delaware G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value RCI (Illinois), Inc. Delaware G 100 common shares, 100 RehabClinics, Inc. no par value RCI (Michigan), Inc. Delaware G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value RCI (S.P.O.R.T.), Inc. Delaware G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value RCI (WRS), Inc. Delaware G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value RCI Nevada, Inc. Delaware G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value
20 165
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Rebound Oklahoma, Inc. Oklahoma G 500 common shares, 500 RehabClinics, Inc. $1.00 par value Redwood Pacific Therapies, Inc. California G 100,000 common 15,120 RehabClinics, Inc. shares, no par value Rehab Managed Care of Arizona, Inc. Delaware B 1,000 common 100 RehabClinics, Inc. shares, $.01 par value Rehab Provider Network Florida G 1,000 common 1,000 RehabClinics, Inc. of Florida, Inc. shares, $.01 par value Rehab Provider Network - New New Jersey G 1,000 common 1,000 RehabClinics, Inc. Jersey, Inc. shares, $.01 par value Rehab Provider Network - California G 100 common 100 RehabClinics, Inc. California, Inc. shares, $.10 par value Rehab Provider Network - Delaware, Delaware G 1,000 common 1,000 RehabClinics, Inc. Inc. shares, $.01 par value Rehab Provider Network - Georgia, Georgia G 1,000 common 1,000 RehabClinics, Inc. Inc. shares, $.01 par value Rehab Provider Network - Illinois, Illinois G 1,000 common 1,000 RehabClinics, Inc. Inc. shares, $.01 par value Rehab Provider Network - Indiana, Indiana G 1,000 common 1,000 RehabClinics, Inc. Inc. shares, $.01 par value Rehab Provider Network - Maryland, Maryland G 1,000 common 1,000 RehabClinics, Inc. Inc. shares, $.01 par value
21 166
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Rehab Provider Network - Michigan, Michigan G 1,000 common 1,000 RehabClinics, Inc. Inc. shares, $.01 par value Rehab Provider Network - Ohio, Inc. Ohio G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value Rehab Provider Network - Oklahoma, Oklahoma G 1,000 common 1,000 RehabClinics, Inc. Inc. shares, $.01 par value Rehab Provider Network - Virginia, Virginia G 1,000 common 1,000 RehabClinics, Inc. Inc. shares, $.01 par value Rehab Provider Network - District of G 1,000 common 1,000 RehabClinics, Inc. Washington, D.C., Inc. Columbia shares, $.01 par value Rehab Provider Network - Pennsylvania G 1,000 common 1,000 RehabClinics, Inc. Pennsylvania, Inc. shares, $.01 par value Rehab Provider Network of Colorado G 100 common 100 RehabClinics, Inc. Colorado, Inc. shares, $.01 par value Rehab Provider Network of Nevada, Nevada G 100 common shares, 100 RehabClinics, Inc. Inc. $1.00 par value Rehab Provider Network of New New Mexico G 1,000 common 1,000 RehabClinics, Inc. Mexico, Inc. shares, $.01 par value Rehab Provider Network of Texas, Texas G 1,000 common 1,000 RehabClinics, Inc. Inc. shares, $.01 par value Rehab Provider Network of Wisconsin G 1,000 common 1,000 RehabClinics, Inc. Wisconsin, Inc. shares, $.01 par value
22 167
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Rehab World, Inc. Delaware G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value Rehab/Work Hardening Management Pennsylvania G 500 common 500 RehabClinics, Inc. Associates, Ltd. shares, no par value RehabClinics (COAST), Inc. Delaware G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value RehabClinics (GALAXY), Inc. Illinois G 1,200 Class A 450 RCI (S.P.O.R.T.), common shares, no Inc. par value RehabClinics (New Jersey), Inc. Delaware G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value RehabClinics (PTA), Inc. Delaware G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value RehabClinics (SPT), Inc. Delaware G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value RehabClinics Abilene, Inc. Delaware G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value RehabClinics Dallas, Inc. Delaware G 1,000 common 1,000 RehabClinics, Inc. shares, $.01 par value RehabClinics Pennsylvania, Inc. Pennsylvania G 1,000 common 1,000 RehabClinics (SPT), shares, no par Inc. value RehabClinics, Inc. Delaware B 1,000 common 1,000 NC Resources, Inc. shares, $.01 par value
23 168
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Rehabilitation Fabrication, Inc. Massachusetts G 15,000 common 1,000 Orthotic and shares, no par value Prosthetic Associates, Inc. Rehabilitation Management, Inc. Delaware G 1,500 common 350 NovaCare Outpatient shares, no par value Rehabilitation East, Inc. Reid Medical Systems, Inc. Florida G 7,500 common 100 NovaCare Orthotics & shares, $1.00 par Prosthetics East, value Inc. Robert M. Bacci, R.P.T. Physical California G 100,000 common 5,000 RehabClinics, Inc. Therapy, Inc. shares, no par value Robin Aids Prosthetics, Inc. California G 50,000 common 50,000 NovaCare Orthotics & shares, no par Prosthetics West, value Inc. Rx One, Inc. Florida E 1,000,000 common 100,000 NovaCare Employee shares, $.01 par Services, Inc. value S.T.A.R.T., Inc. Massachusetts G 12,500 common 200 RehabClinics, Inc. shares, no par value Salem Orthopedic & Prosthetic, Inc. Oregon G 500 common shares, 56.15 NovaCare Orthotics & no par value Prosthetics West, Inc. San Joaquin Orthopedic, Inc. California G 500,000 common 550 NovaCare Orthotics & shares, no par value Prosthetics West, Inc. SG Rehabilitation Agency, Inc. Pennsylvania G 100,000 common 100 NovaCare, Inc. (PA) shares, $10.00 par value SG Speech Associates, Inc. Pennsylvania G 100,000 common 100 NovaCare, Inc. (PA) shares, $10.00 par value
24 169
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ South Jersey Physical Therapy New Jersey G 2,500 common 2,500 NovaCare Outpatient Associates, Inc. shares, no par value Rehabilitation East, Inc. South Jersey Rehabilitation and New Jersey G 2,500 common 60 NovaCare Outpatient Sports Medicine Center, Inc. shares, no par value Rehabilitation East, Inc. Southern Illinois Prosthetic & Illinois G 100 common shares, 82 NovaCare Orthotics & Orthotic, Ltd. no par value Prosthetics East, Inc. Southern Illinois Prosthetic & Missouri G 30,000 common 5,000 NovaCare Orthotics & Orthotic of Missouri, Ltd. shares, $1.00 par Prosthetics East, value Inc. Southpointe Fitness Center, Inc. Pennsylvania G 100,000 common 1,000 NovaCare Outpatient shares, $1.00 par Rehabilitation East, value Inc. Southwest Medical Supply Company New Mexico G 10,000 common 10,000 RehabClinics, Inc. shares, $1.00 par value Southwest Physical Therapy, Inc. New Mexico G 500,000 common 12,500 RehabClinics, Inc. shares, no par value Southwest Therapists, Inc. New Mexico G 5 common shares, no 5 RehabClinics, Inc. par value Sporthopedics Sports and Physical California G 10,000 common 8,000 RehabClinics, Inc. Therapy Centers, Inc. shares, no par value Sports Therapy and Arthritis Delaware G 1,000 common 1,000 RehabClinics, Inc. Rehabilitation, Inc. shares, $.01 par value Staffing Technologies, Inc. New York E 200 common shares, 1 NovaCare Employee no par value Services TPI, Inc.
25 170
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Star Physical Therapy Inc. Florida G 1,000 common 60 RehabClinics, Inc. shares, $1.00 par value Stephenson-Holtz, Inc. California G 100,000 common 10,000 RehabClinics, Inc. shares, no par value T.D. Rehab Systems, Inc. New Jersey G 1,000 common 2 NovaCare Orthotics & shares, no par value Prosthetics East, Inc. Texoma Health Care Center, Inc. Texas G 10,000 common 1,000 NovaCare Orthotics & shares, $1.00 par Prosthetics West, value Inc. The Center for Physical Therapy and New Mexico G 500,000 common 1,000 RehabClinics, Inc. Rehabilitation, Inc. shares, no par value The Orthopedic Sports and Pennsylvania G 3,000 common 2,000 RehabClinics, Inc. Industrial Rehabilitation Network, shares, no par value Inc. Theodore Dashnaw Physical Therapy, California G 100 common 30 RehabClinics, Inc. Inc. shares, no par value Treister, Inc. Ohio G 500 common shares, 100 NovaCare Outpatient no par value Rehabilitation East, Inc. Tucson Limb & Brace, Inc. Arizona G 100,000 common 2,106 NovaCare Orthotics & shares, $10.00 par Prosthetics West, value Inc. Union Square Center for California G 1,000 common 500 RehabClinics, Inc. Rehabilitation & Sports Medicine, shares, no par Inc. value University Orthotic and Prosthetic Pennsylvania G 100 common shares, 100 NovaCare Orthotics & Consultants, Ltd. no par value Prosthetics East, Inc.
