10-K

UNITED STATES
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, 2004

Commission file number 0-19294

RehabCare Group, Inc.
(Exact name of Registrant as specified in its charter)

Delaware 
 (State or other jurisdiction of
incorporation or organization) 51-0265872
 (I.R.S. Employer Identification No.)

7733 Forsyth Boulevard, 23rd 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    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  .

                Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes    No   

                The aggregate market value of voting stock held by non-affiliates of Registrant at June 30, 2004 was $431,335,431. At March 7, 2005, the Registrant had 16,658,534 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

                Part II of this Annual Report on Form 10-K incorporates by reference information contained in the Registrant’s Annual Report to Stockholders for the fiscal year ended December 31, 2004.

                Part III of this Annual Report on Form 10-K incorporates by reference information contained in the Registrant’s definitive Proxy Statement for its Annual Meeting of Stockholders to be held on May 3, 2005.

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PART I

                This Annual Report on Form 10-K contains forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties that may cause our actual results in future periods to differ materially from forecasted results. These risks and uncertainties may include, but are not limited to, our ability to integrate acquisitions and to implement client partnering relationships within the expected timeframes and to achieve the revenue and earnings levels from such acquisitions and relationships at or above the levels projected; changes in and compliance with governmental reimbursement rates and other regulations or policies affecting our continuing businesses; our ability to attract new client relationships or to retain and grow existing client relationships through expansion of our hospital rehabilitation and contract therapy service offerings and the development of alternative product offerings; the future financial results of InteliStaf Holdings, Inc., our unconsolidated affiliate, and the effect of those results on our financial condition and results of operations; the adequacy and effectiveness of our operating and administrative systems; our ability and the additional costs of attracting administrative, operational and professional employees; significant increases in health, workers compensation and professional and general liability costs; litigation risks of our past and future business, including our ability to predict the ultimate costs and liabilities or the disruption of its operations; competitive and regulatory effects on pricing and margins; and general and economic conditions, including efforts by governmental reimbursement programs, insurers, healthcare providers and others to contain healthcare costs.

ITEM 1.      BUSINESS

                The terms “RehabCare,” “our company,” “we” and “our” as used herein refer to “RehabCare Group, Inc.”

Overview of Our Company

RehabCare Group, Inc., a Delaware corporation, is a leading provider of rehabilitation program management services in more than 800 hospitals, nursing homes and other long-term care facilities. In partnership with these facilities, we provide post-acute program management, medical direction, physical rehabilitation, quality assurance, compliance review, specialty programs and census development services. We also provide healthcare management consulting services primarily to hospitals.

Established in 1982, we have more than 20 years experience helping healthcare providers increase revenues and reduce costs while effectively and compassionately delivering rehabilitation services. We believe our clients place a high value on our extensive experience in assisting them to implement clinical best practices, to address competition for patient services, and to navigate the complexities inherent in managed care contracting and government reimbursement systems. Over the years, we have diversified our program management services to include management services for inpatient rehabilitation facilities within hospitals, skilled nursing units, outpatient rehabilitation programs, freestanding skilled nursing and long-term care and assisted living facilities. We also provide healthcare management consulting services.

We hold approximately 25% of the equity of InteliStaf Holdings, Inc., a privately held healthcare staffing company, resulting from our sale of our StarMed staffing division to InteliStaf in February 2004. Under accounting rules, we do not consolidate the financial condition and results of operations of the staffing business, but account for our minority investment in InteliStaf under the equity method.

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We offer our portfolio of program management and consulting services to a highly diversified customer base. In all, we have relationships with more than 800 hospitals, nursing homes and other long-term care facilities located in 37 states, the District of Columbia and Puerto Rico.

For the year ended December 31, 2004, we had consolidated operating revenues of $383.8 million, operating earnings of $41.8 million, net income of $23.2 million and diluted earnings per share of $1.38.

Industry Overview

As a provider of program management services, our revenues and growth are affected by trends and developments in healthcare spending. The Centers for Medicare and Medicaid Services (CMS) estimated that in 2003 total healthcare expenditures in the United States grew by 7.7% to $1.7 trillion, down from a 9.3% increase the previous year, marking the first time in seven years that healthcare spending has slowed. CMS also reports that hospital spending also slowed, but increased 6.5% in 2003.

CMS further projects that total healthcare spending in the United States will grow an average of 7.3% annually from 2005 through 2013. According to these estimates, healthcare expenditures will account for approximately $3.4 trillion, or 18.4%, of the United States gross domestic product by 2013. CMS is taking steps in several areas to control the growth of healthcare spending.

