1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) of the SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 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 No.) incorporation or organization) 7733 Forsyth Boulevard, 17th Floor, St. Louis, Missouri 63105 (Address of principal executive offices and zip code) Registrant's telephone number, including area code (314) 863-7422 Securities registered pursuant to Section 12(b) of the Act: Name of exchange on which registered: Common Stock, par value $.01 per share New York Stock Exchange Preferred Stock Purchase Rights New York Stock Exchange 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) The aggregate market value of voting stock held by non-affiliates of Registrant at March 10, 1999, was $102,030,058. At March 10, 1999, the Registrant had 6,527,082 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Part III of this Annual Report on Form 10-K incorporates by reference information contained in the Registrant's Proxy Statement for its annual meeting of stockholders to be held April 30, 1999. 2 PART I ITEM 1. BUSINESS General RehabCare Group, Inc. (the "Company" or the "Registrant"), is a leading manager of comprehensive medical rehabilitation, subacute (skilled nursing) and outpatient therapy programs on a multi-year contract basis and contract therapy services to hospitals and nursing homes. Therapy professionals employed by the Company include licensed physical and occupational therapists and their licensed assistants, as well as speech language pathologists. The Company believes the locus of care in the communities where it has programs will continue to be the acute-care hospital and, thus, it works primarily with acute-care hospitals to deliver these programs with the goal of enhancing the overall economic viability of the client facility. The Company's strategy is to use its expertise and experience to provide its clients with an efficient and cost-effective means to offer physical medicine and rehabilitation services in whatever setting is most economically feasible while establishing long-term relationships with its clients. Each of the product lines the Company offers is part of a post-acute continuum directed at restoring functional independence and returning patients to a residential setting. On July 31, 1998, the Company acquired Rehabilitative Care Systems of America, Inc. ("RCSA"), a manager of outpatient services for hospitals and school districts, and merged it with its outpatient division. The Company expanded on its 1997 entry into the contract therapy business through the acquisition of Therapeutic Systems, Ltd. ("Therapeutic Systems") on September 9, 1998. The Company also is a leading provider of therapists and nurses to hospitals and long-term care and rehabilitation facilities on both an interim and permanent basis. Traveling nurses and therapists are recruited and typically work on assignment for 13 weeks, while per diem therapists and nurses fill vacancies of 1 day to 13 weeks. On August 17, 1998, the Company acquired StarMed Staffing, Inc. ("StarMed"), a provider of traveling and per diem nurses. Historically, the Company has sought to broaden its service offerings, both through internal growth and acquisition. The Company believes that the acquisition of additional therapy-based contract management companies, established outpatient operators and other therapy providers within the rehabilitation industry and staffing companies is an appropriate strategy for growth. Additional related acquisition opportunities are regularly reviewed by the Company. Industry Overview Many healthcare providers are increasingly seeking to outsource a broad range of services through contracts with product line managers. Outsourcing allows healthcare providers to take advantage of the specialized expertise of contract managers, thereby enabling providers to concentrate on the businesses they know best, such as facility and nurse management. The trend toward lowering the cost of healthcare by reducing lengths of stay has left most healthcare providers with empty beds. Continued reimbursement pressures under managed care and Medicare have driven healthcare providers to look for additional sources of revenue. As overhead and operating cost constraints have come into place and manpower has been reduced, outsourcing has become more important in order to increase patient volumes and provide services at a lower cost without sacrificing quality. By outsourcing post-acute services, healthcare providers use specialty contract managers such as the Company to: 2 3 Utilize unused space - Post-acute services help hospitals utilize empty wings of their facilities, which allows the hospital to recover the cost of capital investment and overhead associated with the space. Increased volumes - Patients needing less intensive treatment or post-acute therapies who would have been referred to other venues for treatment can now remain in the hospital setting, allowing hospitals to capture revenues that would otherwise be realized by another provider. New patients are also attracted to the hospital by new services. Sign agreements with managed care organizations - Managed care organizations find it more advantageous to sign a contract covering both acute and post-acute services with one entity rather than several separate, often unrelated entities. Contract managers may provide patient evaluation systems that collect data on patients in each of their units showing the degree of improvement and the related costs from the time the patient is admitted to the post-acute program through the time of discharge. This is an important feature to managed care organizations in controlling their costs while assuring appropriate outcomes. Contract managers may often also have the ability to capture and analyze this information from a large number of acute rehabilitation and subacute units, which an individual hospital could not otherwise do on its own without a substantial investment in specialized systems. Becoming part of a managed care network helps the hospital attract physicians, and in turn, bring more patients to the hospital. Increase cost control - Because of their extensive experience in post-acute product lines, contract managers can offer pricing structures that effectively control a healthcare provider's financial risk related to the service provided. Contract managers also frequently share in the financial risks with their hospital clients of any losses the hospital incurs in connection with starting the unit and reimbursement from payors. For hospitals using contract managers, the result is often lower average costs per discharge than those of self-managed programs. A hospital is able to increase its revenues without having to increase its administrative staff or incur other fixed costs. Recruit therapists - Although the supply of therapists has greatly improved, therapists are still not readily available in many communities across the nation. Contract managers often operate tele-recruiting departments with recruiters whose job it is to match up candidates with therapist openings. They will typically maintain close connections with therapy schools and attend regional and national therapy association conferences several times a year. Obtain reimbursement advice - The contract managers may also employ reimbursement specialists who are available to assist client hospitals in interpreting complicated regulations. These specialists analyze current regulations and assist the hospital in complying with them, a highly valued service in the current changing healthcare environment. A shortage of medical professionals and providers' efforts to manage costs by maintaining flexible staffing has created opportunities for traveling and per diem staffing services. In reaction to reimbursement cuts under the Balanced Budget Act of 1997 ("BBA"), nursing homes and providers of therapists to the nursing home industry have reduced therapy staff, thus substantially reducing the demand for therapy staffing companies. In contrast, the nurse staffing business, a substantially larger market, is strong due to providers continuing to maintain variable nurse staffing levels, an increase in the average age of nurses, and an insufficient new supply of nursing graduates. Services The Company operates in two businesses that have fundamental differences in operations: program management and staffing. Program management includes the management of acute rehabilitation and skilled nursing units, outpatient programs and contract therapy services. Staffing includes both traveling (generally 13-week assignments) and per diem staffing of nurses and therapists. 3 4 Acute Rehabilitation Units - Since its inception in 1982, the Company's core business has been the staffing and management of acute rehabilitation units within acute-care hospitals. The Company operates these units on a fee basis that is computed in most cases based on patient days in the unit. The unit typically consists of 20 beds and utilizes formerly idle space in the hospital. It treats patients having primarily one of ten required diagnoses including stroke, head injury or hip replacement. The Company typically provides staffing and management of the unit including a program director, a physician, and the clinical staff which may include a psychologist, physical and occupational therapists, a speech pathologist, a social worker, a nurse manager, a case manager and other appropriate supporting personnel. The unit affords the hospital the ability to offer rehabilitation services to its patients, thus retaining those patients who might otherwise be discharged to a setting outside the hospital. This service line represented approximately 46% of the Company's revenues in 1998. The Company plans to continue growing this part of its business both through the signing of new contracts as well as through retention of current clients. Re-signings of expiring acute rehabilitation contracts have historically ranged from 80-90 percent. Subacute Units - In 1994, the Company added the subacute service line in response to client requests for management services and the Company's desire to broaden its post-acute services. The subacute unit is located in the acute-care hospital and is separately licensed as a skilled nursing unit, utilizing formerly idle space in the hospital. This unit treats the patients who are at the low end of need for medical or rehabilitative care, with greater need for nursing care. These patients' diagnoses cover approximately 60 clinical conditions including stroke, post-surgical conditions, pulmonary disease, burn, cancer, congestive heart failure and wound management. The subacute unit makes it possible for the patient to remain in a hospital setting where emergency needs can be quickly met as opposed to being sent to a freestanding skilled nursing facility. The Company provides administrative and nurse management. The hospital benefits, once again, by retaining patients who would be discharged to another setting, thereby capturing additional revenue and utilizing idle space. This service line represented approximately 7% of the Company's revenues in 1998. Due to substantially lower reimbursement rates for skilled nursing facilities and units under BBA, the Company has negotiated reduced rates for its services and expects revenues in this line of business to decline in 1999 compared to 1998. The Company believes there is still opportunity to provide its services to already existing subacute units that require professional management in order to remain economically viable under prospective payment. Outpatient Programs - The outpatient division furnishes primarily therapy, program development and administrative personnel to hospital outpatient departments, satellites and school districts. In 1998, RCSA was acquired and merged into the outpatient division. Pressure from payors to move patients to lower cost settings has helped fuel the growth in outpatient services. Outpatient programs help bring patients into the hospital through the referral development efforts in the community. These programs serve a younger population reimbursed by commercial and managed care payors and treat mainly sports medicine and workers compensation patients. The service line helps hospitals compete with freestanding clinics. The Company's programs are always conducted on the client hospital's campus or in satellite locations controlled by the hospital. In 1998, this product line represented approximately 8% of the Company's revenues. The Company plans to increase this line of business by signing additional contracts with hospitals as well as purchasing existing outpatient facilities in partnership with its hospital clients. Contract Therapy - In 1997, the Company, through acquisitions, added contract therapy to its product lines. In September 1998, the Company expanded this product line through the acquisition of Therapeutic Systems. Contract therapy is the management and delivery of services, including providing therapists, in long-term care settings. Contract therapy revenues in 1998 accounted for approximately 7% of the Company's business. Contract therapy affords the client the opportunity to fulfill their recurring need for therapists on a part-time basis without the need to add full-time staff. The introduction of a prospective payment system for skilled nursing facilities and units has created a demand for the Company's management systems and expertise, including utilization of services and controlling costs. The Company plans to grow this service line both through additional contracts as well as acquisitions. 