26 171
Subsidiary Jurisdiction Borrower/ Authorized No. Shares Shareholder(s) ---------- ------------ --------- ---------- ---------- -------------- Guarantor/ Capital Issued ---------- ------- ------ Excluded -------- Entity ------ Valley Group Physical Therapists, Pennsylvania G 1,000 common 100 NovaCare Outpatient Inc. shares, no par value Rehabilitation East, Inc. Vanguard Rehabilitation, Inc. Arizona G 1,000,000 common 64,500 RehabClinics, Inc. shares, $1.00 par value Wayzata Physical Therapy Center, Minnesota G 2,500 common 1,000 RehabClinics, Inc. Inc. shares, no par value West Side Physical Therapy, Inc. Ohio G 750 common shares, 100 NovaCare Outpatient no par value Rehabilitation East, Inc. West Suburban Health Partners, Inc. Minnesota G 25,000 common 990 RehabClinics, Inc. shares, $1.00 par value Western Rehab Services, Inc. Arizona G 100,000 common 1,000 NovaCare, Inc. (PA) shares, no par value Worker Rehabilitation Services, Inc. Illinois G 10,000 common 2,777.78 RCI (WRS), Inc. shares, no par value Yuma Rehabilitation Center, Inc. Arizona G 1,000,000 common 20,000 NovaCare Outpatient shares, $1.00 par Rehabilitation West, value Inc.
27 172 II. PARTNERSHIP INTERESTS
Name Jurisdiction Partnership Interest Borrower/ ---- ------------ -------------------- --------- Guarantor/ ---------- Excluded -------- Entity ------ A.D. Craig California 50% owned by A.D. Craig Company, 50% owned by San Joaquin G Orthopedic, Inc. Advanced Orthopedic Services, Ltd. Texas 99% limited partnership interest owned by RehabClinics G Dallas, Inc. who is also the general partner 1% limited partnership interest owned by RehabClinics, Inc. Craig Weymouth Enterprises California 50% owned by A.D. Craig Company, 50% owned by NovaCare G Orthotics & Prosthetics West, Inc. Land Park Physical Therapy California 50% owned by RehabClinics, Inc. G 50% owned by Union Square Center for Rehabilitation & Sports Medicine, Inc. Each of these entities are wholly-owned subsidiaries of NovaCare, Inc. NCES Partners (IND), LP Indiana 1% general partnership interest owned by NovaCare E Employee Services, Inc.; 99% limited partnership interest owned by NCES Holdings, Inc. Orthomedics - Voner (Rancho) California 50% owned by NovaCare Orthotics & Prosthetics West, Inc. E Orthomedics - Voner (Whittier) California 50% owned by NovaCare Orthotics & Prosthetics West, Inc. E T.J. Partnership I Delaware 75% owned by RehabClinics (PTA), Inc.; 25% owned by Mark E Stoff NovaPartners (IND), LP Indiana 1% general partnership interest owned by NovaCare, Inc., G a Pennsylvania corporation; 99% limited partnership interest owned by NC Resources, Inc.
III. LIMITED LIABILITY CORP. 28 173
Name Jurisdiction Member Interest Borrower/Guarantor/ ---- ------------ --------------- ------------------- Excluded Entity --------------- TJ Corporation I, L.L.C. Delaware RCI (Illinois), Inc. - 75% interest; E 25% owned by Todd Miner Gill/Balsano Consulting, L.L.C. Delaware Cannon & Associates, Inc. - 40% E interest GP Therapy, L.L.C. Georgia Georgia Physical Therapy, Inc. - 50% E interest
IV. OPTIONS TO PURCHASE 1. Orthomedics - Voner (Rancho), a California general partnership. A 50% interest is held NovaCare Orthotics & Prosthetics West, Inc. a California wholly owned subsidiary of NovaCare Orthotics & Prosthetics Holdings, Inc., a Delaware wholly owned subsidiary of NovaCare Orthotics & Prosthetics, Inc., a Delaware wholly owned subsidiary of NC Resources, Inc., a Delaware wholly owned subsidiary of NovaCare, Inc. (DE). The remaining 50% is owned by Mr. Voner. 2. Orthomedics - Voner (Whittier), a California general partnership. A 50% interest is held NovaCare Orthotics & Prosthetics West, Inc. a California wholly owned subsidiary of NovaCare Orthotics & Prosthetics Holdings, Inc., a Delaware wholly owned subsidiary of NovaCare Orthotics & Prosthetics, Inc., a Delaware wholly owned subsidiary of NC Resources, Inc., a Delaware wholly owned subsidiary of NovaCare, Inc. (DE). The remaining 50% is owned by Mr. Voner. 29 174 EXHIBIT 8.01(m)(iii) COMPLIANCE CERTIFICATE ____________________, 19__ PNC BANK, NATIONAL ASSOCIATION as Agent for the Banks party to the Credit Agreement Referred to Below Fifth Avenue and Wood Street Pittsburgh, PA 15265 Ladies and Gentlemen: I refer to the Credit Agreement dated as of May 27, 1994 (as amended, supplemented or modified from time to time, the "Credit Agreement") among NOVACARE, INC., a Delaware corporation ("NovaCare"), and the other Borrowers and the Guarantors under such Credit Agreement (collectively, the "Loan Parties"), the Banks party thereto and PNC BANK, NATIONAL ASSOCIATION, as Agent for such Banks. Unless otherwise defined herein, terms defined in the Credit Agreement are used herein with the same meanings. I, ______________________________, [President/Chief Executive Officer/Chief Financial Officer] of NovaCare, do hereby certify pursuant to Section 8.01(m)(iii) of the Credit Agreement on behalf of NovaCare as of the [fiscal quarter/year ended _______________, 19___] the "Report Date"), as follows: (1) MINIMUM NET WORTH. (Section 8.02(l)). As of the Report Date, the Consolidated Net Worth is $ ______________ which is not less than the Minimum Net Worth Requirement which is $ ___________. Such amounts are computed as follows: (A) Consolidated Net Worth as of the Report Date equals total stockholders' equity of NovaCare and its Subsidiaries(1), determined and consolidated in accordance with GAAP $ ___________ [For periods after the Spin-Off Consummation, the stockholders' equity of NovaCare Employee Services, Inc. shall be excluded from such calculation. See Schedule A - Item (1)] - ---------- (1) NovaCare Employee Services, Inc. and its Subsidiaries are excluded in all calculations for NovaCare and its consolidated Subsidiaries. 175 PNC BANK, NATIONAL ASSOCIATION ___________________, 19___ Page 2 (B) Minimum Net Worth Requirement as of the Report Date: (i) Fixed amount in accordance with Credit Agreement $ 515,786,000 ___________ (ii) Seventy-five percent (75%) of Consolidated Net Income of NovaCare and its Subsidiaries for each fiscal quarter in which net income was earned (as opposed to a net loss) for each fiscal quarter after June 30, 1997 through (and including) the Report Date, computed as follows: (a) Consolidated net income $ ____________ (b) Less increases in net income or expenses resulting from changes in GAAP after Closing Date $ ____________ (c) Plus decreases in net income or expenses resulting from changes in GAAP after Closing Date $ ____________ (d) Subtotal sum of (a), (b) and (c) $ ____________ (e) Line (d) times 75% $ ____________ (iii) To the extent not included in Item (ii)(e) above, one hundred percent (100%) of all federal and state income tax refunds (collectively, the "Tax Refunds") received by NovaCare or any of its Subsidiaries during the period of determination relating to the sales by them of their rehabilitation hospitals during the fiscal year ended June 30, 1995. $ ____________ (iv) One hundred percent (100%) of all proceeds received by NovaCare in connection with the sale of shares of its capital stock (less any expenses associated with such sale), including proceeds from conversion of the Subordinated Debentures during the period from July 1, 1997 through and including the Report Date. $ ____________
176 PNC BANK, NATIONAL ASSOCIATION ___________________, 19___ Page 3 (v) The cash purchase price of common stock of NovaCare repurchased by NovaCare during the period of determination (not to exceed an aggregate of $21,309,699 plus the portion of the Tax Refunds used for such repurchases). $ ____________ (vi) Sum of Items (i) through (iv), less Item (v), equals Minimum Net Worth Requirement $ ____________ [For periods after the Spin-Off Consummation, the portion of Consolidated Net Income attributable to NovaCare Employee Services, Inc., shall be excluded from such calculation of Minimum Net Worth Requirement in accordance with the Credit Agreement. See Schedule A-1.] (2) FUNDED DEBT TO CASH FLOW FROM OPERATIONS. (Section 8.02(n)). 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 ending on the Report Date, is __________ to 1.0. Pursuant to Section 8.02(n), such ratio is not more than 4.25 to 1.0 for any fiscal quarter ending on or after November 17, 1997 (the Thirteenth Amendment Effective Date) through June 30, 2000, or 3.75 to 1.0 for any fiscal quarter ending after July 1, 2000. (A) Consolidated Funded Debt, the numerator of the foregoing ratio, equals the Indebtedness of NovaCare and its Subsidiaries to persons other than NovaCare and its Subsidiaries, determined as follows (in each case, without duplication): (i) Borrowed money $ ___________ (ii) Amounts raised under or liabilities in respect of any note purchase or acceptance credit facility $ ___________ (iii) Reimbursement obligations under any letter of credit, currency swap agreement, interest rate swap, cap, collar or floor agreement or other interest rate management device $ ___________
177 PNC BANK, NATIONAL ASSOCIATION ___________________, 19___ Page 4 (iv) Other transactions (including without limitation forward sale or purchase agreements, capitalized leases and conditional sales agreements) having the commercial effect of a borrowing of money entered into to finance operations or capital requirements (excluding trade payables and accrued expenses incurred in the ordinary course of business which are not represented by a promissory note $ ___________ (v) Any Guaranty of Indebtedness for borrowed money $ ___________ (vi) Sum of (i) through (v) equals Consolidated Funded Debt $ ___________ (B) Consolidated Cash Flow from Operations(2), the denominator of the foregoing ratio, for the four fiscal quarters ending on the Report Date is determined as follows: (i) Net income $ ___________ (ii) Depreciation $ ___________ (iii) Amortization $ ___________ (iv) Other non-cash charges to net income incurred in the ordinary course of business not to exceed $25,000,000 in any fiscal quarter (to the extent included in determination of net income) $ ___________ (v) Interest expense $ ___________ (vi) Income tax expense $ ___________ (vii) Sum of items (i) through (vi) $ ___________ (viii)Non-cash credits to net income (to the extent included in determination of net income) $ ___________
