1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended August 31, 1996 Commission File Number 0-19294 REHABCARE GROUP, INC. (Exact name of Registrant as specified in its charter) Delaware 51-0265872 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 7733 Forsyth Boulevard, Suite 1700, St. Louis, MO 63105 (Address of principal executive offices and Zip Code) 314-863-7422 (Registrant's telephone number, including area code) Indicate by check mark 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 the number of shares outstanding of the Registrant's common stock, as of the latest practicable date. Class Outstanding at October 9, 1996 Common Stock, par value $.01 per share 4,678,598 2 REHABCARE GROUP, INC. Index Part I. - Financial Information Item 1. - Condensed Consolidated Financial Statements Condensed consolidated balance sheets, August 31, 1996 (unaudited) and February 29, 1996 3 Condensed consolidated statements of earnings for the three months and six months ended August 31, 1996 and 1995 (unaudited) 4 Condensed consolidated statements of cash flows for the six months ended August 31, 1996 and 1995 (unaudited) 5 Notes to condensed consolidated financial statements (unaudited) 6 Item 2. - Management's Discussion and Analysis of Financial Condition and Results of Operations 8 Part II. - Other Information Item 1. - Legal Proceedings 10 Item 6. - Exhibits and Reports on Form 8-K 11 Signatures 12 3 PART 1. - FINANCIAL INFORMATION Item 1. - Condensed Consolidated Financial Statements REHABCARE GROUP, INC. Condensed Consolidated Balance Sheets (Dollar amounts in thousands) August 31, February 29, 1996 1996 (unaudited) Assets: Current assets: Cash and cash equivalents $ -- $ 6,174 Marketable securities 2,995 4,495 Accounts receivable, net of allowance for doubtful accounts of $1,765 and $822 22,222 10,847 Deferred tax assets 1,932 1,596 Prepaid expenses and other current assets 527 473 Total current assets 27,676 23,585 Marketable securities, non-current 1,202 497 Equipment and leasehold improvements, net 3,118 1,601 Other assets: Excess of cost over net assets acquired, net 45,419 27,085 Deferred contract costs, net 1,566 1,661 Pre-opening costs, net 1,859 1,765 Deferred tax assets 771 577 Other 629 295 Total other assets 50,244 31,383 $ 82,240 $ 57,066 Liabilities and Stockholders' Equity: Current liabilities: Revolving credit facility $ 700 $ -- Current portion of long-term debt 3,093 2,093 Accounts payable 3,548 1,788 Accrued salaries and wages 9,110 5,326 Accrued expenses 1,848 1,123 Income taxes payable 1,402 1,437 Total current liabilities 19,701 11,767 Deferred compensation 1,781 1,370 Long-term debt, less current portion 16,245 5,032 Stockholders' equity: Common stock, $.01 par value; authorized 20,000,000 shares, issued 4,663,134 shares and 4,517,816 shares, respectively 47 45 Additional paid-in capital 22,442 20,043 Retained earnings 22,024 18,809 Total stockholders' equity 44,513 38,897 $ 82,240 $ 57,066 See notes to condensed consolidated financial statements. 4 REHABCARE GROUP, INC. Condensed Consolidated Statements of Earnings (Amounts in thousands, except per share data) (Unaudited) Three Months Ended Six Months Ended August 31, August 31, 1996 1995 1996 1995 Operating revenues $30,888 $22,470 $61,888 $44,453 Costs and expenses: Operating expenses 22,111 16,489 44,246 32,450 General and administrative 4,864 2,913 9,984 5,882 Depreciation and amortization 817 612 1,626 1,211 Total costs and expenses 27,792 20,014 55,856 39,543 Operating earnings 3,096 2,456 6,032 4,910 Interest income 39 62 101 114 Interest expense (363) (203) (750) (409) Other income(expense) (2) 7 10 14 Earnings before income taxes 2,770 2,322 5,393 4,629 Income taxes 1,117 948 2,178 1,896 Net earnings $ 1,653 $ 1,374 $ 3,215 $ 2,733 Net earnings per common and common equivalent share: Primary $ .34 $ .30 $ .66 $ .60 Assuming full dilution $ .33 $ .30 $ .64 $ .59 Weighted average number of common and common equivalent shares outstanding: Primary 4,892 4,631 4,874 4,572 Assuming full dilution 5,186 4,652 5,181 4,650 See notes to condensed consolidated financial statements. 