4 5 Traveling Therapists and Nurses - In March 1996, RehabCare acquired Healthcare Staffing Solutions, Inc. ("HSSI"), located in Lowell, Massachusetts, thereby entering the therapy staffing business. Through its Health Tour division, HSSI recruits and relocates physical, occupational and speech therapists to hospitals and long-term care facilities for typically 13-week assignments (traveling therapists). The enactment of the BBA, which established a prospective payment system for skilled nursing facilities and units has significantly reduced the demand for traveling therapists. In response to this decline, HSSI entered the nurse staffing business, a market significantly larger than the therapist market. In August 1998, the Company acquired StarMed, a provider of traveling and per diem nurses, subsequently merging its traveling division, which represented 25% of StarMed's business, with HSSI's traveling therapy division. Business from traveling therapists and nurses accounted for approximately 17% of the Company's 1998 revenues. Growth of this business is planned primarily by increasing the number of traveling therapists and nurses on assignment. Per Diem Staffing - In 1997, HSSI entered the per diem staffing business which provides short-term assignments ranging from 1 day to 13 weeks to fill vacancies typically resulting from turnover, vacation, maternity and sick leave. Per diem staffing is a localized market business. The acquisition of StarMed added 35 local offices providing per diem nurse staffing. Growth of this business is planned by increasing the number of per diem offices and leveraging those offices to furnish both therapy and nurse staffing services. The per diem staffing business accounted for approximately 15% of the Company's 1998 revenues. Expansion Strategy The Company's expertise is in the management of quality acute, subacute and outpatient rehabilitation and therapy programs and contract therapy services, and in the provision of quality clinical personnel to healthcare facilities. Drawing on this expertise, the thrust of its expansion strategy will be to develop and expand contract relationships with host facilities to establish and manage acute, subacute and outpatient physical medicine and rehabilitation programs, and contract therapy services as well as increasing its per diem staffing offices and traveling nurses and therapists. Acute-care hospitals have traditionally been the locus of healthcare delivery in the community and, as such, have controlled a substantial amount of the expenditures for healthcare services. As healthcare reform evolves, the Company believes that hospitals will continue to play a central role in the delivery of healthcare services, provided that they can achieve cost efficiencies and offer a complete range of services required within their communities. To this end, the Company has positioned itself to assist hospitals in providing the full continuum of physical medicine and rehabilitation services within acute, subacute and outpatient settings controlled by the hospital. The economies of scale offered by the hospital's existing plant and equipment, coupled with the Company's expertise in delivering these services, offers the opportunity for a community hospital to be a full service provider in the area of physical medicine and rehabilitation on a cost-effective basis. Business Development The Company's program management sales force focuses on generating new accounts and making follow-on sales. It has nine regional development officers who are responsible for cultivating relationships with prospective clients. In addition, the Company's officers play an integral role in the Company's marketing efforts. With a broad range of services, the Company has significant opportunity to expand within its existing client base. Further, cross-selling more than one product line strengthens the Company's relationships with its clients. The staffing division's ability to expand its per diem offices, by controlling start-up costs and reaching profitability quickly, facilitates rapid growth. The ability to cross-sell therapy per diem staff from existing StarMed offices, and to generate leads for travel and permanent therapists, allows more efficient use of overhead. 5 6 Competition The Company's program management division has no direct competitors offering all the same program services although other companies may offer one or more of the same services. The Company competes with other contract management and therapy companies for agreements with acute-care hospitals and extended care facilities. The Company's programs in acute-care hospitals also compete for patients with the programs of other acute-care hospitals, freestanding rehabilitation, skilled nursing and outpatient facilities. Among the principal competitive advantages the Company believes it has are a reputation for quality, cost effectiveness, a proprietary outcomes management system, innovation and price. The Company also competes with hospitals, nursing homes, clinics, physicians' offices and contract therapy companies for the services of physical, occupational and speech therapists. The Company's staffing division competes with a number of private and public companies and believes its strategic advantage is its diversity of staffing solutions, ranging from single shift, to a 13 week assignment, to permanent placement, which is attractive to clients and prospective employees. Regulation The healthcare industry is regulated by Federal, state and local governmental agencies. These regulations attempt to control the number of healthcare facilities through certificate of need laws, licensure or certification of healthcare facilities and the reimbursement for healthcare services. In many states, acute-care hospitals contracting with the Company generally are not required to obtain a certificate of need prior to opening an inpatient unit. If a certificate of need is required, the process may take up to 12 months or more depending upon the state involved. The application may be denied if contested by a competitor or the state agency. Certificates of need are usually issued for a specified maximum expenditure and require implementation of the proposed improvement within a specified period of time. Licensure is a state or local requirement, while Medicare certification is a Federal requirement. Generally, licensure and Medicare certification follow specific standards and requirements. Compliance is monitored by annual on-site inspections by representatives of relevant government agencies. Loss of licensure or Medicare certification by a hospital with which the Company has a management contract would likely result in the termination of that contract. Prior to 1983, Medicare provided for reimbursement of reasonable direct and indirect costs of the services furnished by hospitals to patients. As a result of the Social Security Amendments Act of 1983, Congress adopted the Prospective Payment System ("PPS") as a means to control costs of most Medicare inpatient hospital services. Under this system, the Secretary of the Department of Health and Human Services established fixed payment amounts per discharge based on Diagnosis-Related Groups ("DRG"). In general, a hospital's payment for Medicare inpatients is limited to the DRG rate, regardless of the amount of services provided to the patient or the length of the patient's hospital stay. Under PPS, a hospital may keep any difference between its DRG payment and its operating costs incurred in furnishing inpatient services, but is at risk for any operating costs that exceed its payment rate. As a result, hospitals have an incentive to discharge Medicare patients as soon as is clinically appropriate. Inpatient rehabilitation units, skilled nursing units and outpatient rehabilitation services have historically been exempt from PPS. Acute rehabilitation units within acute-care hospitals are eligible to obtain an exemption from PPS, generally after the first year of operation, upon satisfaction of specified Federal criteria. Such criteria include the operation for a full 12 months under PPS and the completion of an initial exemption survey. The exemption survey measures compliance with certain criteria applicable to exempt units generally, including approval to participate as a Medicare provider, admission standards, record keeping, compliance with state licensure laws, segregation of beds, accounting standards and certain specific standards applicable to rehabilitation units, including staffing, medical care and patient mix. Upon successful completion of the survey, Medicare payments for 6 7 rehabilitation provided in inpatient units are made under a cost-based reimbursement system. In 1997, Congress enacted the BBA, which includes numerous changes to the Medicare system. These changes include various reductions in payments under the current cost-based reimbursement system, the implementation of a prospective payment system for skilled nursing facilities and units ("SNU-PPS") that is being phased in starting July 1998 and a prospective payment system for acute rehabilitation facilities and units to be phased in over two years starting in late 2000. By January 1, 1999, substantially all of the Company's managed subacute units were fully phased in under SNU-PPS. Although specifics of other prospective payment systems are not yet available, the changes will almost certainly favor low-cost, efficient providers. The Company believes that its strategy of administering programs on the premises of host facilities positions it well for the changing reimbursement environment. Various Federal and state laws regulate the relationship between providers of healthcare services and physicians. These laws include the "fraud and abuse" provisions of the Social Security Act, under which civil and criminal penalties can be imposed upon persons who pay or receive remuneration in return for referrals of patients who are eligible for reimbursement under the Medicare or Medicaid programs. The Company does not believe its business arrangements are out of compliance with these provisions. The provisions are broadly written and the full extent of their application is not currently known. The Inspector General of the Department of Health and Human Services has issued "safe harbor" regulations specifying certain forms of relationships that will not be deemed violations of these provisions. The Company believes that its business arrangements are in compliance with any definitive regulations. In recognition of the importance of achieving and maintaining regulatory compliance, the Company has established a Corporate Compliance Program ("Program") to establish general standards of conduct and procedures that promote compliance with business ethics, regulations, law and accreditation standards. In its design, the Company has established compliance standards and procedures to be followed by its employees and other agents that are reasonably capable of reducing the prospect of criminal conduct, and has designed systems for reporting and auditing of potentially criminal acts. A key element of the Program is the ongoing communication and training of employees and agents such that it becomes a part of the day to day business operations. A compliance committee consisting of representatives of both designated members of Company management and the Company's Board of Directors has been established to oversee implementation and ongoing operations of the Program, to enforce the Program through appropriate disciplinary mechanisms, and to ensure that all reasonable steps are taken to respond to an offense and to prevent further similar offenses. The Company is not aware of the existence of any current activities on the part of any of its employees that would not be materially in compliance with this Program and has undertaken the Program in an effort to enhance the prospects of continued compliance. Employees As of December 31, 1998, the Company had approximately 7,500 employees. The physicians who are the medical directors of the contract units are independent contractors and not employees of the Company. Nurses and therapists in the staffing division may be on either the Company's or client's payroll. None of the Company's employees are subject to a collective bargaining agreement. Management considers the relationship with its employees to be good. ITEM 2. PROPERTIES The Company currently leases 26,000 square feet of executive office space in Clayton, Missouri, under a lease that expires in the year 2008, assuming all options to renew are exercised. In addition to the monthly rental cost, the Company is also responsible for specified increases in operating costs. HSSI leases 32,000 7 8 square feet of executive office space in Lowell, Massachusetts, under a lease that expires in the year 2002, assuming all options to renew are exercised, plus leases various properties throughout the country used as temporary housing for traveling therapists and nurses. StarMed leases 9,000 square feet of executive office space in Clearwater, Florida, under a lease that expires in 2002, plus leases various office space for its per diem staffing businesses throughout the country. ITEM 3. LEGAL PROCEEDINGS Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS Information concerning the Common Stock of the Registrant is included on page 40 in this Annual Report of the Registrant for the year ended December 31, 1998. ITEM 6. SELECTED FINANCIAL DATA Six-Year Financial Summary is included on page 40 in this Annual Report of the Registrant for the year ended December 31, 1998. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company changed its fiscal year end from the last day of February to December 31, effective as of December 31, 1996. The change resulted in a short period of ten months that began March 1, 1996, and ended December 31, 1996. The growth in the Company's operating revenues and net earnings during 1998 was the result of an increase in the number of acute, subacute and outpatient programs, and growth from acquisitions. The 1998 results reflect an increase in the average number of inpatient units from 110 to 128, an increase in the average number of outpatient units managed by the Company from 18 to 26, an increase in contract therapy locations from 44 to 67, and increased nursing weeks worked due to the acquisition of StarMed. The growth for 1997 was primarily attributable to an increase in acute and subacute units plus increased therapy weeks worked at HSSI. The growth for 1996 reflects the increase in the number of subacute units and results from the acquisition of HSSI. In the normal course of business, new units are opened and some existing units are closed each year. During the first year of operation, a new acute rehabilitation unit will typically be subject to limitations in reimbursement from Medicare considerably below the hospital's operating cost. As a consequence, during this period the Company agrees with the client hospital to bear certain costs on the hospital's behalf and to waive a portion of its fees until the unit qualifies for an exemption from Medicare limitations. The Company 8 9 assists the hospital in qualifying the unit for the exemption and in minimizing the unreimbursed costs during this non-exempt period. The Company's average operating losses during the qualifying period can range to as high as $150,000 to $200,000 per unit. If the Company does not obtain an exemption for the unit, the contract may be terminated and, in the event of termination, losses would generally not be recoverable. Upon completion of the qualifying year and obtaining the exemption, the hospital is eligible to recover all of its costs related to the operation of the unit, including the Company's fees under the management contract. Once a unit becomes exempt, the unit experiences accelerated growth in operating revenues and profitability as the patient population is expanded in response to the more favorable reimbursement terms. Subacute units and outpatient programs are not subject to the same limitations in reimbursement from Medicare as acute rehabilitation units and, therefore, should result in significantly reduced start-up losses per unit. In 1997, Congress enacted changes to the Medicare regulations calling for the implementation of SNU-PPS that is being phased in commencing in July 1998. As of January 1, 1999, substantially all of the Company's managed skilled nursing units were wholly under SNU-PPS. In March 1996 the Company acquired HSSI. The aggregate purchase price of $21,450,000 paid at closing included $13,258,000 in cash, a $6,000,000 ten-year convertible subordinated promissory note and 185,295 shares of the Company's common stock. Additional consideration will be paid to the former HSSI stockholders contingent upon the attainment of certain target cumulative earnings before interest and income taxes up to a maximum of $8,800,000 in additional consideration over six years. In 1998 and 1997, $2,104,000 and $1,000,000, respectively, of additional consideration was paid to the former owners of HSSI. On January 28, 1997, the Company acquired TeamRehab, Inc. and Moore Rehabilitation Services, Inc. ("Team and Moore"), a provider of contract therapy. On June 12, 1997, the Company acquired Rehab Unlimited, Inc. and the assets of Cimarron Health Care, Inc. and merged them into Team and Moore. The aggregate purchase prices for these acquisitions paid at closing was $6,950,000, consisting of $4,275,000 in cash, $1,825,000 in subordinated promissory notes and 54,151 shares of the Company's common stock. Additional consideration will be paid to the former Team and Moore stockholders contingent upon the attainment of certain target cumulative earnings before interest and income taxes, up to a maximum of $2,400,000 in additional consideration over four years. In 1998, $301,000 of contingent consideration was paid to the former owners of Team and Moore. On January 31, 1997, the Company made a tender offer to purchase up to 1,387,500 shares of its common stock at a single purchase price, not less than $13.33 nor in excess of $15.00 per share. The actual purchase price was determined based on the lowest single purchase price at which stockholders tendered shares that was sufficient to purchase 1,387,500 shares. As of February 28, 1997, the closing date, shares totaling greater than 1,387,500 were tendered, resulting in the Company's repurchase on March 12, 1997, of a total of 1,499,932 shares at the single per share price of $15.00 per share. The repurchase was financed by an increase in the bank term loan and revolving credit facility. On July 31, 1998, the Company acquired RCSA for consideration consisting of cash and stock. On August 17, 1998, the Company acquired StarMed and certain related entities for cash from Medical Resources, Inc. On September 9, 1998, the Company acquired Therapeutic Systems for consideration consisting of cash, stock and notes. The aggregate purchase prices for these acquisitions paid at closing was $41,150,000, consisting of $37,950,000 in cash, 130,426 shares of stock and $1,000,000 in subordinated notes. An additional $2,000,000 in cash consideration in the purchase of StarMed has been deferred until certain contingencies expire and is secured by a bank letter of credit held by a third-party escrow agent. Additional consideration may be paid to the former stockholders of RCSA, contingent upon the retention of clients and Therapeutic Systems, contingent upon the attainment of certain financial goals over the next three years, of up to $4,950,000. The cash purchase prices were funded through borrowings made available by an increase in the Company's bank credit facility to $90,000,000. 9 10 The acquisitions have been accounted for by the purchase method of accounting, whereby their operating results are included in the Company's results of operations commencing on the respective dates of acquisition. RESULTS OF OPERATIONS The following table sets forth for 1998, 1997 and the ten months ended December 31, 1996, the percentage that certain items in the consolidated statements of earnings bear to operating revenues: Ten Months Ended Year Ended December 31, December 31, - ------------------------------------------------- ------------------------------------------ ----------------- 1998 1997 1996 - ------------------------------------------------- ----------------------- ------------------ ----------------- Operating revenues 100.0% 100.0% 100.0% Costs and expenses: Operating expenses 69.5 68.9 71.1 General and administrative 17.3 17.0 16.1 Depreciation and amortization 1.9 2.3 2.6 Operating earnings 11.3 11.8 10.2 Gain on sale of marketable securities .7 .9 -- Other expense, net (1.4) (1.6) (1.0) Earnings before income taxes and cumulative effect of change in accounting principle 10.6 11.1 9.2 Income taxes 4.3 4.5 3.7 Earnings before cumulative effect of change in accounting principle 6.3 6.6 5.5 Cumulative effect of change in accounting for start-up costs, net of tax (0.4) -- -- Net earnings 5.9% 6.6% 5.5% ====================================================== ============= ===================== =================== Twelve Months Ended December 31, 1998 Compared to Twelve Months Ended December 31, 1997 Operating revenues in 1998 increased by $46,636,000, or 29.0%, to $207,416,000 as compared to 1997. Acquisitions accounted for 89.2% of the net increase. Inpatient unit revenue increased by $14,225,000. A 16.2% increase in the average number of inpatient units from 110.3 to 128.2 units, and an increase in the average daily billable census per inpatient unit of 6.1% from 13.2 to 14.0, generated a 23.3% increase in billable patient days to 656,363 and a 14.6% increase in revenue from inpatient units. The increase in billable census per unit for inpatient units is primarily attributable to a 10.4% increase in admissions per unit, offset by a 3.8% decline in average billable length of stay. 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 1998, which carry a shorter length of stay than acute rehabilitation units. The increase in billable patient days was offset by a 7.1% decrease in average per diem billing rates, reflecting a greater mix of subacute units which carry lower average per diem rates than acute units and lower per diem billing rates for subacute units subject to the BBA. Outpatient revenue increased 74.8% to $16,484,000, reflecting $1,164,000 from the July 1998 acquisition of RCSA, plus an increase in the average number of outpatient clinics managed from 17.9 to 26.1 and an increase in units of service per clinic. Contract therapy revenue increased 66.6% to $13,921,000, reflecting $2,621,000 from the acquisitions of Team and Moore and Rehab Unlimited, and 10 11 $3,935,000 from the acquisition of Therapeutic Systems in September 1998. Staffing revenue increased 43.5% to $66,597,000, reflecting the addition of $34,293,000 in nurse staffing revenue achieved through the August 1998 acquisition of StarMed, offset by an approximate $14,900,000 decrease in therapy staffing revenues. Demand for therapists has declined significantly as a result of the implementation of SNU-PPS. Operating expenses for the twelve month periods compared increased by $33,461,000, or 30.2%, to $144,187,000. Acquisitions accounted for 88% of the net increase. The remaining increase was attributable to the increase in patient days and units of services, offset by decreased therapy staffing costs. The excess of operating expenses over operating revenues associated with non-exempt units decreased from $778,000 to $637,000, on a decrease in the average number of non-exempt units from 7.7 to 3.2. The per unit average excess of operating expenses over operating revenues increased from $102,000 to $199,000 reflecting a greater percentage of units where the Company is obligated to provide therapy staff. The average excess of operating expenses over operating revenues for units during their non-exempt year can range to as high as $150,000 to $200,000. General and administrative expenses increased $8,638,000, or 31.6%, to $35,932,000, reflecting increases in corporate office expenses as well as administration, business development, operations and professional services in support of the increase in units, plus the addition of general and administrative expenses of companies acquired. Depreciation and amortization increased $186,000 reflecting amortization of goodwill from acquisitions, offset by the elimination of amortization of start-up costs in 1998. Interest expense increased $622,000 reflecting interest on additional debt issued in the acquisitions of StarMed and Therapeutic Systems. Gain on sale of marketable securities reflects the sale of the Company's investment in Intensiva HealthCare Corporation, approximately 50% of which was sold in the first quarter of 1997, and the remaining 50% sold in the fourth quarter of 1998. Earnings before income taxes and cumulative effect of change in accounting principle increased by $3,993,000, or 22.3%, to $21,875,000. The provision for income taxes for 1998 was $8,901,000 compared to $7,267,000 in 1997, reflecting effective income tax rates of 40.7% and 40.6%, respectively. Earnings before cumulative effect of change in accounting principle increased by $2,359,000, or 22.2%, to $12,974,000. The cumulative effect of change in accounting principle of $776,000 represents the after-tax charge related to the adoption, effective January 1, 1998, of Statement of Position No. 98-5 Reporting on the Costs of Start-up Activities. Net earnings increased by $1,583,000, or 14.9%, to $12,198,000. Diluted earnings per share increased 16.3% to $1.71 from $1.47 on a 1.8% decrease in the weighted-average shares and assumed conversions outstanding. The gains on sale of marketable securities represented $.12 of the earnings per share in both 1998 and 1997. The cumulative effect of change in accounting principle reduced earnings per share by $.11 in 1998 with no comparable reduction in 1997. Excluding the gains on sales of marketable securities and the cumulative effect of the change in accounting principle, diluted earnings per share increased 25.9% from $1.35 in 1997 to $1.70 in 1998. The decrease in shares outstanding is attributable primarily to shares repurchased and a decrease in the dilutive effect of stock options resulting from a decrease in the average market price of the Company's stock relative to the underlying exercise prices of outstanding options, offset by stock option exercises and shares issued in the acquisitions of RCSA and Therapeutic Systems. Twelve Months Ended December 31, 1997 Compared to Twelve Months Ended December 31, 1996 Management believes that a comparison of the twelve months ended December 31, 1997 to the ten months ended December 31, 1996 is not meaningful because of the difference in length of reporting periods. Therefore, this discussion and analysis of results of operations includes a comparison of the audited twelve-month period ended December 31, 1997, to the unaudited twelve-month period ended December 31, 1996. 11 12 Operating revenues in 1997 increased by $40,924,000, or 34.1%, to $160,780,000 as compared to the same period in 1996. Acquisitions accounted for 35.0% of the net increase. A 20.8% increase in the average number of inpatient units from 91.3 to 110.3 units, and an increase in the average daily billable census per inpatient unit of 3.1% from 12.8 to 13.2, generated a 24.6% increase in billable patient days to 532,195. The increase in billable census per unit for inpatient units is primarily attributable to a 9.0% increase in admissions per unit, offset by a 5.4% decline in average billable length of stay. 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 1997, which carry a shorter length of stay than acute rehabilitation units. The increase in billable patient days was offset by a 3.7% decrease in average per diem billing rates, reflecting a greater mix of subacute units which carry lower average per diem rates than acute units. The $16,279,000 increase in inpatient unit revenue was offset by a 9.8% decrease in outpatient revenue to $9,429,000, primarily reflecting the loss of two units. Revenues of HSSI increased $17,544,000 primarily as a result of an increase in weeks worked plus revenue from HSSI's new per diem staffing division. Operating expenses for the twelve-month periods compared increased by $25,305,000, or 29.6%, to $110,726,000. Acquisitions accounted for 34.2% of the net increase. The remaining increase was attributable to the increase in patient days and increased placements at HSSI. The excess of operating expenses over operating revenues associated with non-exempt units decreased from $912,000 to $778,000, on an increase in the average number of non-exempt units from 5.4 to 7.7. The per unit average excess of operating expenses over operating revenues declined from $169,000 to $102,000 reflecting a 2.5% increase in billable patients per unit to 2.9 plus a greater percentage of units where the Company is not obligated to provide therapy staff. The average excess of operating expenses over operating revenues for units during their non-exempt year can range to as high as $150,000 to $200,000. General and administrative expenses increased $8,725,000, or 47.0%, to $27,294,000, reflecting increases in professional services, business development, general office and operations compared to the previous year, plus the addition of general and administrative expenses of companies acquired. Depreciation and amortization increased $631,000 reflecting primarily the amortization of goodwill from the purchase of Team and Moore and Rehab Unlimited. Interest income decreased $83,000 as a result of reductions in investment balances, as cash was used to make acquisitions and make payments on the Company's debt. Interest expense increased $1,441,000 reflecting interest on additional debt arising from the repurchase of shares of the Company's common stock, and the acquisitions of HSSI, Team and Moore and Rehab Unlimited. Gain on sale of marketable securities reflects the sale of approximately 50% of the Company's investment in Intensiva HealthCare Corporation. Earnings before income taxes increased by $6,192,000, or 53.0%, to $17,882,000. The provision for income taxes for the twelve-month periods compared was $7,267,000 compared to $4,698,000, reflecting effective income tax rates of 40.6% and 40.2% for the respective periods. Net earnings increased by $3,623,000, or 51.8%, to $10,615,000. Diluted earnings per share increased 58.1% to $1.47 from $.93 on a 4.4% decrease in the weighted-average shares outstanding. The gain on sale of marketable securities represented $.12 of the earnings per share in 1997. Excluding the gain, diluted earnings per share increased 45% to $1.35. The decrease in shares outstanding is attributable to the repurchase of shares of the Company's common stock offset by an increase in the dilutive effect of outstanding stock options. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1998, the Company had $8,683,000 in cash and current 12 13 marketable securities and a current ratio of 1.5:1. Working capital as of December 31, 1998, increased from December 31, 1997, by $7,813,000, reflecting working capital from the acquisitions of StarMed and Therapeutic Systems and working capital generated by operations. Net accounts receivable were $46,349,000 at December 31, 1998 compared to $24,147,000 at December 31, 1997. The number of days average net revenues in net receivable was 63.8 days and 52.0 days as of December 31, 1998 and December 31, 1997, respectively. The increase is primarily the result of acquisitions of businesses that traditionally carry longer payment terms from clients. During the year ended December 31, 1998, the Company incurred capital expenditures of $2,103,000 as compared to $1,372,000 for the twelve months ended December 31, 1997. At December 31, 1998, the Company had no material commitments for capital expenditures. In connection with the development and implementation of additional units, the Company may incur capital expenditures for equipment and deferred costs arising from payments made to hospitals for a portion of capital improvements needed to begin a unit's operation. For the twelve months ended December 31, 1998, the Company made deferred cost payments to four client hospitals totaling $450,000 for capital improvements, while for the twelve months ended December 31, 1997, payments were made to four client hospitals totaling $368,000. At December 31, 1998, the Company had 8 commitments totaling $1,084,000 to make additional capital improvement payments to client hospitals. The Company's operating cash flows constitute its primary source of liquidity and historically have been sufficient to fund its working capital 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. As part of the acquisitions of RCSA, StarMed and Therapeutic Systems, 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 bank term loan with a commitment of up to $60,000,000. The amount that may be borrowed under the revolving credit facility was increased to the lesser of $30,000,000 or 85% of eligible accounts receivable, reduced by amounts outstanding under the Company's bank letter of credit. As of December 31, 1998, the Company's borrowings under the term loan and revolving credit facility totaled $57,364,000 and $0, respectively, and a letter of credit was outstanding in the amount of $2,000,000. On January 10, 1997, the Company sold 165,000 shares of its investment in Intensiva HealthCare Corporation in a market transaction for $1,485,000. The remaining 161,287 shares were sold on December 18, 1998 for $1,552,000. On March 12, 1997, the Company repurchased 1,499,932 shares of its common stock. To finance the repurchase, the Company issued $45 million in senior secured debt, which was restructured in 1998 as described above. YEAR 2000 The Company is subject to risks associated with "Year 2000" compliance, a term which refers to the ability of various data processing hardware and software systems to interpret dates correctly after the beginning of January 1, 2000. The Company has developed and presented to the Board of Directors its action plan for Year 2000 compliance. The major phases of the action plan are awareness, assessment, renovation, validation and implementation. The awareness phase included a communication of Year 2000 compliance 13 14 issues and the potential ramifications to the Company, education and identification of key systems. The assessment phase included the inventorying of systems that may be impacted by Year 2000 issues. Most of the Company's systems are purchased from industry-known vendors and are generally used in their standard configuration. Other systems will be replaced by or converted to Year 2000 compatible systems. The Company has closely reviewed the Year 2000 progress as reported by each vendor. The Company has been assured by certain of these vendors, that new Year 2000 compliant systems have been installed. In all other cases, compliant systems will be delivered in time for installation and testing prior to year end 1999. The final phase of the action plan is the implementation of remediated and other systems into the operating environment of the Company. For those systems that have not yet been delivered, the Company expects delivery of compliant systems not later than early in the second quarter of 1999. The final phase of the plan is scheduled to be completed by June 30, 1999. Concurrent with the development and execution of the plan is the evolution of a contingency plan that includes procedures to be followed should a system fail. The Company is also completing an assessment of Year 2000 risks relating to its lines of business separate from its dependence on data processing. The assessment includes corresponding with customers to ascertain their overall preparedness regarding Year 2000 risks. The plan also provides for the identification and communication with significant non-data processing third-party vendors regarding their preparedness for Year 2000 risks. It is not possible to quantify the overall potential adverse effects to the Company resulting from these customers' or non-data vendors' failure to adequately prepare for Year 2000 compliance. The failure of a customer to prepare adequately for Year 2000 could have a significant adverse effect on such customer's operations and profitability, which, in turn, could inhibit its ability to pay for the Company's services in accordance with their terms. Failure of a non-data vendor to prepare adequately for Year 2000 could have a significant adverse effect on the vendor's operations, which, in turn, could inhibit the vendor's ability to deliver purchased goods and services to the Company in a timely manner. The Company also recognizes the importance of Year 2000 compliance by customers, payment sources, and vendors to the Company's customers and vendors. The Company must necessarily rely upon the compliance programs of these third parties. The Company does not expect that the cost of the Year 2000 compliance will be material to its business, financial condition, or results of operations, nor does management anticipate any material disruption in operations as the result of any failure by the Company or its subsidiaries. While the Company is making a substantial effort to become Year 2000 compliant, there is no assurance the failure to adequately address all issues relating to the Year 2000 issue would not have a material adverse effect on its financial condition or results of operations. INFLATION Although inflation has abated during the last several years, the rate of inflation in healthcare related services continues to exceed the rate experienced by the economy as a whole. The Company's management contracts typically provide for an annual increase in the fees paid to the Company by its client hospitals based upon increases in various inflation indices. These increases generally offset increases in costs incurred by the Company. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. 14 15 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Independent Auditors' Report The Board of Directors RehabCare Group, Inc.: We have audited the accompanying consolidated balance sheets of RehabCare Group, Inc. and subsidiaries (the "Company") as of December 31, 1998 and 1997, and the related consolidated statements of earnings, stockholders' equity, cash flows and comprehensive earnings for the years ended December 31, 1998 and 1997 and for the ten months ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of RehabCare Group, Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for the years ended December 31, 1998 and 1997 and for the ten months ended December 31, 1996, in conformity with generally accepted accounting principles. As discussed in note 1 to the consolidated financial statements, the Company changed its method of accounting for start-up costs. St. Louis, Missouri February 5, 1999 15 16 REHABCARE GROUP, INC. Consolidated Balance Sheets (dollars in thousands, except per share data) December 31, Assets 1998 1997 ------ ---- ---- Current assets: Cash and cash equivalents $ 5,666 1,975 Marketable securities, available-for-sale 3,017 4,664 Accounts receivable, net of allowance for doubtful accounts of $3,404 and $1,338, respectively 46,349 24,147 Deferred tax assets 3,382 1,773 Prepaid expenses and other current assets 938 720 ------- ------ Total current assets 59,352 33,279 ------- ------ Marketable securities, trading, noncurrent 1,240 1,812 ------- ------ Equipment and leasehold improvements, net 4,537 3,342 ------- ------ Other assets: Excess of cost over net assets acquired, net 86,285 52,949 Deferred contract costs, net 1,184 1,138 Investments in nonconsolidated subsidiaries 1,648 1,159 Deferred tax assets -- 181 Other 2,624 3,381 ------- ------ Total other assets 91,741 58,808 ------- ------ $156,870 97,241 ======= ====== Liabilities and Stockholders' Equity ------------------------------------ Current liabilities: Current portion of long-term debt $ 11,926 4,520 Accounts payable 2,179 1,700 Accrued salaries and wages 14,049 9,925 Accrued expenses 8,601 3,570 Income taxes payable 1,991 771 ------- ------ Total current liabilities 38,746 20,486 ------- ------ Deferred compensation and other long-term liabilities 3,084 2,501 ------- ------ Deferred tax liabilities 955 -- ------- ------ Long-term debt, less current portion 53,929 34,494 ------- ------ Stockholders' equity: Preferred stock, $.10 par value; authorized 10,000,000 shares, none issued and outstanding -- -- Common stock, $.01 par value; authorized 20,000,000 shares, issued 7,657,391 shares and 7,152,191 shares as of December 31, 1998 and 1997, respectively 77 72 Additional paid-in capital 30,654 23,972 Retained earnings 47,390 35,192 Less common stock held in treasury at cost, 1,166,234 shares and 1,311,307 shares as of December 31, 1998 and 1997, respectively (17,975) (20,212) Accumulated other comprehensive earnings 10 736 ------- ------ Total stockholders' equity 60,156 39,760 ------- ------ $156,870 97,241 ======= ====== See accompanying notes to consolidated financial statements. 16 17 REHABCARE GROUP, INC. Consolidated Statements of Earnings (dollars in thousands, except per share data) Ten Months Ended Year Ended December 31, December 31, 1998 1997 1996 Operating revenues $ 207,416 160,780 104,611 Costs and expenses: Operating expenses 144,187 110,726 74,326 General and administrative 35,932 27,294 16,844 Depreciation and amortization 3,966 3,780 2,743 ------- ------- ------- Total costs and expenses 184,085 141,800 93,913 ------- ------- ------- Operating earnings 23,331 18,980 10,698 Interest income 258 186 152 Interest expense (3,381) (2,759) (1,211) Gain on sale of marketable securities 1,516 1,448 -- Other income, net 151 27 15 ------- ------- ------- Earnings before income taxes and cumulative effect of change in accounting principle 21,875 17,882 9,654 Income taxes 8,901 7,267 3,886 Earnings before cumulative effect of ------- ------- ------- change in accounting principle 12,974 10,615 5,768 Cumulative effect of change in accounting for start-up costs, net of tax (776) -- -- ------- ------- ------- Net earnings $ 12,198 10,615 5,768 ======= ======= ======= Net earnings per common share: Basic Earnings before cumulative effect of change in accounting principle $ 2.10 1.77 .82 Cumulative effect of change in accounting for start-up costs (.13) -- -- ------- ------- ------- Net earnings $ 1.97 1.77 .82 ======= ======= ======= Diluted Earnings before cumulative effect of change in accounting principle $ 1.82 1.47 .76 Cumulative effect of change in accounting for start-up costs (.11) -- -- ------- ------- ------- Net earnings $ 1.71 1.47 .76 ======= ======= ======= See accompanying notes to consolidated financial statements. 17 18 REHABCARE GROUP, INC. Consolidated Statements of Stockholders' Equity (amounts in thousands) Common Stock Accumulated ------------------------- Additional other compre- Total Issued Treasury paid-in Retained Treasury hensive stockholders' shares stock Amount capital earnings stock earnings equity ------ -------- ------ ---------- -------- -------- ---------- ------------ Balance, February 29, 1996 6,777 -- $ 67 20,021 18,809 -- -- 38,897 Net earnings -- -- -- -- 5,768 -- -- 5,768 Issuance of common stock in connection with acquisition 185 -- 2 2,190 -- -- -- 2,192 Exercise of stock options (including tax benefit) 78 -- 1 582 -- -- -- 583 Unrealized gain on marketable securities, net of tax -- -- -- -- -- -- 2,230 2,230 ----- ----- --- ------ ------ ------ ----- ------ Balance, December 31, 1996 7,040 -- 70 22,793 24,577 -- 2,230 49,670 Net earnings -- -- -- -- 10,615 -- -- 10,615 Purchase of treasury stock -- 1,500 -- -- -- (23,131) -- (23,131) Issuance of common stock in connection with acquisitions 38 (41) 1 639 -- 644 -- 1,284 Exercise of stock options (including tax benefit) 74 (148) 1 540 -- 2,275 -- 2,816 Change in unrealized gain on marketable securities, net of tax -- -- -- -- -- -- (1,494) (1,494) ----- ----- --- ------ ------ ------ ----- ------ Balance, December 31, 1997 7,152 1,311 72 23,972 35,192 (20,212) 736 39,760 Net earnings -- -- -- -- 12,198 -- -- 12,198 Issuance of common stock in connection with acquisitions 130 -- 1 2,199 -- -- -- 2,200 Exercise of stock options (including tax benefit) 375 (145) 4 4,483 -- 2,237 -- 6,724 Change in unrealized gain on marketable securities, net of tax -- -- -- -- -- -- (726) (726) ----- ----- --- ------ ------ ------ ----- ------ Balance, December 31, 1998 7,657 1,166 $ 77 30,654 47,390 (17,975) 10 60,156 ===== ===== === ====== ====== ====== ===== ====== See accompanying notes to consolidated financial statements. 