- ---------- (2) To be adjusted in accordance with the definition of "Consolidated Cash Flow from Operations" set forth in the Credit Agreement (a) to give effect to the timing of Permitted Acquisitions and Permitted Asset Transfers and (b) to exclude any item attributable to Restricted Excluded Entities. See Section 8.02(e)(i) or (iv). 178 PNC BANK, NATIONAL ASSOCIATION ___________________, 19___ Page 5 (ix) Actual cash charges incurred in the period of determination related to the $23,500,000 special charge taken by the Loan Parties during the fiscal quarter ended December 31, 1997 $ ___________ (x) Item (vii), less the sum of Items (viii) and (ix), equals Consolidated Cash Flow from Operations $ ___________ [For periods after the Spin-Off Consummation, the portions of Funded Debt and Cash Flow from Operations attributable to NovaCare Employee Services, Inc., shall be excluded from calculation of such ratio. See Schedule A - Items 2 and 3.] (3) MINIMUM FIXED CHARGE COVERAGE RATIO(3). (Section 8.02(o)). The ratio of Consolidated Earnings Available for Fixed Charges to Consolidated Fixed Charges for the four fiscal quarters ending on the Report Date is __________ to 1.0. Such ratio is not more than 1.3 to 1.0 pursuant to Section 8.02(o). (A) Consolidated Earnings Available for Fixed Charges, the numerator of the foregoing ratio, is determined as follows: (i) Net income $ ___________ (ii) Interest expense $ ___________ (iii) Income tax expense $ ___________ (iv) Depreciation $ ___________ (v) Amortization $ ___________ (vi) Other non-cash charges to net income incurred in the ordinary course of business not to exceed $25,000,000 in any fiscal quarter (to the extent included in determination of net income) $ ___________ (vii) Expenses under operating leases $ ___________
- ---------- (3) To be adjusted in accordance with the definitions of "Consolidated Earnings Available for Fixed Charges" and "Consolidated Fixed Charges" set forth in the Credit Agreement (a) to give effect to the timing of Permitted Acquisitions and Permitted Asset Transfers and (b) to exclude any item of expense attributable to Restricted Excluded Entities. 179 PNC BANK, NATIONAL ASSOCIATION ___________________, 19___ Page 6 (viii) Sum of (i) through (vii) $ ___________ (ix) Non-cash credits to net income (to the extent included in determination of net income) $ ___________ (x) Actual cash charges incurred in the period of determination related to the $23,500,000 special charge taken by the Loan Parties during the fiscal quarter ended December 31, 1997 $ ___________ (xi) Item (viii), less the sum of Items (ix) and (x), equals Consolidated Earnings Available for Fixed Charges $ ___________ (B) Consolidated Fixed Charges, the denominator of the foregoing ratio, is determined as follows: (i) Interest expense $ ___________ (ii) Expenses under operating leases $ ___________ (iii) Income tax expense $ ___________ (iv) Current maturities of long-term Indebtedness (for the twelve (12) month period following the Report Date) excluding current maturities of Subordinated Debentures during the fiscal quarter ending March 31, 1999 or any fiscal quarter thereafter $ ___________ (v) Current principal payments under capitalized leases (for the twelve (12) month period following the Report Date) $ ___________ (vi) The sum of (i) through (v) equals Consolidated Fixed Charges $ ___________ [For periods after the Spin-Off Consummation, the portion of Consolidated Earnings Available for Fixed Charges and Consolidated Fixed Charges attributable to NovaCare Employee Services, Inc., shall be excluded from calculation of such ratio. See Schedule A - Item 4.]
180 PNC BANK, NATIONAL ASSOCIATION ___________________, 19___ Page 7 (4) INDEBTEDNESS ASSUMED IN PERMITTED ACQUISITIONS; PURCHASE MONEY SECURITY INTERESTS. (Section 8.02(a)). (A) Permitted Acquisitions and Purchase Money Security Interests. (Section 8.02(a)(v)). The amount of Indebtedness of the Loan Parties described in Section 8.02(a)(v) of the Credit Agreement is $__________ on the Report Date, which is less than $20,000,000, the maximum permitted amount. The amount of such Indebtedness is computed as follows: $ ___________ (i) Purchase Money Security Interests entered into in the ordinary course of business and consistent with past practices. $ ___________ (ii) Permitted Acquisitions (accounted for as a "purchase" under GAAP) (See Section 8.02(d)(ii).) Indebtedness incurred or assumed (including extensions and renewals thereof) by Loan Parties between the Closing Date and the Report Date, either pursuant to Permitted Acquisitions (by purchase, merger or otherwise) of either (1) the assets of other persons or (2) stock, partnership interests or other ownership interests of corporations, partnerships or other entities, which Indebtedness incurred or assumed through either (1) or (2) above remains outstanding on the Report Date, shown as follows: $ ___________
____________________________________________________________________________ Loan Party Which Collateral Securing is Now Liable on Date of Permitted the Indebtedness Indebtedness the Indebtedness Acquisition (If Any) Outstanding ____________________________________________________________________________ __________ __________ __________ $ __________ __________ __________ __________ $ __________ __________ __________ __________ $ __________ Total $ __________ ____________________________________________________________________________
(iii) Sum of Lines (i) and (ii) (may not exceed $20,000,000) $ ___________
181 PNC BANK, NATIONAL ASSOCIATION ___________________, 19___ Page 8 (B) Permitted Acquisitions (accounted for as a "pooling of interests" under GAAP). (Section 8.02(a)(vi)). The amount of Indebtedness of the Loan Parties described in Section 8.02(a)(vi) of the Credit Agreement incurred during the current fiscal year is $__________ which is less than $100,000,000, the maximum amount permitted under said Section. Such Indebtedness is computed as follows: Indebtedness either (1) assumed by acquiring Loan Parties in Permitted Acquisitions during the current fiscal year, or (2) of Pooling Partners and their Subsidiaries whose stock or other ownership interests were acquired in Permitted Acquisitions during the current fiscal year, including in the case of both (1) and (2) any Indebtedness which has been repaid since the date of the pooling as well as Indebtedness which remains outstanding on the date of this certificate, as summarized in the table below:
_______________________________________________________________________________________________ Loan Party Which Assumed Indebtedness or Pooling Partner Collateral Securing Whose Stock Was Date of Pooling the Indebtedness Amount of Acquired Date of Pooling (if any) Indebtedness ** _______________________________________________________________________________________________ __________ __________ __________ $ __________ __________ __________ __________ $ __________ __________ __________ __________ $ __________ Total Indebtedness $ __________ (may not exceed $100,000,000 in the aggregate) _______________________________________________________________________________________________
** Not to exceed the Pooling Consideration (C) Permitted Additional Institutional Indebtedness (Section 8.02(a)(viii) and definition of "Permitted Additional Institutional Indebtedness"). The following is a list of Permitted Additional Institutional Indebtedness outstanding on the Report Date: 182 PNC BANK, NATIONAL ASSOCIATION - -------------------, 19--- Page 9
- --------------------------------------------------------------------------------- Documentation Qualified Delivered Lender Loan Party Amount to Agent (yes/no)** - --------------------------------------------------------------------------------- ---------- ---------- $ ---------- ---------- ---------- ---------- $ ---------- ---------- ---------- ---------- $ ---------- ---------- - ---------------------------------------------------------------------------------
** Documentation governing Indebtedness should be enclosed with this compliance certificate if not previously delivered to Agent. (D) Permitted Additional Subordinated Indebtedness (Section 8.02(a)(ix) and definition of "Permitted Additional Subordinated Indebtedness"). The following is a list of Permitted Additional Subordinated Indebtedness outstanding on the Report Date:
- ------------------------------------------------------------------------------- Documentation Loan Delivered Lender Party Amount to Agent (yes/no)** - ------------------------------------------------------------------------------- ---------- ---------- $ ---------- --------- ---------- ---------- $ ---------- ---------- ---------- ---------- $ ---------- ---------- - -------------------------------------------------------------------------------