5 REHABCARE GROUP, INC. Condensed Consolidated Statements of Cash Flows (Amounts in thousands) (Unaudited) Six Months Ended August 31, 1996 1995 Cash flows from operating activities: Net earnings $ 3,215 $ 2,733 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 1,626 1,211 Provision for losses on accounts receivable 392 205 Deferred compensation 411 346 Decrease (increase) in accounts receivable (4,260) 731 Decrease (increase) in prepaid expenses and other current assets 257 (93) Decrease in other assets 54 133 Decrease in accounts payable and accrued expenses (499) (10) Increase in accrued salaries and wages 956 462 Decrease in income taxes payable (718) (255) (1,781) 2,730 Net cash provided by operating activities 1,434 5,463 Cash flows from investing activities: Additions to equipment and leasehold improvements, net (630) (155) Deferred contract costs (228) (165) Purchase of investments (1,020) (2,597) Proceeds from sale/maturities of investments 1,815 10 Pre-opening costs (382) (461) Acquisition of business, net of cash received (5,300) -- Repayment of advance to affiliate 265 -- Net cash used in investing activities (5,480) (3,368) Cash flows from financing activities: Payments on revolving credit facility, net (1,300) -- Payments on long-term debt (1,037) (2,027) Other 209 59 Net cash used in financing activities (2,128) (1,968) Net increase (decrease) in cash and cash equivalents (6,174) 127 Cash and cash equivalents at beginning of period 6,174 3,226 Cash and cash equivalents at end of period $ 0 $ 3,353 See notes to condensed consolidated financial statements. 6 REHABCARE GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1. - Basis of Presentation The condensed consolidated balance sheets and related condensed consolidated statements of earnings and statements of cash flows contained in this Form 10-Q, which are unaudited, include the accounts of the Company and its wholly owned subsidiaries, RehabCare Outpatient Services, Inc.(formerly Physical Therapy Resources, Inc.) and Healthcare Staffing Solutions, Inc. d/b/a Health Tour ("Health Tour"). All significant intercompany accounts have been eliminated in consolidation. In the opinion of management, all adjustments necessary for a fair presentation of such financial statements have been included. Adjustments consisted only of normal recurring items. The results of operations for the six months ended August 31, 1996, are not necessarily indicative of the results to be expected for the full fiscal year. The condensed consolidated financial statements do not include all information and footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with generally accepted accounting principles. Reference is made to the Company's audited consolidated financial statements and the related notes as of February 29, 1996 and February 28, 1995 and for each of the years in the three-year period ended February 29, 1996, included in the Annual Report on Form 10-K on file with the Securities and Exchange Commission, which provide additional disclosures and a further description of accounting policies. Note 2. - Contingencies The Company, together with Comprehensive Care Corporation ("CompCare"), its former parent, is undergoing a Federal payroll tax audit for the years 1989 through 1993. The Internal Revenue Service ("IRS") has asserted that certain medical professionals and others engaged as independent contractors by CompCare and the Company should have been treated as employees for payroll tax purposes. The IRS, in May 1996, issued a proposed assessment against the Company of $1,935,455 for years 1989 through 1993. The Company subsequently received from the IRS separate proposed Closing Agreements for these same independent contractors under the IRS's new "Classification Settlement Program" with an alternate aggregate assessment of $253,426 covering the 1989 through 1993 audit, including any additional potential liability through September 30, 1991. The Company is currently evaluating whether to accept any of the settlement offers and as a result, change its classification policy as required by the Closing Agreement, or to continue to defend its current practice. While the Company believes it has arguments to support its current position, there can be no assurance that the Company will prevail in whole or in part. Pursuant to terms of a settlement reached with CompCare in February 1996, in satisfaction of a lawsuit previously filed by the Company with regard to a tax sharing agreement between the Company and CompCare, entered into in conjunction with the Company's initial public offering in 1991, CompCare has agreed to pay the Company 72.5% of any loss and costs incurred after December 31, 1995 related to the employment tax issue for years 1989 through February 1991. On