Demographic considerations affect long-term growth projections for healthcare spending. While we deliver therapy to adults of all ages, the bulk of our services are delivered to persons 65 and older. According to the U.S.Census Bureau’s 2000 census, there were approximately 35 million U.S. residents aged 65 or older, comprising approximately 13% of the total United States population. The number of U.S. residents aged 65 or older is expected to climb to approximately 40 million by 2010 and to approximately 54 million by 2020. By 2030, the number of U.S. residents 65 and older is estimated to reach approximately 70 million, or 20%, of the total population. Due to the increasing life expectancy of U.S. residents, the number of people aged 85 years or older is also expected to increase from 4.3 million to 9.6 million by 2030.

We believe that healthcare expenditures and longer life expectancy of the general population will place increased pressure on healthcare providers to find innovative, efficient means of delivering healthcare services. In particular, many of the health conditions associated with aging — such as stroke and heart attack, neurological disorders and diseases and injuries to the muscles, bones and joints — will increase the demand for rehabilitative therapy. These trends, combined with the need for client hospitals to move their patients into the appropriate level of care on a timely basis, will encourage healthcare providers to efficiently direct patients to inpatient rehabilitation units, outpatient therapy, freestanding skilled nursing therapy programs and home health.

The growth of managed care and its focus on cost control has encouraged healthcare providers to deliver quality care at the lowest cost possible. While generally less aggressive than managed care, Medicare and Medicaid incentives also have driven declines in average inpatient days per admission. In many cases, patients are treated initially in the higher cost, acute-care hospital setting. After their condition has stabilized, they are either moved to a lower cost setting, such as a skilled nursing facility, or are discharged to their home and treated on a home health or outpatient basis. Thus, while hospital inpatient admissions have continued to grow, the number of average inpatient days per admission has declined.

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Many healthcare providers partner with companies who will manage either individual or a broad range of product lines. Partnering allows healthcare providers to take advantage of the specialized expertise of contract management companies, enabling them to concentrate on the businesses they know best, such as facility and acute-care management. Continued reimbursement pressures under managed care and Medicare have driven healthcare providers to look for additional sources of revenue. As constraints on overhead and operating costs have increased and manpower has been reduced, partnering with providers of ancillary and post-acute services has become more important in order to increase patient volumes and provide services at a lower cost while maintaining high quality standards.

By partnering with contract management companies, healthcare facilities may be able to:
	•	Improve Clinical Quality. Program managers focused on rehabilitation are able to develop and employ best practices, which benefit client facilities and their patients.
	•	Increase Volumes. Through the addition of specialty services such as rehabilitative care and skilled nursing, patients who were being discharged to other venues for treatment can now remain in the hospital setting. This allows hospitals to capture revenues that would otherwise be realized by another provider. Upon discharge, patients can return for outpatient care, creating added revenues for the provider. New services also help hospitals attract new patients. The addition of a managed rehabilitation program helps skilled nursing facilities attract residents by broadening their scope of services.
	•	Optimize Utilization of Space. Inpatient services help hospitals optimize physical plant space to treat patients who are within specific diagnoses of the particular hospital’s targeted service lines.
	•	Increase Cost Control. Because of their extensive experience in the product line, contract management companies can offer pricing structures that effectively control a healthcare provider’s financial risk related to the service provided. For hospitals and other providers that utilize program managers, the result is often lower average cost than that of self-managed programs. As a result, the facility is able to increase its revenues without having to increase administrative staff or incur other fixed costs.
	•	Sign Agreements with Managed Care Organizations. Program managers often have the ability to improve clinical care by capturing and analyzing this information from a large number of acute rehabilitation and skilled nursing units, which an individual hospital could not 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, attract more patients to the hospital.
	•	Provide Access to Capital.  Contract management companies, particularly those which have access to public markets, are able to make capital available to their clients for adding programs and services like physical rehabilitative service or expanding existing programs when community needs dictate.
	•	Enhance Care Management.  The efficient flow of patients through all phases of their acute and post-acute care has a significant influence on a hospital’s outcomes and financial performance. Providers of specialty care services can supply the expertise, training, data management and personnel necessary to manage this process.

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• Obtain Reimbursement Advice. Contract management companies often employ reimbursement specialists who are available to assist client facilities in interpreting complicated regulations within a given specialty — a highly valued service in the changing healthcare environment.

• Obtain Clinical Resources and Expertise. Rehabilitation service providers have the ability to develop and implement clinical training and program development that will provide best practices for clients.