** Documentation governing any Subordinated Indebtedness greater than $5,000,000 should be enclosed with this compliance certificate if not previously delivered to Agent. (5) PERMITTED ACQUISITIONS (Section 8.02(d)). The Loan Parties made the following Permitted Acquisitions during the quarter ending on the Report Date: 183 PNC BANK, NATIONAL ASSOCIATION ___________________, 19___ Page 10
_______________________________________________________________________________ Type of Transaction Seller/ (Purchase or Pooling Partner Pooling under Date of Closing Consideration ** GAAP) _______________________________________________________________________________ __________ __________ __________ $ __________ __________ __________ __________ $ __________ __________ __________ __________ $ __________ _______________________________________________________________________________
** Not to exceed $30,000,000. The aggregate Consideration with respect to the Permitted Acquisitions made during the quarter ending on the Report Date, together with the aggregate Consideration for all other Permitted Acquisitions during the current fiscal year, is $_____________, which does not exceed the Annual Permitted Acquisition Amount for the fiscal year as set forth in Section 8.02(d)(ii)(g). (6) Permitted Investment in Excluded Entities (Sections 8.02(f) and (i)). With reference to the definition of "Permitted Investment in Excluded Entities," the Loan Parties' Restricted Investments total, in the aggregate, $ _____________, which amount does not exceed the permitted amount of $50,000,000 for all Excluded Entities, as computed below: (i) Restricted Investments in Excluded Entities which are Minority Subsidiaries (in each instance, not to exceed $5,000,000) $ __________ (ii) Restricted Investments in Excluded Entities which are Subsidiaries (in each instance, not to exceed $10,000,000) $ __________ (iii) Restricted Investments in Excluded Entities which are either (a) Unaffiliated Managed Companies or (b) entities which are neither Subsidiaries nor Minority Subsidiaries (in each instance, not to exceed $1,000,000 and in the aggregate not to exceed $5,000,000) $ __________ (iv) Sum of Items (i) through (iii) $ __________
184 PNC BANK, NATIONAL ASSOCIATION - -------------------, 19--- Page 11 The table below lists as of the Report Date (a) each Subsidiary and Minority Subsidiary which is not a Borrower or Guarantor (whether or not the Loan Parties have made a Restricted Investment therein), (b) each Unaffiliated Managed Company in which the Loan Parties have made a Restricted Investment and (c) each other entity in which the Loan Parties have made a Permitted Investment in Excluded Entities.
- -------------------------------------------------------------------------------------------------- (i) (ii) (iii) (iv) Investments(4) Other Total in or Obligations Restricted Contributions Guaranties to or for the Investments to Loans to on Behalf of Benefit of (Sum of Excluded Excluded Excluded Excluded Excluded columns Entity Entity Entity Entity Entity (i) thru (iv)) - -------------------------------------------------------------------------------------------------- -------- -------- -------- -------- -------- $ --------- -------- -------- -------- -------- -------- $ --------- - -------------------------------------------------------------------------------------------------- Total (not to exceed $50,000,000) $ ---------
(7) EVENTS OF DEFAULT OR POTENTIAL DEFAULT. No event has occurred and is continuing which constitutes an Event of Default or Potential Default. (8) REPRESENTATIONS AND WARRANTIES. The representations and warranties contained in Article VI of the Credit Agreement are true on and as of the date hereof with the same effect as though such representations and warranties had been made on and as of the date hereof (except representations and warranties which expressly relate solely to an earlier date or time, which representations and warranties shall have been true and correct on and as of the specific dates or times referred to therein) and the Loan Parties have performed and complied with all covenants and conditions hereof. - ---------- (4) Indicate if nature of Restricted Investment is tangible property. Restricted Investment in certain Excluded Entities is limited to the per entity amount and certain aggregate sublimits specified in the definition of Permitted Investment in Excluded Entities. 185 PNC BANK, NATIONAL ASSOCIATION ___________________, 19___ Page 12 IN WITNESS WHEREOF, the undersigned has executed this Certificate this _____ day of _____________, 19 . By:____________________________________ Name:__________________________________ Title:_________________________________ 186 SCHEDULE A to Compliance Certificate ADJUSTMENTS FOR NOVACARE EMPLOYEE SERVICES, INC. ________________________, 19__ (1) MINIMUM NET WORTH. (Section 8.02(l)). (A) As of the Report Date, the stockholders' equity of NovaCare Employee Services, Inc. equals: $ _____________ (B) As of the Report Date, the net income attributable to NovaCare Employee Services, Inc. (excluding from such net income any increases or decreases in income or expenses resulting from changes in GAAP on or after the Closing Date) equals: $ _____________ (2) FUNDED DEBT (Section 8.02(n)) of NovaCare Employee Services, Inc., determined as follows: Indebtedness of NovaCare Employee Services, Inc. on the Report Date to persons other than NovaCare and its Subsidiaries in respect of, without duplication: (i) Borrowed money $ _____________ (ii) Amounts raised under or liabilities in respect of any note purchase or acceptance credit facility $ _____________ (iii) Reimbursement obligations under any letter of credit, currency swap agreement, interest rate swap, cap, collar or floor agreement or other interest rate management device $ _____________ (iv) Other transactions (including without limitation forward sale or purchase agreements, capitalized leases and conditional sales agreements) having the commercial effect of a borrowing of money entered into to finance operations or capital requirements (excluding trade payables and accrued expenses incurred in the ordinary course of business which are not represented by a promissory note) $ _____________ (v) Any Guaranty of Indebtedness for borrowed money $ _____________
187 PNC BANK, NATIONAL ASSOCIATION _______________, 19__ Page 14 (vi) Sum of (i) through (v) equals Funded Debt of NovaCare Employee Services, Inc. $ _____________ (3) CASH FLOW FROM OPERATIONS attributable to NovaCare Employee Services, Inc. for the four fiscal quarters ending on the Report Date is determined as follows (i) Net income $ _____________ (ii) Depreciation $ _____________ (iii) Amortization $ _____________ (iv) Other non-cash charges to net income incurred in the ordinary course of business (to the extent included in determination of net income) $ _____________ (v) Interest expense $ _____________ (vi) Income tax expense $ _____________ (vii) Sum of (i) through (vi) $ _____________ (viii) Non-cash credits to net income (to the extent included in determination of net income) $ _____________ (ix) Item (vii) less Item (viii) equals Cash Flow from Operations for NovaCare Employee Services, Inc. $ _____________ (4) MINIMUM FIXED CHARGE COVERAGE RATIO. (Section 8.02(o)). $ _____________ (A) Earnings Available for Fixed Charges attributable to NovaCare Employee Services, Inc. is determined as follows: (i) Net income $ _____________ (ii) Interest expense $ _____________ (iii) Income tax expense $ _____________ (iv) Depreciation $ _____________
188 PNC BANK, NATIONAL ASSOCIATION _______________, 19__ Page 15 (v) Amortization $ _____________ (vi) Other non-cash charges to net income incurred in the ordinary course of business (to the extent included in determination of net income) $ _____________ (vii) Expenses under operating leases $ _____________ (viii) Sum of (i) through (vii) $ _____________ (ix) Non-cash credits to net income (to the extent included in determination of net income) $ _____________ (x) Item (viii) less Item (ix) equals Earnings Available for Fixed Charges attributable to NovaCare Employee Services, Inc. $ _____________ (B) Fixed Charges attributable to NovaCare Employee Services, Inc. is determined as follows: (i) Interest expense $ _____________ (ii) Expenses under operating leases $ _____________ (iii) Income tax expense $ _____________ (iv) Current maturities of long-term Indebtedness (for the twelve (12) month period following the Report Date) $ _____________ (v) Current principal payments under capitalized leases (for the twelve (12) month period following the Report Date) $ _____________ (vi) Sum of (i) through (v) equals Fixed Charges attributable to NovaCare Employee Services, Inc. $ _____________
EX-13 5 ANNUAL REPORT TO SHAREHOLDERS FISCAL YEAR 6/30/98 1 HARNESSING CHANGE TO ACHIEVE LEADERSHIP & PERFORMANCE NOVACARE 1998 ANNUAL REPORT 2 N O V A C A R E I N C RESPECT FOR THE INDIVIDUAL SERVICE TO THE CUSTOMER PURSUIT OF EXCELLENCE COMMITMENT TO PERSONAL INTEGRITY NOVACARE NovaCare, Inc. is a national leader in physical rehabilitation services and employee services, and a rapidly growing provider of occupational health services. As the clinical leader in rehabilitation, the company treats more than 47,000 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 physical therapy and rehabilitation services and the third largest occupational health services company. Its subsidiary, NovaCare Employee Services, Inc., is 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. OUR VALUES 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 and new markets. Our values-based culture enables us to set aside the organizational anxiety and self-interest that often accompany change. The pursuit of our values unlocks our inherent capacity to drive change, creating immense opportunity. Without question, our people, values-driven culture and capacity for change are our greatest strengths and our competitive advantage. ON THE COVER Mike Penketh, a NovaCare customer who has been fitted with two myoelectric devices, is the only bilateral amputee pilot in the world authorized to perform low level aerobatics.