18 19 REHABCARE GROUP, INC. Consolidated Statements of Cash Flows (dollars in thousands) Ten Months Ended Year Ended December 31, December 31, 1998 1997 1996 ----------------------- ---------------- Cash flows from operating activities: Net earnings $ 12,198 10,615 5,768 Adjustments to reconcile net earnings to net cash provided by operating activities: Cumulative effect of change in accounting for start-up costs 776 -- -- Depreciation and amortization 3,966 3,780 2,743 Provision for losses on accounts receivable 1,093 717 549 Equity in earnings of affiliate (107) (20) -- Gain on sale of marketable securities (1,516) (1,448) -- Increase (decrease) in deferred compensation (598) 545 586 Increase in accounts receivable, net (6,666) (7,755) (4,586) Decrease (increase) in prepaid expenses and other current assets 43 (155) 259 Decrease in other assets 161 15 122 Increase (decrease) in accounts payable and accrued expenses 1,059 1,759 (1,915) Increase in accrued salaries and wages 1,990 2,386 1,390 Increase (decrease) in income taxes payable and deferred 1,156 (622) (498) -------- ------ ------- Net cash provided by operating activities 13,555 9,817 4,418 -------- ------ ------- Cash flows from investing activities: Additions to equipment and leasehold improvements, net (1,868) (1,343) (732) Purchase of marketable securities (1,838) (1,473) (1,128) Proceeds from sale/maturities of marketable securities 4,363 2,080 1,815 Cash paid in acquisition of businesses, net of cash received (42,449) (6,629) (19,258) Investment in joint venture (382) (630) -- Deferred contract costs, net (450) (368) (160) Other, net (805) (1,483) (1,282) -------- ------ ------- Net cash used in investing activities (43,429) (9,846) (20,745) -------- ------ ------- Cash flows from financing activities: Proceeds from (payments on) revolving credit facility -- (500) 2,000 Payments on long-term debt (10,559) (3,603) (2,408) Proceeds from issuance of long-term debt 36,400 23,500 4,750 Proceeds from issuance of notes payable 1,000 2,150 6,000 Purchase of treasury stock -- (23,131) -- Exercise of stock options (including tax benefit) 6,724 2,816 583 -------- ------ ------- Net cash provided by financing activities 33,565 1,232 10,925 -------- ------ ------- Net increase (decrease) in cash and cash equivalents 3,691 1,203 (5,402) Cash and cash equivalents at beginning of period 1,975 772 6,174 -------- ------ ------- Cash and cash equivalents at end of period $ 5,666 1,975 772 ======== ====== ======= See accompanying notes to consolidated financial statements. 19 20 REHABCARE GROUP, INC. Consolidated Statements of Comprehensive Earnings (Amounts in thousands) Ten Months Ended Year Ended December 31, December 31, 1998 1997 1996 ---- ---- ---- Net earnings $ 12,198 10,615 5,768 Other comprehensive earnings, net of tax-- Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during period 184 (625) 2,230 Less: reclassification adjustment for realized gains included in net earnings (910) (869) -- ------ ------ ------ Comprehensive earnings $ 11,472 9,121 7,998 ====== ====== ====== See accompanying notes to consolidated financial statements. 20 21 REHABCARE GROUP, INC. Notes to Consolidated Financial Statements (1) Summary of Significant Accounting Policies (a) Principles of Consolidation The consolidated financial statements include the accounts of the parent company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The Company has an investment which is accounted for using the equity method and records its share of the net earnings (losses) of this entity in consolidated net income. (b) Change in Fiscal Year The Company changed its fiscal year end from the last day of February to December 31, effective as of December 31, 1996. The change resulted in a short fiscal period of ten months that began March 1, 1996, and ended December 31, 1996. Information included in the footnotes to the financial statements for 1996 refers to the ten months ended December 31, 1996. (c) Accounting Change The Company adopted the provisions of Statement of Position No. 98-5 ("SOP 98-5"), Reporting on the Costs of Start-Up Activities on January 1, 1998, which requires that costs of start-up activities be expensed as incurred. Start-up activities are defined in SOP 98-5 as those one-time activities related to opening a new facility, introducing a new territory, conducting business with a new class of customer or beneficiary, initiating a new process in an existing facility or commencing a new operation. Previously, the Company capitalized these costs and amortized them over the term of the contract. The change resulted in a cumulative after-tax charge of $776,000, $.11 per diluted share, recorded in the quarter ended March 31, 1998. (d) Cash Equivalents and Marketable Securities Cash in excess of daily requirements is invested in short-term investments with original maturities of three months or less. Such investments are deemed to be cash equivalents for purposes of the consolidated statements of cash flows. The Company classifies its debt and equity securities into one of three categories: held-to- maturity, trading, or available-for-sale. Management determines the appropriate classification of its investments at the time of purchase and reevaluates such determination at each balance sheet date. Investments at December 31, 1998 consist of marketable equity securities, variable rate municipal bonds and money market securities. All marketable securities included in current assets are classified as available-for-sale and as such, the difference between cost and market, net of estimated taxes, is recorded as other comprehensive earnings. Gain (or loss) on such securities is not recognized in the consolidated statement of earnings until the securities are sold. All marketable securities in non-current assets are classified as trading. (e) Credit Risk The Company primarily provides services to a geographically diverse clientele of healthcare providers throughout the United States. The Company performs ongoing credit evaluations of its clientele and does not require collateral. An allowance for doubtful accounts is maintained at a level which management believes is sufficient to cover potential credit losses. 21 22 REHABCARE GROUP, INC. Notes to Consolidated Financial Statements (f) Equipment and Leasehold Improvements Depreciation and amortization of equipment and leasehold improvements are computed on the straight-line method over the estimated useful lives of the related assets, principally: equipment - five to seven years and leasehold improvements - life of lease or life of asset, whichever is less. (g) Intangible Assets Substantially all the excess of cost over net assets acquired (goodwill) relates to acquisitions and is amortized on a straight-line basis over 40 years. Accumulated amortization of goodwill was $7,483,773 and $5,206,000 as of December 31, 1998 and 1997, respectively. The Company evaluates the realizability of goodwill based upon expectations of undiscounted cash flows and operating income. Based upon its most recent analysis, the Company believes that no impairment of goodwill exists at December 31, 1998. (h) Deferred Contract Costs Deferred contract costs represent payments made to hospitals for a portion of capital improvements needed to begin a unit's operation. The Company is entitled to a pro rata refund of deferred capital improvement costs in the event that the hospital terminates the contract before its scheduled termination date. Deferred contract costs are charged to expense over the initial term of the contracts. Accumulated amortization of deferred contract costs was $391,000 and $1,138,000 as of December 31, 1998 and 1997, respectively. (i) Disclosure About Fair Value of Financial Instruments The estimated fair-market value of the revolving credit facility and long-term debt (including current portions thereof), approximates carrying value due to the variable rate features of the instruments. The Company believes it is not practical to estimate a fair value different from the carrying value of its subordinated debt and the notes payable to related parties as the instruments have numerous unique features as discussed in note 6. (j) Revenues and Costs The Company recognizes revenues as services are provided or when the revenue is earned. Costs related to marketing and development of new contracts are expensed as incurred. (k) Income Taxes Deferred tax assets and liabilities are recognized for temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those differences are expected to be recovered or settled. (l) Treasury Stock The purchase of the Company's common stock is recorded at cost. Upon subsequent reissuance, the treasury stock account is reduced by the average cost basis of such stock. (m) Comprehensive Earnings On January 1, 1998, the Company adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting Comprehensive Income, which requires reporting of comprehensive income (earnings) and its components, in the statement of 22 23 REHABCARE GROUP, INC. Notes to Consolidated Financial Statements earnings and statement of stockholders' equity, including net earnings as a component. Comprehensive earnings is the change in equity of a business from transactions and other events and circumstances from non-owner sources. (n) Segment Disclosures The Company has adopted the provisions of SFAS No. 131 ("SFAS 131"), Disclosures about Segments of an Enterprise and Related Information. SFAS 131 establishes standards for reporting information about operating segments and related disclosures about products and services, geographic areas and major customers. (o) 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. Estimates also affect the reported amounts of revenues and expenses during the period. Actual results may differ from those estimates. (p) Reclassifications Certain prior years' amounts have been reclassified to conform with the current year presentation. (q) Derivatives In June 1998, the Financial Accounting Standards Board issued SFAS No. 133 ("SFAS 133"), Accounting for Derivative Instruments and Hedging Activities. SFAS 133 establishes standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. SFAS 133 is effective for all fiscal years beginning after June 15, 1999. Earlier application of SFAS 133 is encouraged but should not be applied retroactively to financial statements of prior periods. The Company is currently evaluating the requirements and impact of SFAS 133. (2) Acquisitions On July 31, 1998, the Company acquired Rehabilitative Care Systems of America, Inc. ("RCSA"), a provider of program outpatient therapy, for consideration consisting of cash and stock. On August 17, 1998, the Company acquired StarMed Staffing, Inc. ("StarMed"), a provider of nurse staffing, and certain related entities for cash from Medical Resources, Inc. On September 9, 1998, the Company acquired Therapeutic Systems, Ltd. ("Therapeutic Systems"), a provider of contract therapy, for consideration consisting of cash, stock and notes. The aggregate purchase prices for these acquisitions paid at closing was $41,150,000, consisting of $37,950,000 in cash, 130,426 shares of stock and $1,000,000 in subordinated notes. An additional $2,000,000 in cash consideration in the purchase of StarMed has been deferred until certain contingencies expire and is secured by a bank letter of credit held by a third-party escrow agent. Additional consideration may be paid to the former stockholders of RCSA, contingent upon the retention of clients, and Therapeutic Systems, contingent upon the attainment of certain financial goals over the next three years, of up to $4,950,000. The cash purchase price was funded through borrowings made available by an increase in the Company's bank credit facility to $90,000,000. See note 6. Goodwill of approximately $33,000,000 related to the acquisitions is being amortized over 40 years. 23 24 REHABCARE GROUP, INC. Notes to Consolidated Financial Statements The following unaudited pro forma financial information assumes the acquisitions occurred as of January 1, 1997. This information is not necessarily indicative of results of operations that would have occurred had the purchases actually been made at the beginning of the periods presented. Year Ended December 31, 1998 1997 ----------------------- Operating revenues $ 264,635,000 229,669,000 Net earnings 13,727,000 12,355,000 Net earnings per common and common equivalent share: Basic $ 2.19 2.02 Diluted $ 1.90 1.68 On August 15, 1997, the Company acquired a 40% interest in Allied Therapy Services, L.L.C. ("Allied") for $630,000 in cash and notes. The joint venture provides physical, occupational and speech therapy services to nursing homes, other long-term care facilities, outpatient clinics, school systems and home health agencies. The Company accounts for its investment using the equity method. On January 28, 1997, the Company acquired TeamRehab, Inc. and Moore Rehabilitation Services, Inc. ("Team and Moore"), a provider of contract therapy. On June 12, 1997, the Company acquired Rehab Unlimited, Inc. and the assets of Cimarron Health Care, Inc. and merged them into Team and Moore. The aggregate purchase prices for these acquisitions paid at closing was $6,950,000, consisting of $4,275,000 in cash, $1,825,000 in subordinated promissory notes and 54,151 shares of the Company's common stock. Additional consideration will be paid to the former Team and Moore stockholders contingent upon the attainment of certain target cumulative earnings before interest and income taxes, up to a maximum of $2,400,000 in additional consideration over four years. In 1998, $301,000 of contingent consideration was paid to the former owners of Team and Moore. Goodwill related to the acquisitions totaling $6,254,000 is being amortized over 40 years. On March 1, 1996, the Company acquired Healthcare Staffing Solutions, Inc. ("HSSI"), a provider of therapy staffing. The aggregate purchase price of $21,450,000 paid at closing included $13,258,000 in cash, a $6,000,000 ten-year convertible subordinated promissory note and 185,295 shares of the Company's common stock. Of the $13,258,000 of cash paid, $8,750,000 was borrowed under the Company's term loan and revolving credit facility. Additional consideration will be paid to the former HSSI stockholders contingent upon the attainment of certain target cumulative earnings before interest and income taxes up to a maximum of $8,800,000 in additional consideration over six years. In 1998 and 1997, $2,104,000 and $1,000,000, respectively of contingent consideration was paid to the former owners of HSSI. The acquisitions, with the exception of Allied, have been accounted for by the purchase method of accounting, whereby their operating results are included in the Company's results of operations commencing on the respective closing dates of acquisition. 