October 30, 1992, CompCare filed an action against the Company with the Federal District Court for the Eastern District of Missouri alleging fraud by the Company under the common law and the Federal securities laws in the 7 negotiation of the Stock Redemption Agreement dated September 1, 1992, by and between CompCare and the Company. The action sought both actual and punitive monetary damages from the Company. On March 8, 1995, a Federal court jury returned a verdict against the Company on three of the six counts of the lawsuit in the amount of $2,681,250. No punitive damages were awarded. The Company believes each of the verdicts against it is erroneous and, that it has meritorious legal defenses. Appellate arguments were heard on June 10, 1996, before a three-judge panel of the Eighth Circuit Court of Appeals. No decision has yet been rendered in connection with such appeal; therefore, the Company and its counsel have determined that it is not possible to estimate the amount of damages, if any, that may ultimately be incurred. As a result, no provision has been made in the consolidated financial statements with respect to this matter. The Company has purchased a $3,000,000 supersedeas bond to obtain a stay of execution on any proceedings by CompCare to enforce the judgement. The bond is backed by a bank letter of credit. Note 3. - Acquisition On March 1, 1996, the Company purchased 100% of the capital stock of Health Tour. The aggregate purchase price of $21,450,000 paid at closing included $13,250,000 in cash, a $6,000,000 ten-year convertible subordinated promissory note, and 123,530 shares of the Company's common stock. Additional consideration will be paid to the former Health Tour stockholders contingent upon the attainment of certain target cumulative earnings before interest and income taxes up to a maximum of $8,650,000 in additional consideration over six years. The acquisition has been accounted for by the purchase method of accounting, whereby the operating results of Health Tour are included in the Company's results of operations commencing on the date of acquisition. Goodwill related to the acquisition totaling $19.1 million is being amortized over 40 years. The following unaudited pro forma financial information assumes the acquisition of Health Tour occurred at the beginning of the six-month period ended August 31, 1995. This information is not necessarily indicative of results of operations that would have occurred had the purchase been made at the beginning of such periods presented. Six Months Ended August 31, 1996 August 31, 1995 Operating revenues $ 61,888,000 $ 57,488,000 Net earnings 3,215,000 3,020,000 Net earnings per common and common equivalent share: Primary $ .66 $ .64 Assuming full dilution $ .64 $ .62 On March 1, 1996 as part of the acquisition of Health Tour, the Company's bank term loan and revolving credit facility were restructured. Under the terms of the restructured loan agreement, the Company entered into a five-year, $10,000,000 bank term loan which bears interest, at the Company's option, at the bank's CBR, or LIBOR plus from 1.375% to 1.875%, or a combination of the two, such rates being dependent on the ratio of the Company's available credit to cash flow. The amount that may be borrowed under the revolving credit facility was increased to the lesser of $14,000,000 or 85% of eligible accounts receivable, reduced by amounts outstanding under the Company's bank letter of credit. The revolving credit facility will terminate with the balance payable on April 30, 1998. Advances under the revised revolving credit facility will 8 bear interest at the Company's option of either LIBOR plus 1.125% to 1.625%, or the bank's CBR as of the date of the advance, with such rates being dependent on the ratio of the Company's available credit to cash flow. As of August 31, 1996 the Company's borrowings under the revolving credit facility totaled $3,200,000 of which $2,500,000 is classified as long-term debt and a letter of credit was outstanding in the amount of $3,000,000. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations The Company provides physical medicine, rehabilitation and chronic care services in a variety of settings under multi-year contracts with acute-care hospitals. These settings include distinct-part acute rehabilitation units that may or may not be exempt from the Medicare Prospective Payment System (PPS), depending on their stage of development; subacute units that are operated within licensed skilled nursing units; and outpatient clinics, both on and off campus of the host hospital. The Company also is a contract provider of therapists on a temporary basis to hospitals and long-term care and rehabilitation facilities. Three Months Ended Six Months Ended Operating Statistics August 31, August 31, 1996 1995 1996 1995 Inpatient Units (Acute and Subacute) Average bed capacity 1,814 1,674 1,805 1,645 Average billable length of stay (days) 15.8 17.4 16.0 17.6 Billable patient days served 105,149 102,764 209,572 203,914 Admissions 6,645 5,897 13,110 11,613 Average daily billable census 1,143 1,117 1,139 1,108 Average occupied beds per unit 12.8 13.4 12.9 13.7 Total units in operation at end of period 91 85 91 85 Outpatient Clinics Patient visits 48,788 69,001 111,835 138,782 Units of service 152,222 185,222 338,203 365,242 Total clinics in operation at end of period 19 22 19 22 Three Months Ended August 31, 1996 Compared to Three Months Ended August 31, 1995 Operating revenues during the second quarter of fiscal 1997 increased by $8,418,000, or 37.5%, to $30,888,000. The acquisition of Health Tour accounted for substantially all of the net increase. A 7.6% increase in the average number of inpatient units from 84.4 to 90.8 units, offset by a decrease in the average daily billable census per inpatient unit of 4.5% from 13.2 to 12.6, generated a 2.3% increase in billable patient days at those units to 105,149 and a 2.0% increase in inpatient unit revenue. The decrease in billable census per unit for inpatient units is primarily attributable to a 9.2% decline in average length of stay on a 4.7% increase in admissions per unit. The decline in average length of stay reflects both the continued trend of reduced rehabilitation lengths of stay and the increase in subacute units operational in fiscal 1997, which carry a shorter length of stay. The increase in inpatient unit revenue was offset by a comparable decrease in outpatient revenue. 9 Operating expenses for the three-month periods compared increased by $5,622,000 or 34.1% to $22,111,000. The acquisition of Health Tour accounted for substantially all of the net increase. The excess of operating expenses over operating revenues associated with non-exempt units increased from $25,000 to $192,000, attributable to the increase in the average number of non-exempt units from 1.0 to 5.0. Average start-up losses for a unit during the non-exempt year typically range from $150,000 to $200,000. General and administrative expenses increased $1,951,000, or 67.0%, to $4,864,000, reflecting increases in professional services, operations and legal compared to the previous year, plus the addition of Health Tour's corporate staff. Interest expense increased $160,000 reflecting an increase in interest rates and interest on net new debt issued in the acquisition of Health Tour. Earnings before income taxes increased by $448,000, or 19.3%, to $2,770,000. The provision for income taxes for the second quarter of fiscal 1997 was $1,117,000, compared to $948,000 for 1996, reflecting effective income tax rates of 40.3% and 40.8% for the respective quarters. Net earnings increased by $279,000, or 20.3% to $1,653,000. Earnings per share increased 13.3% to 34 cents from 30 cents on a 5.6% increase in the weighted average shares outstanding. The increase in shares outstanding is attributable primarily to the shares issued in the acquisition of Health Tour and an increase in common stock equivalents resulting from an increase in the market price of the Company's stock relative to the underlying exercise prices of outstanding stock options. See "Liquidity and Capital Resources." Six Months Ended August 31, 1996 Compared to Six Months Ended August 31, 1995 Operating revenues during the first six months of fiscal 1997 increased by $17,435,000, or 39.2%, to $61,888,000. The acquisition of Health Tour accounted for substantially all of the increase. An 8.9% increase in the average number of inpatient units from 82.7 to 90.1 units, offset by a decrease in the average daily billable census per inpatient unit of 6.0% from 13.4 to 12.6, generated a 2.8% increase in billable patient days at those units to 209,572 and a 1.9% increase in inpatient unit revenue. The decrease in billable census per unit for inpatient units is primarily attributable to a 9.0% decline in average length of stay on a 3.6% increase in admissions