FINANCIAL HIGHLIGHTS (In thousands, except per share data) FOR THE YEAR ENDED JUNE 30, 1998 1997 1996 Net revenues $ 1,671,925 $ 1,066,451 $ 793,038 Net income 57,915 38,910 15,281 Net income per share assuming dilution .91 .62 .24 Weighted average number of common shares outstanding assuming dilution 63,584 62,455 63,918 AS OF JUNE 30, 1998 1997 1996 Working capital $ 225,773 $ 173,576 $ 223,712 Total assets 1,356,042 1,014,304 789,731 Total liabilities 775,369 506,298 305,337 Shareholders' equity 580,673 508,006 484,394
3 Outpatient physical therapy and rehabilitation, orthotic and prosthetic services and occupational health services are provided through a network of 910 centers in 38 states. NovaCare treats nearly one of every five patients receiving rehabilitation services in long-term care facilities, providing treatment in 1,900 customer facilities nationwide. Three thousand small and medium-sized businesses rely on NovaCare for human resources expertise, including the management of health care benefits and workers' compensation. 1 4 TO OUR SHAREHOLDERS TIMOTHY E. FOSTER, CHIEF EXECUTIVE OFFICER; JOHN H. FOSTER, CHAIRMAN; AND JAMES W. MCLANE, PRESIDENT AND CHIEF OPERATING OFFICER. Fiscal 1998 was another very successful year for NovaCare. Net revenues increased by 57% over fiscal 1997 to nearly $1.7 billion. That growth, coupled with expanding margins in each business, generated earnings per share (before nonrecurring items) of $.77, an increase of 24% over the prior year. After recording gains derived from the initial public offering of NovaCare Employee Services, Inc. and a partially offsetting restructure charge, the company reported fiscal 1998 earnings per share of $.91. Our continued growth is attributable to the disciplined implementation of strategies set forth in our 1996 and 1997 annual reports: - Focus outpatient services growth in targeted geographic markets. - Develop occupational health services. - Launch an employee services company. In addition, changes in the marketplace provided the impetus for a fourth key strategy: - Leverage regulatory change to gain market share in long-term care services. OUTPATIENT SERVICES GROWTH IN TARGET MARKETS Health care remains a business in which the highest margins accrue to the provider with the greatest regional market share and scale. National market leadership has value only if it is derived from a portfolio of pre-eminent regional market positions. This is especially true for our outpatient services business -- outpatient physical therapy and rehabilitation, orthotics and prosthetics (O&P) and occupational health. During fiscal 1998 we acquired 43 outpatient physical therapy and rehabilitation practices and opened 40 centers in the confined geography of 15 high opportunity markets. This increased our 2 5 national network of outpatient centers to 506 locations, the second largest in the nation. Similarly, we acquired 42 O&P businesses in essentially the same markets, broadening our distribution system to 365 sites, and achieved 4% same market growth during the year. At year-end we held the number one or two market position in the majority of our target markets for outpatient physical therapy and rehabilitation and O&P services. EXPANDING OCCUPATIONAL HEALTH SERVICES Over the past two years, we have developed an occupational health business that offers an integrated continuum of pre-employment testing, work safety training, physician care and physical rehabilitation services. These services both enhance employee safety and minimize the total cost of disability to employers, and are a natural extension of our experience in rehabilitating thousands of patients with work-related injuries. We expanded our occupational health capabilities and revenues in fiscal 1998 through five acquisitions and 4% same market growth. Our network now totals 39 sites concentrated in our 15 target markets. As a result of our disciplined growth strategy, revenues in outpatient services increased 43% over fiscal 1997 to $513 million. Gross profit margins expanded from 30% to 31% despite continued pricing pressures from payers. SUCCESSFUL LAUNCH OF NOVACARE EMPLOYEE SERVICES Our professional employer organization (PEO), NovaCare Employee Services, Inc. (Nasdaq:NCES), provides small and medium-sized businesses with comprehensive, fully integrated outsourcing solutions to their human resource needs. Services include payroll and benefits administration, risk management, recruiting and training, and human resource consulting. Our initial public offering of NCES in November raised $46 million, which we used to retire acquisition debt. NovaCare, Inc. retains an ownership position of 71% in NCES. NCES leverages our (1) extensive experience in managing our employees at remote customer worksites, (2) information technology systems, (3) workers' compensation and occupational health expertise, and (4) competencies as a consolidator of fragmented businesses. In addition, by focusing on many of the same target markets as our outpatient businesses, NovaCare's name recognition and credibility help compress the lengthy selling cycle that characterizes this business. Since its founding in September 1996, NCES has become the second largest company in its industry. Its 36% same market growth rate is the highest among publicly traded PEOs and its margins exceed the industry average. These results, along with three successfully integrated acquisitions and entry into two new markets, produced a 223% revenue increase in fiscal 1998. We congratulate the NCES team for an excellent year, evidenced by a 249% increase in earnings before interest, taxes, depreciation and amortization -- to $14.7 million. RECORD PERFORMANCE FOR LONG-TERM CARE SERVICES Revenues in our long-term care services business increased 15% in fiscal 1998 to $657 million, and the gross profit margin rose from 27% to 28%. We achieved these excellent results despite a nearly 20% reduction in reimbursement in the fourth quarter, due to Medicare's implementation of a revised salary equivalency system in April. NovaCare has been preparing for salary equivalency for several years. We led the industry's effort to ensure that the new Medicare 3 6 TO OUR SHAREHOLDERS therapy rates would be both appropriate and adequate. At the same time, we reduced our costs and improved our operational flexibility. NovaCare was the first in our industry to convert therapists from fixed (salary) to variable (hourly) compensation. Through information technology, we transitioned our field management into "virtual offices" and broadened spans of control. Our success with the salary equivalency transition positions us very well for another Medicare reimbursement change called the prospective payment system (PPS). Under PPS, Medicare assigns the highest reimbursement to rehabilitation patients and makes long-term care providers far more accountable for controlling costs. As implementation of PPS began on July 1, the need for quality rehabilitation programs to attract patients and variable-cost outsourcing solutions grew far more urgent among long-term care providers. For NovaCare, the move to PPS is an exceptional opportunity to increase our market share among smaller, independent and not-for-profit long-term care providers. These facilities have neither the scale nor the expertise to establish in-house therapy programs. Over the past few years, we have concentrated on and expanded our marketing efforts in these segments with great success. As a result of this strategy, NovaCare now treats one in five patients receiving physical rehabilitation in U.S. long-term care facilities. LOOKING AHEAD As NovaCare enters fiscal 1999 we hold leading market positions in all of our businesses -- outpatient services, long-term care services, and employee services. Our fundamental operating strategies will remain constant with a focus on leveraging our core competencies in physical rehabilitation, occupational health and employee services. We will continue to capitalize on structural change in our industries to achieve market leadership. We remain very enthusiastic about the prospects for each of NovaCare's businesses. While our strategy will remain constant, a rapidly changing industry environment may dictate a new corporate and capital structure. When we founded NovaCare, and for more than 13 years thereafter, the critical success factor in rehabilitation was the ability to attract and retain clinical professionals. We became differentiated as the "Employer of Choice" for clinicians. Once we developed that core competency, we extended it from the long-term care setting into outpatient services and employee services. In recent years, however, an increased supply of therapists and lower therapy utilization in the long-term care industry have reduced the leverage available from this integrated human resource activity. Today, the most critical success factor in all of our businesses is recognizing and meeting the unique needs of our different customers. Clearly, the needs of long-term care providers are quite different from the needs of the payers, physicians and employers in our outpatient services customer base. The capital requirements of the long-term care and outpatient services businesses also differ. Our long-term care services business requires relatively