24 25 REHABCARE GROUP, INC. Notes to Consolidated Financial Statements (3) Marketable Securities Current marketable securities at December 31, 1998 consist primarily of variable rate municipal bonds. Noncurrent marketable securities consist of marketable equity securities ($840,000 and $1,469,000 at December 31, 1998 and 1997, respectively) and money market securities ($400,000 and $343,000 at December 31, 1998 and 1997, respectively) held in trust under the Company's deferred compensation plan. (4) Allowance for Doubtful Accounts Activity in the allowance for doubtful accounts is as follows: Ten Months Ended Year Ended December 31, December 31, 1998 1997 1996 -------------------------- ----------------- Balance at beginning of period $ 1,338,000 1,386,000 822,000 Provisions for doubtful accounts 1,093,000 717,000 549,000 Allowance related to acquisitions 1,720,000 30,000 387,000 Accounts written off (747,000) (795,000) (372,000) --------- --------- --------- Balance at end of period $ 3,404,000 1,338,000 1,386,000 ========= ========= ========= (5) Equipment and Leasehold Improvements Equipment and leasehold improvements, at cost, consist of the following: December 31, 1998 1997 ------------------ Equipment $ 8,227,000 5,752,000 Leasehold improvements 384,000 132,000 --------- --------- 8,611,000 5,884,000 Less accumulated depreciation and amortization 4,074,000 2,542,000 --------- --------- $ 4,537,000 3,342,000 ========= ========= 25 26 REHABCARE GROUP, INC. Notes to Consolidated Financial Statements (6) Long-Term Debt Long-term debt consists of the following: December 31, 1998 1997 ---- ---- Bank Debt: - ---------- Term facility - LIBOR plus 1.0% to 2.0% or Corporate Base Rate ("CBR"), rate dependent on the ratio of indebtedness, net of cash and marketable securities, to cash flow, maturing October 1, 2003 (weighted- average rates of 6.7% and 7.2% at December 31, 1998 and 1997, respectively) $ 57,364,000 22,750,000 Revolving credit facility-LIBOR plus 1.0% to 2.0% or CBR, rate dependent on the ratio of indebtedness, net of cash and marketable securities, to cash flow, maturing October 1, 2003 (weighted-average rate of 7.4% at December 31, 1997) -- 8,000,000 Subordinated Debt: Note payable, 6.25% convertible, maturing March 1, 2006 6,000,000 6,000,000 Note payable, 8%, maturing October 15, 1997, held in escrow as of December 31, 1997 -- 395,000 Note payable, 8%, payable $93,750 quarterly through February 1, 2001 844,000 1,219,000 Note payable, 8%, payable in quarterly installments of $40,625 commencing July 1, 1999, maturing July 1, 2001 322,000 325,000 Note payable, 8%, maturing August 15, 2001 325,000 325,000 Note payable, 8%, maturing September 9, 2002 1,000,000 -- ---------- ---------- 65,855,000 39,014,000 Less current portion 11,926,000 4,520,000 ---------- ---------- Total long-term debt $ 53,929,000 34,494,000 ========== ========== On August 17, 1998, as part of the 1998 acquisitions, the Company restructured and increased its bank debt. Under the terms of the restructured loan agreement the Company entered into a five-year, $60,000,000 term loan and a revolving line of credit which allows the Company to borrow up to the lesser of $30,000,000 or 85% of eligible accounts receivable as defined by the agreement, reduced by amounts outstanding under bank letters of credit. The Company pays a fee on the unused portion of the commitment from .2% to .5% per annum, with such rate being dependent on the ratio of the Company's indebtedness, net of cash and marketable securities, to cash flow. Borrowings under the agreement, including the revolving credit facility, are secured primarily by the Company's accounts receivable, equipment and leasehold improvements, and future income and profits. The loan agreement requires the Company to meet certain financial covenants including maintaining minimum net worth and fixed charge coverage ratios. The loan agreement also restricts the Company's ability to pay dividends to its stockholders. As of December 31, 1998, the Company had an outstanding bank letter of credit in the amount of $2,000,000. The average outstanding borrowings under the revolving credit facility for 1998, 1997 and 1996 were $3,451,000, $7,507,000 and $3,000,000 at weighted-average interest rates of 7.0%, 7.4% and 7.5% per annum, respectively. 26 27 REHABCARE GROUP, INC. Notes to Consolidated Financial Statements The $6,000,000 convertible subordinated notes payable may be redeemed in whole or in part by the Company at any time after March 1, 2000 at from 100% to 104% of the principal balance. The notes are convertible into the Company's common stock prior to March 1, 2006, subject to earlier redemption by the Company, at the option of the former HSSI shareholders, at a conversion price of $14.17 per share. Of the $6,000,000 balance outstanding $4,500,000 is payable to a director of the Company who is president of HSSI. The scheduled principal payments of long-term debt at December 31, 1998 are as follows: $11,926,000 in 1999, $12,010,000 in 2000, $11,973,000 in 2001, $12,473,000 in 2002, $11,473,000 in 2003 and $6,000,000, thereafter. Interest paid for 1998, 1997 and 1996 was, $3,630,000, $2,598,000 and $1,053,000, respectively. The Company purchases interest rate swaps and caps of twelve months in length to reduce the impact of fluctuations in interest rates on its floating rate debt. At December 31, 1998, the Company had a $20,000,000 interest rate swap outstanding. The difference to be paid or received under these agreements is recognized as an adjustment to interest expense. The fair value of the swap if the Company were to terminate the agreement at December 31, 1998 was not material. (7) Stockholders' Equity On January 31, 1997, the Company made a tender offer to purchase up to 1,387,500 shares of its common stock at a single purchase price, not less than $13.33 nor in excess of $15.00 per share. The actual purchase price was determined based on the lowest single purchase price at which stockholders tendered shares that was sufficient to purchase at least 1,387,500 shares. As of February 28, 1997, the closing date, shares totaling greater than 1,387,500 were tendered, resulting in the Company's repurchase on March 12, 1997, of a total of 1,499,932 shares at the single purchase price of $15.00 per share. The repurchase was financed by an increase in the bank term loan and revolving credit facility. The Company has a 1996 Long-Term Performance Plan pursuant to which stock appreciation rights, restricted stock, performance awards, incentive stock options or nonqualified stock options, may be granted to employees. Under the plan, stock awards for 1,050,000 shares may be granted within 10 years of the date of adoption of the plan. The Company also has a 1987 Incentive Stock Option Plan, a 1987 Nonstatutory Stock Option Plan, and a Directors' Stock Option Plan (together with the 1996 Long-Term Performance Plan, the "Plans") pursuant to which incentive stock options may be granted to employees and nonstatutory stock options may be granted to employees or directors. Under the 1987 Incentive Stock Option and Nonstatutory Stock Option Plans, options to purchase 1,500,000 shares were available for grant, of which 825,000 shares were incentive stock options. Under the Directors' Stock Option Plan (the "Directors' Plan"), options to purchase 525,000 shares of stock may be granted. Stock options may be granted for a term not to exceed 10 years (five years with respect to a person receiving an incentive stock option who owns more than 10% of the capital stock of the Company) and must be granted within 10 years from the date of adoption of the respective plan. The exercise price of all stock options must be at least equal to the fair market value (110% of fair market value for a person receiving an incentive stock option who owns more than 10% of the capital stock of the Company) of the shares on the date granted. Under the Directors' Plan, each director who is not otherwise an officer or employee of the Company, receives an option each year through 1998 to acquire 15,000 shares of stock, or such lesser amount as provided in the Directors' Plan, at the fair market value on the respective option grant date. Options for a designated number of shares may also be granted to a particular director or directors from time to time at the discretion of the Board. All stock options become fully exercisable after four years from date of grant, except for options granted under the Directors' Plan which become fully exercisable after six months. 27 28 REHABCARE GROUP, INC. Notes to Consolidated Financial Statements The per share weighted-average fair value of stock options granted during 1998, 1997 and 1996 was $8.55, $7.64 and $6.89 on the dates of grant using the Black Scholes option-pricing model with the following weighted-average assumptions: 1998 - expected dividend yield 0%, volatility of 40%, risk-free interest rate of 4.7% and an expected life of 4 to 7 years; 1997 - expected dividend yield 0%, volatility of 33%, risk-free interest rate of 5.6% and an expected life of 4 to 7 years; 1996 expected dividend yield 0%, volatility of 30%, risk-free interest rate of 6.25% and an expected life of 4 to 7 years. The Company applies Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for its Plans. Accordingly, no compensation cost has been recognized for its long-term performance and stock option plans. Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123 ("SFAS 123"), Accounting for Stock Based Compensation, the Company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated below: Ten Months Ended Year Ended December 31, December 31, 1998 1997 1996 ---- ---- ---- Net earnings As reported $12,198,000 $10,615,000 $5,768,000 Pro forma 10,546,000 9,820,000 5,340,000 Basic earnings per share As reported 1.97 1.77 .82 Pro forma 1.71 1.64 .76 Diluted earnings per share As reported 1.71 1.47 .76 Pro forma 1.49 1.36 .71 In accordance with SFAS 123, the pro forma net earnings reflects only options granted subsequent to February 1995 and does not reflect the full impact of calculating compensation cost for stock options granted prior to March 1995, that vested in 1998, 1997 and 1996. A summary of the status of the Company's stock option plans as of December 31, 1998, 1997 and 1996, and changes during the periods ending on those dates is presented below: Year Ended Year Ended Ten Months Ended December 31, 1998 December 31, 1997 December 31, 1996 ----------------- ----------------- ----------------- Weighted-Average Weighted-Average Weighted-Average Shares Exercise Price Shares Exercise Price Shares Exercise Price ------ -------------- ------ ---------------- ------ ---------------- Outstanding at beginning of period 1,925,809 $ 11.00 1,863,671 $ 9.11 1,625,738 $ 8.64 Granted 833,696 15.53 335,375 19.43 456,399 10.78 Exercised (519,848) 8.76 (221,558) 7.78 (78,028) 6.65 Forfeited (469,508) 26.16 (51,679) 11.45 (140,438) 10.43 --------- --------- --------- Outstanding at end of period 1,770,149 13.26 1,925,809 11.00 1,863,671 9.11 ========= ========= ========= Options exercisable at end of period 1,061,756 1,247,265 1,159,959 ========= ========= ========= 28 29 REHABCARE GROUP, INC. Notes to Consolidated Financial Statements The following table summarizes information about stock options outstanding at December 31, 1998: Options Outstanding Options Exercisable --------------------------------------------------- -------------------------------- Weighted-Average Range of Number Remaining Weighted-Average Number Weighted-Average Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price --------------- ----------- ---------------- ---------------- ----------- ---------------- $ 4.83 - 9.17 630,503 4.8 years $ 8.60 589,234 $ 8.60 10.67 - 14.38 552,044 7.6 11.37 333,022 11.45 16.25 - 20.08 396,884 9.8 18.36 3,891 17.43 22.08 - 27.38 190,718 8.3 23.52 135,609 23.81 --------- --------- 4.83 - 27.38 1,770,149 7.2 13.26 1,061,756 11.47 ========= ========= The Board of Directors of the Company declared a dividend distribution of one preferred stock purchase right (the "Rights") for each share of the Company's common stock owned as of October 1, 1992, and for each share of the Company's common stock issued until the Rights become exercisable. Each Right, when exercisable, will entitle the registered holder to purchase from the Company one sixty-seventh of a share of the Company's Series A junior participating preferred stock, $.10 par value (the Series A preferred stock), at a price of $35 per one sixty-seventh of a share. The Rights are not exercisable and are transferable only with the Company's common stock until the earlier of 10 days following a public announcement that a person has acquired ownership of 15% or more of the Company's outstanding common stock, or the commencement or announcement of a tender offer or exchange offer, the consummation of which would result in the ownership by a person of 15% or more of the Company's outstanding common stock. The Series A preferred stock will be nonredeemable and junior to any other series of preferred stock that the Company may issue in the future. Each share of Series A preferred stock, upon issuance, will have a preferential dividend in an amount equal to the greater of $1.00 per share or 100 times the dividend declared per share of the Company's common stock. In the event of the liquidation of the Company, the Series A preferred stock will receive a preferred liquidation payment equal to the greater of $100 or 100 times the payment made on each share of the Company's common stock. Each one sixty-seventh of a share of Series A preferred stock outstanding will have one vote on all matters submitted to the stockholders of the Company and will vote together as one class with the holders of the Company's common stock. In the event that a person acquires beneficial ownership of 15% or more of the Company's common stock, holders of Rights (other than the acquiring person or group) may purchase, at the Rights' then current purchase price, shares of the Company's common stock having a value at that time equal to twice such exercise price. In the event that the Company merges into or otherwise transfers 50% or more of its assets or earnings power to any person after the Rights become exercisable, holders of Rights (other than the acquiring person or group) may purchase, at the then current exercise price, common stock of the acquiring entity having a value at that time equal to twice such exercise price. 