NovaCare, Inc. History

Company History:

NovaCare, Inc. is America's leading provider of contract rehabilitation services as well as orthotic supports and prosthetics. The company's largest business group, Contract Services (constituting over two-thirds of revenues), coordinates speech, occupational, and physical therapists with over 1,900 health care institutions&mdash′imarily nursing homes--in 39 states. NovaCare is the largest non-government employer of rehabilitation therapists, and has a nine percent share of the orthotics and prosthetics field. Having grown dramatically through acquisition and internal growth, the company reported average annual sales and earnings increases from 1987 to 1992 of 70.2 percent and 74.6 percent, respectively. In 1993, John H. Foster, chairperson and CEO, predicted that the firm would reach annual sales of $3 billion by 1998.

NovaCare was founded in 1976 as InSpeech, Inc. by speech pathologist Leslie Isenberg. However, the company's phenomenal growth was largely attributable to the direction of John H. Foster. In 1980, Foster, a medical services entrepreneur, founded Foster Medical Corp., a home health care services and equipment company, which he took public two years later. In 1983, Foster sold his namesake venture to Avon Products Inc. for $240 million in Avon stock. He then used the profits from that sale to acquire InSpeech, Inc. through his Foster Management Co. venture capital firm in 1985.

Foster then began to make good on his goal of consolidating and integrating rehabilitation services in America, using InSpeech as his base. At the time, the highly fragmented industry was dominated by thousands of local practices that Foster disparagingly called "mom and pop franchises" in an October 1991 Business Week article. Foster foresaw the expansion of the rehabilitation industry, as Americans (especially the "baby boomer" generation) continued to age and advances in the treatment of serious injuries resulted in physical impairment rather than death. InSpeech also lobbied for legislation that required nursing homes to provide therapy to residents, which further boosted its potential market.

The rehabilitation industry offered inherently low overhead--the therapists themselves represented the overhead and the assets--that would be further enhanced through consolidation. Whereas nursing homes and hospitals often did not have enough patients to justify employment of a full-time therapist and suffered high turnover, InSpeech could staff more cost-effectively than health care institutions, pay its employees higher salaries on average than they made independently, and still earn a high return on equity through economies of scale. Foster also wanted to establish a strong market presence and become a service sector "category killer."

With the backing of partners, Foster began immediately to augment InSpeech through acquisitions of occupational and physical therapy businesses. The May 1986 purchase of Irwin Lehrhoff Associates gave InSpeech a national presence, and acquisitions in Arizona, California, Colorado, Florida, Georgia, Illinois, Minnesota, North Carolina, Virginia, and Wisconsin followed within the year. Foster took InSpeech public in November and spent the next year integrating his purchases.

During this time, the significance of InSpeech's human assets--its therapists--came to the fore, as InSpeech suffered a backlash from clinicians who perceived the company's integration and economization methods as infringements on their ability to provide quality care. Turnover at InSpeech soared to 56 percent by the end of 1987, as therapists who could not make the transition from their relatively autonomous working environment to a tightly controlled corporate culture left. Foster tackled the crisis by making a survey of staff members throughout the country. The employees who remained convinced the CEO to renew and clarify InSpeech's emphasis on professionalism. After six months and 250 drafts, the firm ratified a 16-page statement of its "Purpose and Beliefs," which included the oft-cited credo: "Helping Make Life a Little Better." Foster also hired C. Arnold Renschler, M.D., a prominent nursing-home executive, as president. Therapist turnover declined to 20 percent, below the industry's average, and, by fall 1991, the company was hiring about 100 new clinicians each month. In 1989, Foster changed the company's name to NovaCare, Inc. to reflect its diversification into occupational and physical therapy and reorganized the firm into four geographical divisions.

In the early 1990s, NovaCare began to expand into freestanding outpatient hospitals and community re-entry programs with the acquisition of Rehab Systems Company's seven facilities in 1991. NovaCare also purchased Orthopedic Services, Inc. (OSI), the country's largest manufacturer and fitter of custom braces and prosthetics, in exchange for $265 million of its own stock. OSI had been, not coincidentally, launched by Foster Management Co. in 1987 at a cost of $.12 per share. OSI's initial public offering drew $16 per share in 1990, and NovaCare paid the equivalent of $32 per share for it the following year.