little capital for growth. Stock price multiples in the long-term care sector are expected to be low for the foreseeable future, given the investment community's uncertainty regarding the recent changes in Medicare reimbursement. In contrast, the very fragmented outpatient services business offers substantial consolidation opportunities, with a corresponding need for capital to fund acquisitions. A stock with a higher stock 4 7 price-earnings multiple that is typical of outpatient services industries would afford an attractive currency for strategic acquisitions and for raising capital. For all of these reasons, we are considering separating our rehabilitation businesses into two publicly held companies -- a long-term care, geriatric-oriented business and an outpatient physical rehabilitation-oriented business. The precise course and timing we will follow depends on a variety of capital markets, tax, regulatory and operational issues. HARNESSING CHANGE The following pages will discuss in greater detail our strategies for Harnessing Change to Achieve Leadership and Performance. Whether it is meeting the needs of our customers in changing reimbursement environments, or changing the structure of our businesses, all of our achievements will continue to have their source in our capacity for change. As always, the cornerstone of our success is our employees. We have turned to them time and time again to pursue new opportunities in our rapidly changing marketplace, and they have consistently delivered excellent results for our patients, customers and shareholders. On behalf of your Board and management, we extend our thanks to all NovaCare employees for Helping Make Life a Little Better, and we offer our appreciation to you, our shareholders, for your continuing confidence and support. JOHN H. FOSTER Chairman TIMOTHY E. FOSTER Chief Executive Officer JAMES W. MCLANE President and Chief Operating Officer EXPANDED MARGINS IN EACH BUSINESS AND 57% NET REVENUE GROWTH CONTRIBUTED TO A 24% INCREASE IN EARNINGS PER SHARE (BEFORE NONRECURRING ITEMS) IN FISCAL 1998. 5 8 1 ONE FOR OUR PATIENTS, AN ARTIFICIAL LIMB IS THE MEANS FOR RETURNING TO A FULL AND PRODUCTIVE LIFE. RODERICK GREEN, 18, THE BASKETBALL PLAYER SHOWN ON THE LEFT, IS A BELOW-THE-KNEE AMPUTEE FITTED WITH NOVACARE'S UNIQUE SABOLICH SOCKET TECHNOLOGY. TODAY, RODERICK PLAYS BASKETBALL FOR OKLAHOMA CHRISTIAN UNIVERSITY. HARNESSING CHANGE TO ACHIEVE LEADERSHIP AND PERFORMANCE 9 HELPING MAKE LIFE A LITTLE BETTER OUTPATIENT SERVICES Treating 18,000 patients per day, NovaCare's outpatient physical therapy and rehabilitation, orthotics and prosthetics (O&P) and occupational health businesses have proven that size and scale are the agents for clinical excellence, efficiency of operations and rapid growth. These businesses have pursued aggressive strategies of focused acquisitions and start-ups in our target markets, earning them leadership positions in large, highly fragmented industries. ORTHOTICS AND PROSTHETICS Technology leadership in O&P is not an abstract concept. For our patients, a brace or an artificial limb is the means for reestablishing a full and productive life. NovaCare's purpose is to effectively meet the rehabilitation and health care needs of our patients through clinical leadership. They come to us to receive the best and they get it. NovaCare is recognized worldwide for technology that improves our patients' quality of life. Our research has produced prosthetics that can feel hot and cold and pressure, myoelectric devices that enable amputees to open and close their hands at will, and our unique Sabolich(R) socket system that offers comfort, a secure fit, and maximum functionality. Because of our clinical and technological leadership, NovaCare commands a 16% market share in O&P patient care services, twice the size of our largest competitor, in a highly fragmented, $1.6 billion industry. Over the past six years, through acquisitions and internal growth, we have built a 365-site network in 37 states, serving 4,900 patients each day. In fiscal 1998, O&P revenues increased 56% to $252 million -- reflecting 4% same market growth and 42 acquisitions. Orthotics and prosthetics is a growing market. Diabetes and vascular disease are the leading causes of amputation, and an aging population increases demand. Referrals come from vascular and orthopedic surgeons, primary care physicians, case managers at payer organizations and amputee support groups. Our services extend beyond technology to the individual care and concern that each patient and family receives, including clinical evaluation and fitting, training, and follow-up care. We are advocates for our patients -- linking them to other patients, coordinating with case managers, and in many cases, forming life-long relationships between patients and prosthetists. We continue to receive high marks from our patients, with 93% giving us the highest ratings in patient satisfaction. We expect continued gains in fiscal 1999, based on our focus on clinical excellence, research and training. Our objective is to strengthen our leadership position with focused acquisitions, new clinics and enhanced same store growth. We will capitalize on our technology leadership in an industry where clinical superiority produces a clear competitive advantage. NOVACARE'S LEADERSHIP IN ORTHOTIC AND PROSTHETIC SERVICES IS A DIRECT RESULT OF TECHNOLOGICAL INNOVATIONS, LIKE THE MYOELECTRIC DEVICES WORN BY THE PILOT ON THE COVER OF THIS REPORT AND THE SABOLICH SOCKET TECHNOLOGY SHOWN AT THE LEFT. 7 10 18 THOUSAND NOVACARE PROVIDES EMPLOYERS WITH AN INTEGRATED PACKAGE OF SERVICES THAT RETURNS EMPLOYEES TO WORK SAFELY AND QUICKLY. WORKING WITH THE TOWN GOVERNMENT AND SCHOOL DISTRICT OF WEST HARTFORD, CONNECTICUT, WE REDUCED BY 30% THE NUMBER OF WORKERS' COMPENSATION CLAIMS RESULTING IN DAYS AWAY FROM WORK. HARNESSING CHANGE TO ACHIEVE LEADERSHIP AND PERFORMANCE 11 HELPING MAKE LIFE A LITTLE BETTER OUTPATIENT PHYSICAL THERAPY AND REHABILITATION Our network of 506 outpatient physical therapy and rehabilitation centers is the second largest in the United States. NovaCare utilizes a sports medicine approach to rehabilitate patients and manage recovery from orthopedic surgery, injuries and disease-related conditions. Quality clinical care and cost-effective outcomes are critical to success in this $6 billion industry, which serves a broad base of customers -- from physicians and payers to employers and professional sports teams. NovaCare rehabilitates and conditions athletes in more than 300 high schools and for 20 professional teams, including the Philadelphia Eagles, Flyers and 76ers, Indiana Pacers and Atlanta Falcons, to name a few. Together with our support of organizations for the disabled and local charitable events, these relationships contribute to strong brand identity in our markets. A target market strategy is particularly important in outpatient physical therapy and rehabilitation. By establishing a large and easily accessible network of sites, we offer convenience and consistent service to our customers and create leverage in negotiations with payers. Consolidation is also the key to achieving scale that creates margin opportunity and leverages investments in brand visibility. We have been disappointed in same market growth in this business. We are realigning and expanding our field management to better focus on the unique needs of our customers and improve performance. In fiscal 1998 our outpatient rehabilitation revenues increased 23%, on the strength of local market relationships, the addition of managed care contracts, 43 acquisitions and 40 start-ups in target markets. We anticipate continued strong growth in fiscal 1999 as we augment same market growth with start-ups and acquisitions in target markets. OCCUPATIONAL HEALTH Work-related injuries and illnesses cost U.S. businesses $70 billion annually in medical and legal expenses and lost productivity -- and these costs have risen 200% over 10 years. The key to reducing these costs is an effective work safety program, comprising pre-employment testing, work-site assessment, training and an aggressive injury treatment program that returns employees to work in a manner consistent with the short and long-term health and productivity of the worker. Traditionally, employers have looked to a myriad of providers to deliver these services or they have surrendered the choice of care providers to the employee. Through our occupational health business, NovaCare offers the employer and employee a fully integrated service that promotes safety and provides care intervention on an expedited basis to reduce lost workdays. Our expansion into occupational health is a natural extension of our outpatient rehabilitation business, where one quarter of revenues comes from the treatment of work-related injuries. With 39 facilities in seven states, NovaCare's occupational health revenues tripled in fiscal 1998. We expect similar growth in 1999 through a combination of same market growth, new facility start-ups and acquisitions -- in a rapidly growing industry with an estimated $30 billion market potential. NOVACARE TREATS 18,000 PATIENTS PER DAY IN COST-EFFECTIVE OUTPATIENT SETTINGS, INCLUDING PHYSICAL THERAPY AND REHABILITATION FACILITIES, ORTHOTIC AND PROSTHETIC TREATMENT CENTERS AND OCCUPATIONAL HEALTH CLINICS. OCCUPATIONAL HEALTH IS OUR NEWEST AND FASTEST GROWING OUTPATIENT BUSINESS. 