29 30 REHABCARE GROUP, INC. Notes to Consolidated Financial Statements (8) Earnings per Share The following table sets forth the computation of basic and diluted earnings per share: Ten Months Ended Year Ended December 31, December 31, 1998 1997 1996 ---- ---- ---- Numerator: Numerator for basic earnings per share - earnings available to common stockholders (net earnings) $ 12,198,000 10,615,000 5,768,000 Effect of dilutive securities - after-tax interest on convertible subordinated promissory notes 225,000 225,000 184,000 ---------- ---------- --------- Numerator for diluted earnings per share - earnings available to common stockholders after assumed conversions $ 12,423,000 10,840,000 5,952,000 ========== ========== ========= Denominator: Denominator for basic earnings per share - weighted-average shares outstanding 6,184,000 5,999,000 7,001,000 Effect of dilutive securities: Stock options 585,000 809,000 388,000 Convertible subordinated promissory notes 423,000 423,000 423,000 Contingently issuable shares 53,000 144,000 -- ---------- ---------- --------- Denominator for diluted earnings per share - adjusted weighted-average shares and assumed conversions 7,245,000 7,375,000 7,812,000 ========== ========== ========= Basic earnings per share $ 1.97 1.77 .82 ==== ==== === Diluted earnings per share $ 1.71 1.47 .76 ==== ==== === (9) Employee Benefits The Company has an Employee Savings Plan, which is a defined contribution plan qualified under Section 401(k) of the Internal Revenue Code, for the benefit of its eligible employees. Employees who attain the age of 21 and complete twelve consecutive months of employment with a minimum of 1,000 hours worked are eligible to participate in the plan. Each participant may contribute from 2% to 20% of his or her compensation to the plan subject to limitations on the highly compensated employees to ensure the plan is nondiscriminatory. Contributions made by the Company to the Employee Savings Plan were at rates of up to 50% of the first 4% of employee contributions. Expense in connection with the Employee Savings Plan for 1998, 1997 and 1996 totaled $681,000, $439,000 and $329,000, respectively. The Company maintains a nonqualified deferred compensation plan for certain employees. Under the plan, participants may defer up to 100% of their yearly compensation. The amounts deferred are held in trust but remain the property of the Company. The Company establishes supplemental bonus plans in order to retain key members of management. The current plans have vesting periods of from four to seven years. Deferred payments that have vested are distributed upon termination of employment or at such later date as established by 30 31 REHABCARE GROUP, INC. Notes to Consolidated Financial Statements the plans. The total cost of the supplemental bonus plans is charged to earnings as compensation over the service period of the participant. Compensation expense under the plans for 1998, 1997, and 1996 totaled $360,000, $56,000, and $309,000, respectively. At December 31, 1998 and 1997, $1,240,000 and $1,812,000, respectively, were payable under the nonqualified deferred compensation and supplemental bonus plans and approximated the value of the trust assets owned by the Company. (10) Lease Commitments The Company leases office space and certain office equipment under noncancellable operating leases. Future minimum lease payments under noncancellable operating leases, as of December 31, 1998, that have initial or remaining lease terms in excess of one year total approximately $1,639,000 for 1999, $1,426,000 for 2000, $1,036,000 for 2001, $887,000 for 2002 and $512,000 for 2003 and thereafter. Rent expense for 1998, 1997 and 1996 was approximately $1,203,000, $766,000 and $605,000, respectively. (11) Income Taxes Income taxes consist of the following: Ten Months Ended Year Ended December 31, December 31, 1998 1997 1996 ---- ---- ---- Federal - current $ 7,922,000 6,298,000 3,787,000 Federal - deferred 42,000 (122,000) (539,000) State 937,000 1,091,000 638,000 --------- --------- --------- $ 8,901,000 7,267,000 3,886,000 ========= ========= ========= Deferred tax liability recorded in stockholders' equity $ 4,000 520,000 1,367,000 ========= ========= ========= A reconciliation between expected income taxes, computed by applying the statutory Federal income tax rates to earnings before income taxes, and actual income tax is as follows: Ten Months Ended Year Ended December 31, December 31, 1998 1997 1996 ---- ---- ---- Statutory U.S. Federal rate 35% 35% 34% === === === Expected income taxes $ 7,656,000 6,259,000 3,282,000 Tax effect of interest income from municipal bond obligations exempt from Federal taxation (65,000) (54,000) (43,000) State income taxes, net of Federal income tax benefit 609,000 709,000 421,000 Tax effect of amortization expense not deductible for tax purposes 261,000 261,000 211,000 Other, net 440,000 92,000 15,000 --------- --------- --------- $ 8,901,000 7,267,000 3,886,000 ========= ========= ========= 31 32 REHABCARE GROUP, INC. Notes to Consolidated Financial Statements The tax effects of temporary differences that give rise to the deferred tax assets and liabilities are as follows: December 31, 1998 1997 ---------------------------- Deferred tax assets: Net operating loss $ 95,000 569,000 Provision for doubtful accounts 1,112,000 519,000 Accrued insurance, bonus and vacation expense 2,776,000 2,442,000 Other 740,000 351,000 --------- --------- 4,723,000 3,881,000 --------- --------- Deferred tax liabilities: Unrealized gains on marketable securities 4,000 520,000 Goodwill amortization 1,494,000 765,000 Other 798,000 642,000 --------- --------- 2,296,000 1,927,000 --------- --------- Net deferred tax asset $ 2,427,000 1,954,000 ========= ========= The Company is required to establish a valuation allowance for deferred tax assets if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income of the periods which the deferred tax assets are deductible, management believes that a valuation allowance is not required, as it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets. As a result of the acquisition of Advanced Rehabilitation Resources, Inc. in 1993, the Company, as of December 31, 1998, has approximately $231,000 of net operating loss carryforwards for income tax purposes, which will expire in years 2005 through 2008. The Tax Reform Act of 1986 imposes an annual limitation on the amount of any preacquisition loss carryforwards that can be used to offset Company Federal taxable income generated after the acquisition date. Generally, this annual limitation will approximate $1,200,000. Income taxes paid by the Company for 1998, 1997 and 1996 were $6,500,000, $6,400,000 and $4,234,000, respectively. (12) Industry Segment Information The Company operates in two business segments that are managed separately based on fundamental differences in operations: program management and staffing. The program management segment includes the management of acute rehabilitation and skilled nursing units, outpatient programs and 32 33 REHABCARE GROUP, INC. Notes to Consolidated Financial Statements contract therapy services. The staffing segment includes staffing of nurses and therapists on a temporary and permanent basis. All of the Company's services are provided in the United States. Summarized information about the Company's operations in each industry segment is as follows: Revenues from Unaffiliated Customers Operating Earnings ------------------------------------ ---------------------------------- 1998 1997 1996 1998 1997 1996 ---- ---- ---- ---- ---- ---- Program management $ 142,051,000 115,209,000 76,349,000 21,225,000 14,566,000 8,043,000 Staffing 65,365,000 45,571,000 28,262,000 2,106,000 4,414,000 2,655,000 ----------- ----------- ----------- ---------- ---------- ---------- Total $ 207,416,000 160,780,000 104,611,000 23,331,000 18,980,000 10,698,000 =========== =========== =========== ========== ========== ========== Total Asset Depreciation and Amortization ------------------------------------ ---------------------------------- 1998 1997 1996 1998 1997 1996 ---- ---- ---- ---- ---- ---- Program management $ 89,369,000 67,530,000 54,236,000 2,758,000 2,874,000 2,076,000 Staffing 67,501,000 29,711,000 26,566,000 1,208,000 906,000 667,000 ----------- ---------- ---------- --------- --------- --------- Total $ 156,870,000 97,241,000 80,802,000 3,966,000 3,780,000 2,743,000 =========== ========== ========== ========= ========= ========= Capital Expenditures ------------------------------------ 1998 1997 1996 ---- ---- ---- Program management $ 1,491,000 1,123,000 541,000 Staffing 612,000 249,000 191,000 --------- --------- ------- Total $ 2,103,000 1,372,000 732,000 ========= ========= ======= (13) Quarterly Financial Information (Unaudited) (In thousands, except per share data) Quarter Ended 1998 Dec. 31 Sep. 30 June 30 Mar. 31 ---- ------- ------- ------- ------- Operating revenues $ 66,835 54,050 42,967 43,564 Operating earnings 6,712 5,935 5,345 5,339 Earnings before income taxes and cumulative effect of change in accounting principle 7,178 5,147 4,808 4,742 Net earnings 4,227 3,072 2,883 2,016 Net earnings per common share: Basic Earnings before cumulative effect of change in accounting principle .65 .49 .48 .47 Net earnings .65 .49 .48 .35 Diluted Earnings before cumulative effect of change in accounting principle .59 .43 .41 .40 Net earnings .59 .43 .41 .29 33 34 Quarter Ended 1997 Dec. 31 Sep. 30 June 30 Mar. 31 ---- ------- ------- ------- ------- Operating revenues $ 42,728 42,151 39,496 36,405 Operating earnings 5,352 4,854 4,464 4,310 Earnings before income taxes 4,659 4,139 3,741 5,343 Net earnings 2,744 2,439 2,165 3,267 Net earnings per common share: Basic .47 .43 .38 .48 Diluted .38 .35 .31 .42 The sum of the quarterly earnings per common share may not equal the full year earnings per common share due to rounding and computational differences. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Certain information regarding directors and executive officers of the Company is contained under the caption "Item 1 - Election of Directors" and "Compliance with Section 16(a) of the Securities Exchange Act of 1934" included in the Proxy Statement for the 1999 Annual Meeting of Stockholders, which information is incorporated herein by reference. The following is a list as of March 11, 1999, of the names and ages of the executive officers of the Company and positions with the Company. The employment history of each of the executive officers for the past five years follows the list. There is no family relationship between any of the named persons. Name Age Position ---- --- -------- Alan C. Henderson 53 President and Chief Executive Officer Richard C. Stoddard 50 Executive Vice President, President, HSSI Gregory F. Bellomy 42 President, Contract Therapy Division Tom E. Davis 49 President, Inpatient Division Keith L. Goding 48 Executive Vice President and Chief Development Officer Alfred J. Howard 46 President, Outpatient Division Hickley M. Waguespack 55 Executive Vice President, Customer Service and Retention John R. Finkenkeller 46 Senior Vice President, Chief Financial Officer and Secretary ALAN C. HENDERSON has been President and Chief Executive Officer and a Board Member of the Company since May 1998 and was Executive Vice President, Chief Financial Officer and Secretary from 1991 through May 1998. RICHARD C. STODDARD is a co-founder of HSSI, has been President of HSSI since 1989, and is also a Board Member at the Company. 34 35 GREGORY F. BELLOMY has been President of the Company's Contract Therapy Division since September 1998. Prior to joining the Company, Mr. Bellomy served in various capacities, including Division President, Division Vice President and Area General Manager, at TheraTex Incorporated from 1992 to 1997, at which time TheraTex was acquired by Vencor Incorporated. Mr. Bellomy was National Director of Vencare Ancillary Services for Vencor until he joined the Company. TOM E. DAVIS has been President of the Inpatient Division of the Company since January 1998 and joined the Company in January 1997 as Senior Vice President of Operations. Prior to joining the Company, Mr. Davis was Group Vice President for Quorum Health Resources from January 1990 to January 1997. KEITH L. GODING has been Executive Vice President and Chief Development Officer of the Company since February 1995. Prior to joining the Company, Mr. Goding was Vice President for Corporate Alliances and Vice President of Sales, Marketing and Product Development for Spectrum Healthcare Services, a division of ARAMARK, where he was employed since 1974. ALFRED J. HOWARD has been President of the Outpatient Division of the Company since August 1996. Prior to joining the Company he was President of the Eastern Operations for Pacific Rehabilitation and Sports Medicine from October 1993 to August 1996. HICKLEY M. WAGUESPACK has been Executive Vice President, Customer Service and Retention of the Company since January 1998, was Chief Operating Officer of the Company from March 1995 through December 1997, and was Senior Vice President - - Operations from June 1991 until February 1995. JOHN R. FINKENKELLER has been Senior Vice President and Chief Financial Officer of the Company since June 1998, was elected Secretary in August 1998 and was Senior Vice President and Treasurer since October 1991. ITEM 11. EXECUTIVE COMPENSATION Information regarding executive compensation is contained under the caption "Compensation of Executive Officers," included in the Proxy Statement for the 1999 Annual Meeting of Stockholders, which is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information regarding security ownership of certain beneficial owners and management is contained under the captions "Voting Securities and Principal Holders Thereof" and "Security Ownership by Management," included in the Proxy Statement for the 1999 Annual Meeting of Stockholders, which is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Not applicable. 