per unit. The increase in inpatient unit revenue was offset by the decrease in outpatient revenue in the second quarter of fiscal 1997. The decline in average length of stay reflects both the continued trend of reduced rehabilitation lengths of stay and the increase in subacute units operational in fiscal 1997, which carry a shorter length of stay. Operating expenses for the six-month periods compared increased by $11,796,000 or 36.4% to $44,246,000. The acquisition of Health Tour accounted for $11,660,000 or 98.8% of the increase. The remaining increase was attributable to the increase in patient days. The excess of operating expenses over operating revenues associated with non-exempt units increased from $123,000 to $455,000, attributable to the increase in the average number of non-exempt units from 1.7 to 5.0. Average start-up losses for a unit during the non-exempt year typically range from $150,000 to $200,000. General and administrative expenses increased $4,102,000, or 69.7%, to 10 $9,984,000, reflecting increases in business development, operations and professional services compared to the previous year, plus the addition of Health Tour's corporate staff. Interest expense increased $341,000 reflecting the increase in interest rates and interest on net new debt issued in the acquisition of Health Tour. Earnings before income taxes increased by $764,000, or 16.5%, to $5,393,000. The provision for income taxes for the first six months of fiscal 1997 was $2,178,000, compared to $1,896,000 for 1996, reflecting effective income tax rates of 40.4% and 41.0% for the respective quarters. Net earnings increased by $482,000, or 17.6% to $3,215,000. Earnings per share increased 10.0% to 66 cents from 60 cents on a 6.6% increase in the weighted average shares outstanding. The increase in shares outstanding is attributable primarily to the shares issued in the acquisition of Health Tour and an increase in common stock equivalents resulting from an increase in the market price of the Company's stock relative to the underlying exercise prices of outstanding stock options. See "Liquidity and Capital Resources." Liquidity and Capital Resources As of August 31, 1996, the Company had $2,995,000 in cash and current marketable securities and a current ratio of 1.4:1. Working capital decreased by $3,843,000 as of August 31, 1996, compared to February 29, 1996 due to the cash tendered and debt issued in the acquisition of Health Tour. Net accounts receivable were $22,222,000 at August 31, 1996, compared to $10,847,000 at February 29, 1996. The number of days average net revenue in net receivables was 66.2 at August 31, 1996 compared to 43.9 at February 29, 1996, reflecting the addition of Health Tour's receivables, which averaged 113 days due to credit terms that typically allow payments in installments over the term of the therapists' assignments, typically 13 weeks in duration. The Company's operating cash flows constitute its primary source of liquidity and historically have been sufficient to fund its working capital and capital expansion requirements. The Company expects to meet its future working capital, capital expenditure, business expansion and debt service requirements from a combination of internal sources and outside financing. The Company has a $14,000,000 revolving line of credit and a balance outstanding as of August 31, 1996 of $3,200,000. The Company has purchased a $3,000,000 supersedeas bond to obtain a stay of execution on any proceedings by CompCare to enforce the judgment rendered in the March 1995 Federal Court jury verdict. This bond is backed by a bank letter of credit that reduces the amount the Company may borrow under the revolving line of credit by the amount of the bond. Part II. - OTHER INFORMATION Item 1. - Legal Proceedings The Company together with CompCare is undergoing a Federal Payroll tax audit for the years 1989 through 1993. The Company is also a party to a Federal Court proceeding with CompCare. See Part I, "Notes to Condensed Consolidated Financial Statements," Note 2, for further disclosure. 11 Item 6 - Exhibits and Reports on Form 8-k (a) Exhibits 27 Financial Data Schedule (b) Report on Form 8-k None 12 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. REHABCARE GROUP, INC. October 9, 1996 By /S/ John R. Finkenkeller John R. Finkenkeller Senior Vice President and Treasurer (Chief Accounting Officer) 13 EXHIBIT INDEX Page Number 27 Financial Data Schedule