9 12 64 THOUSAND NOVACARE'S REPUTATION IS FOUNDED ON CLINICAL EXCELLENCE AND ACCOUNTABILITY FOR OUTCOMES. THE SUCCESS OF VIGOR(SM), OUR REHABILITATION AND WELLNESS PROGRAM FOR SENIORS, DEVELOPED IN PARTNERSHIP WITH NAUTILUS(TM), CONTRIBUTES TO OUR LEADERSHIP IN SERVING THE ASSISTED LIVING INDUSTRY. HARNESSING CHANGE TO ACHIEVE LEADERSHIP AND PERFORMANCE 13 HELPING MAKE LIFE A LITTLE BETTER LONG-TERM CARE SERVICES In today's long-term care industry, exceptional opportunity is veiled by the uncertainty of change. In July 1998, Medicare began a yearlong transition to a prospective payment system (PPS) which employs managed care techniques to control costs. Instead of reimbursing nursing homes for their actual costs, the new system is based on predetermined daily rates that vary with the condition of patients and the extent of care they require. With PPS, therapy utilization in long-term care facilities is expected to decline from current levels. At the same time, PPS introduces administrative complexities arising from patient assessments, utilization management and documentation. The need for cost-effective, just-enough, just-in-time rehabilitation -- coupled with administrative support and reimbursement expertise -- is prompting an increasing number of facilities to outsource therapy. Of the 18,000 long-term care facilities in the United States today, only 4,100 are affiliated with large national chains with scale sufficient to provide rehabilitation services with their own full-time staff. Our customer base comprises the remaining 13,900 facilities operated by smaller chains, not-for-profit organizations, and sole proprietors. These customers require a quality rehabilitation program to attract patients along with variable costs that rise and fall in direct proportion to their caseload. NovaCare has made the investments in operations and systems required to achieve the lowest cost operating model in our industry in anticipation of the move to PPS. In fiscal 1999, we will convert our clinical delivery model from one characterized by a high concentration of one-on-one therapy by licensed professionals to a model characterized by therapy teams that treat patients simultaneously and rely more heavily on well-trained, supervised therapy assistants and aides. Ultimately, we expect that the clinical service model employed by our long-term care services will closely resemble the model currently utilized by our outpatient physical therapy and rehabilitation business where we have successfully served our managed care customers. But cost control is only one dimension of the new PPS-driven marketplace. Facility success under PPS will also require sophisticated management information systems. Our proprietary system, NovaNet PLUS, provides our customers with the tools required to manage caseload, costs and outcomes while attracting patients who match the facility's cost structure and capabilities. For many long-term care providers who cannot develop these systems profitably on their own, NovaCare's outsourcing solution is an obvious choice. For NovaCare, the move to PPS is an enormous opportunity to increase market share. We enjoyed record sales in fiscal 1998. In 1999, we will continue our aggressive marketing to the hospital and long-term care industries, and expand our sales team in anticipation of continued strong demand. During 1998, we also extended our leadership to the rapidly expanding assisted living industry, with rehabilitation programs in more than 110 facilities. Our success in assisted living is based in part on our unique Vigor(SM) program for seniors. Vigor continues to enjoy strong demand from facilities that wish to offer clinically differentiated rehabilitation as well as health and wellness programs to their communities. Long-term care is a growing market. According to the Census Bureau, the percentage of the U.S. population over age 65 is expected to increase 18% from 1996 to 2010, and 75% from 2010 to 2030. That means an ever-increasing incidence of stroke, diabetes and orthopedic conditions requiring rehabilitation and long-term care. As the market grows and the rules change, NovaCare remains at the forefront - -- leveraging 13 years of experience to meet the demands of a growing number of older Americans for active and fulfilling lives. ADMISSION AND DISCHARGE SCORES DOCUMENT THE PROGRESS OF A 67-YEAR-OLD STROKE PATIENT WHO REGAINED SUFFICIENT FUNCTIONAL INDEPENDENCE FOLLOWING REHABILITATION TO RETURN HOME TO HIS FAMILY. OUR DATABASE OF 64,000 GERIATRIC OUTCOMES IS THE LARGEST IN THE U.S. 11 14 52 MILLION ALLIANCES WITH BUSINESS ORGANIZATIONS HELP NOVACARE BUILD A STRONG BRAND IDENTITY IN EMPLOYEE SERVICES. CHARLES P. PIZZI IS VICE CHAIRMAN OF THE AMERICAN CHAMBER OF COMMERCE EXECUTIVES AND PRESIDENT OF THE GREATER PHILADELPHIA CHAMBER OF COMMERCE, WHICH ENDORSED NOVACARE EMPLOYEE SERVICES AS A PREFERRED SOURCE FOR ITS 6,000 MEMBERS. HARNESSING CHANGE TO ACHIEVE LEADERSHIP AND PERFORMANCE 15 HELPING MAKE LIFE A LITTLE BETTER EMPLOYEE SERVICES In today's knowledge-based marketplace, successful companies compete for talented employees with the same zeal once reserved for snaring a prized customer from a rival. Unfortunately, it's a battle that many small and medium-sized businesses are ill-equipped to fight on their own. According to a recent survey commissioned by NovaCare Employee Services (NCES) and conducted by Roper Starch Worldwide, attracting and retaining employees are among the greatest challenges facing small and medium-sized employers today. Increasingly, these employers are looking for solutions that can help them provide the benefits of a large company -- while allowing them to retain the agility and energy of a small enterprise. Smaller business owners also seek convenience. They spend nearly 20% of their time on human resource (HR) issues -- time they would rather spend on running their businesses. They want fewer hassles and one-stop shopping for their HR needs, and in today's regulatory environment, they want the peace of mind that comes from having expert advice. In NCES they have found a strong partner. NCES is the second largest and fastest growing professional employer organization (PEO) in the United States. PEOs provide businesses with comprehensive, fully integrated outsourcing for a wide range of HR issues, including payroll, risk management, benefits administration, unemployment services and human resources consulting. The employee services business leverages NovaCare's competencies in human resource management, information technology, acquisitions and integration -- in an emerging industry where market potential is estimated at $1.2 trillion. Our same market growth in fiscal 1998 was 36% -- well above the industry growth rate of 30%. We have been successful in leveraging the NovaCare brand in target markets. Alliances with trade groups like the Florida Home Builders Association and the Greater Philadelphia Chamber of Commerce have substantially shortened the sales cycle and helped us establish leadership positions very quickly. We supplemented our strong internal growth with market openings and focused acquisitions in selected markets. Last year we entered four new markets -- two via start-ups and two through acquisitions. It is our plan to enter approximately four new markets each year. As we seek to create the leading national brand in employee services, we are pursuing a strategy of Operational Excellence. NCES is achieving a reputation and a track record as a responsive and accountable partner with advanced systems, efficient operations and few errors. Our client retention rate, at 86% in fiscal 1998, is among the highest in the industry. By outsourcing to NCES, customers benefit from specialized expertise and broader human resource benefits and services to offer employees, at a cost generally unavailable to smaller employers. Management is relieved of distractions and is able to concentrate on running the core business. According to the NovaCare-sponsored Roper survey, awareness of employee services companies is not widespread. Those perceptions will change as more and more employers realize that PEO outsourcing is the best solution to a perpetual business challenge. FIFTY-TWO MILLION U.S. WORKERS ARE EMPLOYED BY BUSINESSES WITH FEWER THAN 500 EMPLOYEES. BY OUTSOURCING HUMAN RESOURCE MANAGEMENT TO NOVACARE, SMALLER COMPANIES ARE ABLE TO PROVIDE BENEFIT PLANS COMPARABLE TO THOSE OFFERED BY LARGE EMPLOYERS. TODAY NOVACARE EMPLOYEE SERVICES MANAGES 52,000 EMPLOYEES FOR ITS CUSTOMERS. 