35 36 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: (1) Financial Statements Independent Auditors' Report Consolidated Balance Sheets as of December 31, 1998 and 1997 Consolidated Statements of Earnings for the years ended December 31, 1998 and 1997, and for the ten months ended December 31, 1996 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998 and 1997, and for the ten months ended December 31, 1996 Consolidated Statements of Cash Flows for the years ended December 31, 1998 and 1997, and for ten months ended December 31, 1996 Consolidated Statements of Comprehensive Earnings for the years ended December 31, 1998 and 1997, and for the ten months ended December 31, 1996 Notes to Consolidated Financial Statements (2) Financial Statement Schedules: None (3) Exhibits: See Exhibit Index on page 46 of this Report. (b) Reports on Form 8-K No reports on Form 8-K were filed by the Registrant during the three months ended December 31, 1998. 36 37 SIGNATURES Pursuant to the requirements of Section 13 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. Dated: March 11, 1999 REHABCARE GROUP, INC. (Registrant) By: /s/ ALAN C. HENDERSON ------------------------------------- (Alan C. Henderson) President and Chief Executive 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 date indicated. Signature Title Dated --------- ----- ----- /s/ ALAN C. HENDERSON President, Chief Executive March 11, 1999 -------------------------------- Officer and Director (Alan C. Henderson) Principal Executive Officer /s/ JOHN R. FINKENKELLER Senior Vice President March 11, 1999 -------------------------------- and Chief Financial Officer (John R. Finkenkeller) Principal Financial Officer /s/ WILLIAM G. ANDERSON Director March 11, 1999 -------------------------------- (William G. Anderson) /s/ RICHARD E. RAGSDALE Director March 11, 1999 -------------------------------- (Richard E. Ragsdale) /s/ JOHN H. SHORT Director March 11, 1999 -------------------------------- (John H. Short) /s/ RICHARD C. STODDARD Director March 11, 1999 -------------------------------- (Richard C. Stoddard) /s/ H. EDWIN TRUSHEIM Director March 11, 1999 -------------------------------- (H. Edwin Trusheim) /s/ THEODORE M. WIGHT Director March 11, 1999 -------------------------------- (Theodore M. Wight) 37 38 EXHIBIT INDEX 3.1 Restated Certificate of Incorporation (filed as Exhibit 3.1 to the Registrant's Registration Statement on Form S-1, dated May 9, 1991 [Registration No. 33-40467] and incorporated herein by reference) 3.2 Certificate of Amendment of Certificate of Incorporation (filed as Exhibit 3.1 to the Registrant's Report on Form 10-Q for the quarter ended May 31, 1995 and incorporated herein by reference) 3.3 Bylaws (filed as Exhibit 3.2 to the Registrant's Registration Statement on Form S-1, dated May 9, 1991 [Registration No. 33-40467] and incorporated herein by reference) 4.1 Rights Agreement, dated September 21, 1992, by and between the Company and Boatmen's Trust Company (filed as Exhibit 1 to the Company's Registration Statement on Form 8-A filed September 24, 1992 and incorporated herein by reference) 10.1 1987 Incentive Stock Option and 1987 Nonstatutory Stock Option Plans (filed as Exhibit 10.1 to the Registrant's Registration Statement on Form S-1, dated May 9, 1991 [Registration No. 33-40467] and incorporated herein by reference) 10.2 Form of Stock Option Agreement (filed as Exhibit 10.2 to the Registrant's Registration Statement on Form S-1, dated May 9, 1991 [Registration No. 33-40467] and incorporated herein by reference) 10.3 Employment Agreement with Alan C. Henderson, dated May 1, 1991 (filed as Exhibit 10.4 to Amendment No. 1 to the Registrant's Registration Statement on Form S-1, dated June 19, 1991 [Registration No. 33-40467] and incorporated herein by reference) 10.4 Employment Agreement with Richard C. Stoddard, dated March 1, 1996 by and between Registrant, Healthcare Staffing Solutions, Inc. d/b/a Health Tour, and Richard C. Stoddard (filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K, dated March 1, 1996 and incorporated herein by reference) 10.5 Form of Termination Compensation Agreement for Alan C. Henderson (filed as Exhibit 10.6 to the Registrant's Registration Statement on Form S-1, dated February 18, 1993 [Registration No. 33-58490] and incorporated herein by reference) 10.6 Form of Termination Compensation Agreement for other executive officers (filed as Exhibit 10.7 to the Registrant's Registration Statement on Form S-1, dated February 18, 1993 [Registration No. 33-58490] and incorporated herein by reference) 10.7 Supplemental Bonus Plan (filed as Exhibit 10.8 to the Registrant's Registration Statement on Form S-1, dated February 18, 1993 [Registration No. 33-58490] and incorporated herein by reference) 10.8 Deferred Profit Sharing Plan (filed as Exhibit 10.15 to the Registrant's Registration Statement on Form S-1, dated February 18, 1993 [Registration No. 33-58490] and incorporated herein by reference) 10.9 RehabCare Executive Deferred Compensation Plan (filed as Exhibit 10.12 to the Registrant's Report on Form 10-K, dated May 27, 1994 and incorporated herein by reference) 38 39 EXHIBIT INDEX (CONT'D) 10.10 RehabCare Directors' Stock Option Plan (filed as Appendix A to Registrant's Proxy Statement for the 1994 Annual Meeting of Stockholders and incorporated herein by reference) 10.11 RehabCare Group, Inc. 1996 Long-Term Performance Plan (filed as Appendix A to the Registrant's Proxy Statement for the 1996 Annual Meeting of Stockholders and incorporated herein by reference) 10.12 Form of Subordinated Convertible Promissory Note of Registrant issued to stockholders of Healthcare Staffing Solutions, Inc. d/b/a Health Tour (filed as Exhibit 2.4 to the Registrant's Current Report on Form 8-K, dated March 1, 1996 and incorporated herein by reference) 10.13 Stock Purchase Agreement, dated January 27, 1997 by and among Registrant and the stockholders of TeamRehab, Inc., Moore Rehabilitation Services, Incorporated and Moore Rehabilitation Services, PC. (filed as Exhibit 10.19 to the Registrant's Report on Form 10-K, dated March 12, 1997 and incorporated herein by reference) 10.14 Form of Subordinated Promissory Note of Registrant issued to the stockholders of TeamRehab, Inc., Moore Rehabilitation Services, Incorporated and Moore Rehabilitation Services, PC. (filed as Exhibit 10.20 to the Registrant's Report on Form 10-K, dated March 12, 1997 and incorporated herein by reference) 10.15 Stock Purchase Agreement, dated July 8, 1998 by and among Medical Resources, Inc., HealthCare Staffing Solutions, Inc. and RehabCare Group, Inc. (filed as Exhibit 2.1 to Registrant's Current Report on Form 8-K, dated August 14, 1998 and incorporated herein by reference) 10.16 Escrow Agreement, dated as of August 14, 1998 by and among Medical Resources Inc., RehabCare Group, Inc. and IBJ Schroder Bank & Trust Company (filed as Exhibit 2.2 to Registrant's Current Report on Form 8-K, dated August 14, 1998 and incorporated herein by reference) 10.17 L/C Procedures Agreement, dated as of July 8, 1998 by and between Medical Resources, Inc. and RehabCare Group, Inc. (filed as Exhibit 2.3 to Registrant's Current Report on Form 8-K, dated August 14, 1998 and incorporated herein by reference) 10.18 Stock Purchase Agreement dated as of August 5, 1998 by and among RehabCare Group Inc., Therapeutic Systems, Ltd. and Ronald C. Stauber (filed as Exhibit 2.1 to Registrant's Current Report on Form 8-K, dated September 9, 1998 and incorporated herein by reference) 10.19 Amendment No. 1 to Stock Purchase Agreement dated as of September 9, 1998 by and among RehabCare Group, Inc., Therapeutic Systems, Ltd. and Ronald C. Stauber (filed as Exhibit 2.2 to Registrant's Current Report on Form 8-K, dated September 9, 1998 and incorporated herein by reference) 13.1 Those portions of the Annual Report for the year ended Page 40 December 31, 1998 of the Registrant included in response to Items 5 and 6 of Form 10-K 21.1 Subsidiaries of the Registrant Page 41 23 Consent of KPMG LLP Page 42 27 Financial Data Schedule Page 43 39 40 Exhibit 13.1 SIX-YEAR FINANCIAL SUMMARY Dollars in thousands, except per share data (year ended December 31, unless noted) 1998 1997 1996<F1> 1996<F2> 1995<F2> 1994<F2> - ------------------------------------------------------------------------------------------------------------------------------------ Statement of earnings data: Operating revenues $207,416 $160,780 $119,856 $89,377 $83,210 $61,740 Operating earnings 23,331 18,980 12,717 10,276 8,531 5,533 Net earnings <F4> 12,198 10,615 6,992 5,878 4,735 3,070 Net earnings per share (EPS): <F3> <F4> Basic $ 1.97 $ 1.77 $ 1.01 $ .87 $ .71 $ .59 Diluted $ 1.71 $ 1.47 $ .93 $ .84 $ .70 $ .59 Weighted average shares outstanding (000s):<F3> Basic 6,184 5,999 6,955 6,725 6,614 4,514 Diluted 7,245 7,375 7,711 6,975 6,783 5,214 - ------------------------------------------------------------------------------------------------------------------------------------ Balance sheet data: Working capital $ 20,606 $ 12,793 $ 9,254 $11,818 $ 5,460 $ 6,271 Total assets 156,870 97,241 80,802 57,066 52,833 45,445 Total debt 65,855 39,014 17,467 7,125 10,200 7,700 Stockholders' equity 60,156 39,760 49,670 38,897 32,431 24,132 - ------------------------------------------------------------------------------------------------------------------------------------ Financial statistics: Operating margin 11.3% 11.8% 10.6% 11.5% 10.2% 9.0% Net margin<F5> 5.8% 6.1% 5.8% 6.6% 5.7% 5.0% Current ratio 1.5:1 1.6:1 1.6:1 2.0:1 1.4:1 1.6:1 Diluted EPS growth rate <F5> 25.9% 45.2% 14.8% 20.0% 18.6% 22.9% Return on equity<F5> <F6> 24.1% 21.8% 16.1% 16.5% 16.7% 25.8% - ------------------------------------------------------------------------------------------------------------------------------------ Operating statistics: Inpatient (acute rehab and subacute): Average number of units 128.2 110.3 91.3 84.7 84.1 64.4 Average admissions per unit 354 321 294 279 261 264 Average length of stay (billable) 14.5 15.0 15.9 17.3 18.4 19.0 Patient days (billable) 656,363 532,195 426,995 408,385 403,784 323,040 Outpatient: Average number of locations 26.1 17.9 19.6 21.2 13.6 7.6 Patient visits 378,108 231,256 223,904 278,970 135,064 N/A Therapy staffing - Number of weeks worked 52,265 29,652 21,908 -- -- -- Contract therapy - Average number of locations 49.5 35.6 -- -- -- -- - ------------------------------------------------------------------------------------------------------------------------------------ <FN> <F1>For comparability purposes, reflects the twelve months ended December 31, 1996. <F2>Twelve month period ended last day of February. <F3>All share data adjusted for 3-for-2 stock split in October 1997. <F4>1998 and 1997 include pre-tax gains of $1.5 million ($0.9 million after tax or $0.12 per share) and $1.4 million ($0.9 million after tax or $0.12 per share), respectively, from sales of marketable securities. 1998 includes an $0.8 million ($0.11 per share) after-tax charge for the cumulative effect of change in accounting for start-up costs. <F5>Excludes gains from sale of marketable securities and charge for the cumulative effect of change in accounting principle described in <F4>. <F6>Average of beginning and ending equity. N/A - Not available </FN> - -------------------------------------------------------------------------------- STOCK DATA The Company's common stock is listed and traded on the New York Stock Exchange under the symbol "RHB". The stock prices below are the high and low sale prices. Calendar Quarter 1st 2nd 3rd 4th 1998: High $27.50 $31.75 $25.13 $21.00 Low 20.63 21.75 11.88 11.00 1997: High 17.58 24.83 25.25 31.13 Low 12.50 15.75 17.67 23.50 The Company has not paid dividends on its common stock during the two most recently completed fiscal years and has not declared any dividends during the current fiscal year. The Company does not anticipate paying cash dividends in the foreseeable future. The number of holders of the Company's common stock as of March 11, 1999 was approximately 3,637 including 158 shareholders of record and an estimated 3,479 persons or entities holding common stock in nominee name. Shareholders may receive earnings news releases, which provide timely financial information, by notifying our investor relations department or by visiting our website at http://www.rehabcare.com. 40 41 Exhibit 21.1 Subsidiaries of Registrant Healthcare Staffing Solutions, Inc. Incorporated in the Commonwealth d/b/a Health Tour of Massachusetts Health Tour Management, Inc. Incorporated in the Commonwealth of Massachusetts TeamRehab, Inc. Incorporated in the State of Missouri Moore Rehabilitation Services, Inc. Incorporated in the State of Missouri RehabCare Group East, Inc. Incorporated in the State of Delaware RehabCare Group Management Services, Inc. Incorporated in the State of Delaware RehabCare Group of California, Inc. Incorporated in the State of Delaware RehabCare Group of Texas Holdings, Inc. Incorporated in the State of Delaware RehabCare Group of Texas, L.P. Organized in the State of Texas StarMed Management, L.L.C. Incorporated in the State of Delaware StarMed Health Personnel, Inc. Incorporated in the State of Delaware Wesley Medical Resources, Inc. Incorporated in the State of Delaware Therapeutic Systems, Ltd. Incorporated in the State of Illinois 41 42 Exhibit 23 Independent Auditors' Consent The Board of Directors RehabCare Group, Inc.: We consent to the incorporation by reference in the registration statement No. 33-82106 on Form S-8, registration statement No. 33-82048 on Form S-8, and registration statement No. 333-11311 on Form S-8 of RehabCare Group, Inc. of our report dated February 5, 1999, with respect to the consolidated balance sheets of RehabCare Group, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of earnings, stockholders' equity, cash flows and comprehensive earnings for the years ended December 31, 1998 and 1997 and for the ten months ended December 31, 1996, which report is included in the December 31, 1998 annual report on Form 10-K of RehabCare Group, Inc. As discussed in note 1 to the consolidated financial statements, the Company changed its method of accounting for start-up costs. KPMG LLP St. Louis, Missouri March 24, 1999 42