Similar inside transactions followed in 1993 and 1994. NovaCare acquired Rehabilitation Hospital Corporation of America (RHCA), a chain of five freestanding hospitals and outpatient centers, which it merged into its newly formed NovaCare Medical Rehabilitation Hospital Group in October 1993. The $49 million cash transaction included $19 million in repayments of loans to Foster's partnerships. The following February saw NovaCare's acquisition of RehabClinics Inc., a 181-clinic, publicly traded group of outpatient centers, which was 42 percent controlled by Foster.

In the mid-1990s, Foster faced increasing criticism that his inside deals benefited him and his partners more than NovaCare and its shareholders, about half of whom were institutional investors. However, Foster insisted that Foster Management Co. was an investment arm of NovaCare. In November 1993, he told Janet Novack of Forbes that "NovaCare's board has determined that NovaCare is not in the venture capital business." In the same article, he pointed out that "the timing and price of deals between his companies [were] determined by outside directors using outside advisers." Neither critics nor investors could argue with the financial success of the deals: NovaCare's split-adjusted share price had tripled from $4.25 in 1986 to $13 in 1993.

However, some analysts cautioned that profit margins in the entire health care industry would shrink as social, corporate, and governmental pressure to control upwardly spiraling health care costs became vital to the Clinton administration. Moreover, others predicted that high health care earnings were due for a downward cycle, regardless of legislation. Nevertheless, such warnings seemed more applicable to segments of the health care industry other than that represented by NovaCare. The rehabilitation industry appeared limited only by the number of therapists available, as demand for therapy in nursing homes doubled from 1990 to 1992, while the number of clinicians only increased five percent per year. As Foster noted in his 1993 letter to shareholders, the field was "marked by excess demand, with many unserved patients and too few clinical professionals." NovaCare recruited a significant number of the therapists available, signing on a record 2,300 for a 46 percent increase in its clinical contract staff. Being a preferred employer in the field helped shield NovaCare from competition. Moreover, national health care reform remained a matter of debate in the mid-1990s, and rehabilitation and treatment in outpatient facilities like NovaCare's appeared a cost-effective alternative regardless of federal initiatives. Analysts also emphasized the continued growth potential of the rehabilitation market, which remained largely fragmented. NovaCare's reliance on Medicare and Medicaid for 34 percent of revenues put the company at the mercy of regulatory changes but also gave it a preferred position in the event that a single-payer health care system was adopted.

NovaCare has linked its future growth to managed care organizations, referring to them as the "customer of the future." Foster hoped to sell health management organizations (HMOs) a "seamless continuum of care," including hospital, nursing home, and outpatient care, thereby increasing and capturing the HMOs' investment in rehabilitation. Foster and his colleagues hoped to capture six percent of managed care insurers' annual rehabilitation services outlays by being the most cost-effective provider. They reasoned that NovaCare could move patients out of acute care hospitals and into its more efficient rehabilitation hospitals and nursing homes more quickly. Some analysts noted that such large health care groups had already been chosen by half of insured Americans and predicted that they would capture 90 percent of the health insurance market by the turn of the century. Toward that end, NovaCare began to quantify its recovery rates, enabling it to clearly and credibly illustrate its performance to such large clients.

In 1993, with revenues of $539.07 million, Foster predicted that NovaCare would be a highly profitable company with $3 billion in revenues by 1998 and that company stock would sell between $50 and $80 a share. Although compound growth of 40 percent annually would be necessary to reach that goal, this plan allowed for a slower growth rate than the previous five years' 70 percent average annual growth. If his expectations were realized, Foster and NovaCare would increase their net worth considerably; Foster's five percent share in NovaCare was worth about $30 million in 1993, according to Forbes.