13 16 WE FOCUS ON (15) FIFTEEN TARGET MARKETS - - 35% SHARE IN LONG-TERM CARE SERVICES - - 29% SHARE IN OUTPATIENT PHYSICAL THERAPY AND REHABILITATION - - 18% SHARE IN ORTHOTIC AND PROSTHETIC SERVICES Local relationships drive market share in today's health care marketplace...and market share drives profitability. That's why NovaCare concentrates primarily on 15 target markets, instead of trying to develop a broad national presence. Minneapolis is one of NovaCare's largest target markets. Over the past five years, strategic acquisitions and strong local relationships have helped us build a network of 25 outpatient physical therapy and rehabilitation centers, eight orthotic and prosthetic patient care centers, 33 long-term care services customers, and three Vigor(SM) programs in this market. In 1999, we intend to establish an occupational health presence. Our concentration of talent, resources and facilities translates into strong brand recognition in Minneapolis among patients, employers, providers and payers. NovaCare's clinical orientation and our reputation for superior, cost-effective outcomes make us a preferred provider in the complex web of referrals that makes up the local health care community. PATIENTS IN HEALTH PARTNERS, ONE OF MINNEAPOLIS' LARGEST PROVIDER NETWORKS, RANK NOVACARE HIGH IN HELPING THEM MEET THEIR TREATMENT GOALS. NOVACARE ACHIEVES THESE QUALITY OUTCOMES COST-EFFECTIVELY -- WITH FEWER VISITS PER PATIENT THAN OTHER PROVIDERS IN THE MARKET. 17 N O V A C A R E I N C DIRECTORS Peter O. Crisp Vice Chairman Rockefeller Financial Services, Inc. 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 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 Dean Emeritus, Harvard Medical School SENIOR MANAGEMENT Richard S. Binstein Acting General Counsel and Secretary Susan J. Campbell Vice President Investor Relations Daryl A. Dixon President and General Manager Long-Term Care Services 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. Kathryn P. Kehoe Vice President Human Resources Laurence F. Lane Senior Vice President Regulatory Affairs James W. McLane President and Chief Operating Officer Raymond J. Pennacchia Vice President Marketing Communications Barry E. Smith Vice President, Controller and Chief Accounting Officer Steven M. Wise Senior Vice President Information Systems and Chief Information Officer CORPORATE HEADQUARTERS NovaCare, Inc. 1016 West Ninth Avenue King of Prussia, PA 19406 (800) 331-8840 Online addresses: www.novacare.com www.novacaresabolich.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 Investor Relations (610) 992-7495 To receive faxed copies of press releases, investors may call: (800) 758-5804 and enter extension # 613069 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 18 NovaCare, Inc. 1016 West Ninth Avenue King of Prussia, PA 19406 www.novacare.com EX-21 6 SUBSIDIARIES OF THE COMPANY 1 EXHIBIT 21 Subsidiary Name Only Listing A.D. Craig Company ASK Colorado Health Care Services, P.C. Advance Orthotics, Inc. Advanced Orthopedic Systems, 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. Advanced Orthotics and Prosthetics, Inc. Affiliated Physical Therapists, Ltd. American Rehabilitation Center, Inc. American Rehabilitation Clinic, Inc. American Rehabilitation Systems, Inc. Artificial Limb and Brace Center Athens Sports Medicine Clinic, Inc. Ather Sports Injury Clinic, Inc. Atlanta Prosthetics, Inc. Atlantic Health Group, Inc. Atlantic Rehabilitation Services, Inc. Boca Rehab Agency, Inc. Bowman-Shelton Orthopedic Service, Incorporated Buendel Physical Therapy, Inc. C.E.R. - West, Inc. C.O.A.S.T. Institute Physical Therapy, Inc. CMC Center Corporation CMC Occupational Medical Center, Professional Corporation Cahill Orthopedic Laboratory, Inc. Cannon & Associates, Inc. Cenla Physical Therapy & Rehabilitation Agency, Inc. Center for Evaluation & Rehabilitation, Inc. 2 Center for Physical Therapy & Sports Rehabilitation, Inc. CenterTherapy, Inc. Central Valley Prosthetics & Orthotics, Inc. Certified Orthopedic Appliance Co., Inc. Champion Physical Therapy, 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. E.A. Warnick-Pomeroy Co., Inc. Elk County Physical Therapy, Inc. Employee Benefits Management, Inc. Employers' Risk Management, Inc. Fine, Bryant & Wah, Inc. Francis Naselli, Jr. & Stewart Rich Physical Therapists, Inc. Frank J. Malone & Son, Inc. Fresno Orthopedic Company GP Therapy, L.L.C. Gallery Physical Therapy Center, Inc. Georgia Health Group, Inc. Georgia Physical Therapy of West Georgia, Inc. Georgia Physical Therapy, Inc. Gill/Balsano Consulting, L.L.C. 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. Hangtown Physical Therapy, Inc. Hawley Physical Therapy, Inc. Heartland Rehabilitation, Inc. High Desert Institute of Prosthetics and Orthotics Indianapolis Physical Therapy and Sports Medicine, Inc. Industrial Health Care Company, Inc. J. E. Hanger, Incorporated JOYNER SPORTS SCIENCE INSTITUTE, Inc. JOYNER SPORTSMEDICINE INSTITUTE, INC. Jim All, Inc. Joyner Sportsmedicine, P.C. Joyner/Wendt-Bristol, L.L.C. Kesinger Physical Therapy, Inc. Kroll's, Inc. Lester OSM, P.C. 3 Lynn M. Carlson, Inc. Marilyn Hawker, Inc. Mark Butler Physical Therapy Center, Inc. McFarlen & Associates, Inc. McKinney Prosthetics/Orthotics, Inc. Meadowbrook Orthopedics, Inc. MedStat, P.C. Medical Arts O&P Services, Inc. Medical Plaza Physical Therapy, Inc. Metro Rehabilitation Services, Inc. Michigan Therapy Centre, Inc. MidAtlantic Health Group, 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. NCES Finance, Inc. NCES Holdings, Inc. NCES Licensing, Inc. New England Health Group, Inc. New Mexico Physical Therapists, Inc. Northeast Physical Therapy, P.C. 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. NovaCare Employee Services West, Inc. NovaCare Employee Services of America, Inc. NovaCare Employee Services of Boston, Inc. NovaCare Employee Services of Florida, Inc. 4 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 Occupational Health Services, 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. NovaCare Rehab Agency of Arkansas, Inc. 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 Reno, Inc. NovaCare Rehab Agency of San Diego, 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. 5 NovaStock, Inc. OSI Midwest, Inc. Opus Care, Inc. Ortho East, Inc. Ortho Rehab Associates, Inc. Ortho-Fab Laboratories, Inc. Orthopedic Appliances, Inc. Orthopedic Rehabilitative Services, Ltd. Orthopedic and Sports Physical Therapy of Cupertino, Inc. Orthotic & Prosthetic Rehabilitation Technologies, Inc. Orthotic Specialists, Inc. Orthotic and Prosthetic Associates, Inc. Paralign Staffing Technologies, Inc. Peter Trailov R.P.T. Physical Therapy Clinic, Orthopaedic Rehabilitation & Sports Medicine, Ltd. Peters, Starkey & Todrank Physical Therapy Corporation Philadelphia Occupational Health, P.C. Physical Focus, Inc. Physical Rehabilitation Partners, Inc. Physical Restoration Laboratories, Inc. Physical Therapy Enterprises, Inc. Physical Therapy Institute, Inc. Professional Insurance Planners of Florida, Inc. Professional Orthotics and Prosthetics, Inc. Professional Orthotics and Prosthetics, Inc. of Santa Fe Professional Therapeutic Services, Inc. Progressive Orthopedic Prosthetics-Orthotics Associates, Inc. Protech Orthotic and Prosthetic Center, 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. Rehab Provider Network - California, Inc. Rehab Provider Network - Delaware, Inc. Rehab Provider Network - Georgia, Inc. Rehab Provider Network - Illinois, Inc. 6 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. 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. Rehabilitation Management, Inc. Reid Medical Systems, 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. South Jersey Rehabilitation and Sports Medicine Center, Inc. Southern Illinois Prosthetic & Orthotic of Missouri, Ltd. Southern Illinois Prosthetic & Orthotic, Ltd. Southpointe Fitness Center, Inc. Southwest Emergency Associates, Inc. Southwest Medical Supply Company, Inc. Southwest Physical Therapy, Inc. 7 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. Stephenson-Holtz, Inc. T.D. Rehab Systems, 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. Treister, Inc. Tucson Limb & Brace, Inc. Union Square Center for Rehabilitation & Sports Medicine, Inc. University Orthotic & Prosthetic Consultants, Ltd. Valley Group Physical Therapists, Inc. Vanguard Rehabilitation, Inc. Wayzata Physical Therapy Center, Inc. West Side Physical Therapy, Inc. West Suburban Health Partners, Inc. Western Missouri Rehabilitation Services, Inc. Western Rehab Services, Inc. Worker Rehabilitation Services, Inc. Yuma Rehabilitation Center, Inc. EX-23 7 CONSENT OF INDEPENDENT ACCOUNTANTS 1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 33-88744, 33-88745 and 33-88746) of NovaCare, Inc. of our report dated July 31, 1998 appearing on page 55 of this form 10-K. We also consent to the incorporation by reference of our report on the Financial Statement Schedule, which appears on page 55 of this Form 10-K. PricewaterhouseCoopers LLP Philadelphia, PA September 11, 1998 EX-27 8 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM (A) THE CONSOLIDATED BALANCE SHEET AS OF JUNE 30, 1998 AND THE CONSOLIDATED STATEMENT OF OPERATIONS FOR THE TWELVE MONTHS ENDED JUNE 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH (B) STATEMENTS IN FORM 10-K FOR THE ANNUAL PERIOD ENDED JUNE 30, 1998. 0000802843 NOVA CARE, INC. 1,000 U.S. DOLLARS YEAR JUN-30-1998 JUL-01-1997 JUN-30-1998 1 32,760 0 393,388 55,060 38,207 451,853 181,306 100,449 1,356,042 226,080 476,308 0 0 679 579,994 1,356,042 0 1,671,925 0 1,516,559 5,628 21,907 28,285 99,546 41,631 57,915 0 0 0 57,915 .94 .91 "TOTAL COSTS" CONSIST OF COST OF SERVICES AND SELLING AND ADMINISTRATIVE EXPENSES. "OTHER EXPENSES" CONSIST OF AMORTIZATION OF GOODWILL, MINORITY INTEREST AND PROVISION FOR RESTRUCTURE OFFSET BY INVESTMENT INCOME AND GAIN FROM ISSUANCE OF SUBSIDIARY STOCK.
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