Principal Subsidiaries: Ask Colorado Health Care Services, P.C.; Cannon & Associates, Inc.; CR Services Corp.; Craig & Ford Rehabilitation Services, Inc.; Farh Services Corp.; FD Capital Corp.; Heartland Rehabilitation, Inc.; Jana B. Mason Therapy Associates, Inc.; Jana B. Mason L.P.T., Inc.; Life Dimensions, Inc.; Life Dimension of California, Inc.; National Rehab Services; Ninth Avenue Capital Corp.; Northwest Rehabilitation, Inc.; NovaCare (Colorado), Inc.; NovaCare, Inc. (PA); NovaCare Management Co.; NovaCare Rehabilitation Agency of Northern California; NovaCare Rehabilitation Agency of Southern California; NovaCare Rehabilitation Agency of Tennessee, Inc.; NovaCare Rehabilitation Agency of Wisconsin, Inc.; NovaCare Services Corp.; NovaCare Speech Therapy & Audiology, Inc.; NovaCare (Texas), Inc.; Irwin Lehrhoff & Associates, Inc. (Illinois); Irwin Lehrhoff & Associates, Inc. (Oregon); Irwin Lehrhoff & Associates, Inc. (Texas); Irwin Lehrhoff & Associates, Inc. (Washington); Marilyn Hawker, Inc.; Marina Professional Services; Mitchell-Zoltowicz-Hotz & Associates, Inc.; Northside Physical Therapy Services, Inc.; Physio West Rehabilitation Services, Inc.; Prather & Associates, Inc.; SG Rehabilitation Agency, Inc.; SG Speech Associates Inc.; Western Rehabilitation Services, Inc.; Easton & Moran Physical Therapy, Inc.; NovaCare (Arizona), Inc.; NovaCare (Illinois), Inc.; Rehabilitation Systems of Illinois, Ltd.; Rehabilitation Systems, Inc.; Rehabilitation Systems Illinois Clinics, Inc.; Rehab Therapy, Inc.; Rehab Systems Co.; Rehab Systems Financial Corp.; Meridian Point Rehabilitation Hospital, Inc.; Arizona Rehabilitation Hospital, Inc.; Tri-State Regional Rehabilitation Hospital, Inc.; Rehabilitation Hospital of North Texas, Inc.; Tucson Regional Rehabilitation Hospital, Inc.; West Virginia Rehabilitation Hospital, Inc.; California Rehabilitation Systems, Inc.; NovaCare Orthotic & Prosthetics, Inc.; Applied Orthotic/Prosthetic Technologies, Inc.; Arizona Therapy Limb & Brace, Inc.; Barnhart Prosthetic & Orthotic Center, Inc.; Burge-Lloyd Surgical Company, Inc.; Coastal Orthopedics, Inc.; Commonwealth Prosthetics & Orthotics, Inc.; Custom Prosthetics Of Arizona, Inc.; Fillauer Orthotic & Prosthetic Services, Inc.; Florida Foot Care Centers, Inc.; Florida Orthotic & Prosthetic Centers of Broward, Inc.; Florida Orthotic & Prosthetic Centers of Palm Beach, Inc.; Gaines Brace & Limb, Inc.; Isle Acquisition, Inc.; Jim All, Inc.; Karg Prosthetics, Inc.; Knoxville Orthopedic Appliance Co., Inc.; Lux Artificial Limb & Brace Co.; McFarlen & Associates, Inc.; McFarlen & Associates, I, II, II, & IV; Mobility Orthotic & Prosthetics, Inc.; Newport Orthopedic & Prosthetic Center, Inc.; Ortho-Care, Inc.; NovaCare Orthotics & Prosthetics West, Inc.; NovaCare Orthotics & Prosthetics East, Inc.; NovaCare Orthotics & Prosthetics Holdings, Inc.; Phoenix Limb Shop, Inc.; R.E. Huck Co.; Rehabilitation Services, Inc.; Rex McKinney, CPO, Ltd.; R. Press, Inc.; Savannah Orthotics, Inc.; Savannah Orthopedic, Inc. of Boulder; Webb's K.I. Karlson Co., Inc.; Young's Orthopedic Service, Inc.; Southwest Rehabilitation Hospital, Inc.; West Coast Rehab Systems Co.; New Jersey Rehab Systems Co.; Advanced O & P; Allied Limb & Brace; Aurora Orthopedics, Inc.; Bryco Fabrication, Inc.; Brywood Orthopedic Center, Inc.; Canoga Orthopedic; North Iowa Prosthetics; Oak Ridge Orthopedic Appliance Co.; Southside Orthopedic Specialties; Worcester Orthopedic Appliance Co.

Further Reading:

• Bianco, Anthony, "Health Care's Busiest Empire Builder," Business Week, October 28, 1991, pp. 126, 128.
• Novack, Janet, "Insider Trading," Forbes, November 8, 1993, pp. 118--120.

Source: International Directory of Company Histories, Vol. 11. St. James Press, 1995.

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