• Ensure Appropriate Levels of Staffing for Rehabilitation Professionals. Therapy staffing in both hospitals and skilled nursing settings presents unique challenges that can be facilitated by a provider with national presence. Program managers have the ability to manage staffing levels to address the fluctuating clinical needs of the host facility.

• Improve Profitability. Rehabilitation service providers are equipped to support the clinical needs of the facility and to manage staffing levels such that the client’s overall profitability for their rehabilitation patients is improved.

Of the approximately 4,900 general acute-care hospitals in the United States, an estimated 1,120 hospitals operate inpatient acute rehabilitation units, of which we estimate approximately 15%-20% currently partner with providers of acute rehabilitation program management services.

                 Of the total population of skilled nursing facilities in the United States, there are an estimated 5,900 facilities that are ideal prospects for our contract therapy services. In addition to skilled nursing facilities, we have expanded our service offerings to deliver therapy management services in additional settings such as long-term care and assisted living facilities.

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Overview of Our Business Units

We currently operate in two business segments, program management services, which consists of two business units — hospital rehabilitation services and contract therapy and healthcare management consulting. The following table describes the services we offer within these business units.

Business Segments	Description of Service	Benefits to Client
Program Management Services:
Hospital Rehabilitation Services:
Inpatient             Acute Rehabilitation Units:	High acuity rehabilitation for conditions such as strokes, orthopedic conditions and head injuries.	Affords the client opportunities to retain and expand market share in the post-acute market by offering specialized clinical rehabilitation services to patients who might otherwise be discharged to a setting outside the client’s facility.
Skilled Nursing Units:	Lower acuity rehabilitation but often more medically complex than acute rehabilitation units for conditions such as stroke, cancer, heart failure, burns and wounds.
Outpatient	Outpatient therapy programs for hospital-based and satellite programs (primarily sports and work-related injuries).	Helps bring patients into the client’s facility and helps the client compete with freestanding clinics.
Contract Therapy	Rehabilitation services in freestanding skilled nursing, long-term care and assisted living facilities for neurological, orthopedic and other medical conditions.	Affords the client the ability to fulfill the continuing need for therapists on a full-time or part-time basis. Offers the client a better opportunity to improve the quality of the programs.
Healthcare Management Consulting	Strategic and financial planning, performance improvement, physicians’ services and revenue cycle services for healthcare providers in the United States.	Provides management advisory services and solutions to healthcare provider executives in several key success areas.

Financial information about each of our business segments is contained in Note 18 “Industry Segment Information” to our consolidated financial statements.

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The following table summarizes by geographic region in the United States our program management locations as of December 31, 2004.

Geographic Region	Acute Rehabilitation/ Skilled Nursing Units		Outpatient Therapy Programs		Contract Therapy Programs
Northeast Region		18/1		4		34
Southeast Region		21/4		16		74
North Central Region		28/1		4		200
Mountain Region		4/1		1		49
South Central Region		35/3		14		274
Western Region		6/19		0		59
Puerto Rico		1/0		0		0
Total		113/29		39		690

Program Management Services

Inpatient

We have developed an effective business model in the prospective payment environment, and we are instrumental in helping our clients achieve favorable outcomes in their inpatient rehabilitation settings.

Acute Rehabilitation. Since 1982, our inpatient division has been the market leader in operating acute rehabilitation units in acute-care hospitals on a contract basis. As of December 31, 2004, we managed inpatient acute rehabilitation units in 113 hospitals for patients with diagnoses including stroke, orthopedic conditions, arthritis, spinal cord and traumatic brain injuries.

Of the approximately 3,780 acute-care hospitals that do not currently operate acute rehabilitation units, we estimate that as many as 1,060 meet our general criteria for support of acute rehabilitation units in their markets. We believe that there is an opportunity for growth to the extent that many of the hospitals currently operating their own acute rehabilitation units re-evaluate the efficiency of their operations and consider partnering with companies such as ours for management services.

We establish acute rehabilitation units in hospitals that have vacant space and unmet rehabilitation needs in their markets. We also work with hospitals that currently operate acute rehabilitation units to determine the projected level of cost savings we can deliver to them by implementing our scheduling, clinical protocol and outcome systems. In the case of hospitals that do not operate acute rehabilitation units, we review their historical and existing hospital population, as well as the demographics of the geographic region, to determine the optimal size of the proposed acute rehabilitation unit and the potential of the new unit under our management to generate revenues sufficient to cover anticipated expenses.

Our relationships with hospitals take a number of different forms. Our historical approach is a contractual relationship for management services averaging about 3 years in duration. More recently, we have developed joint ownership agreements allowing us to jointly own rehabilitation units and facilities with our host hospital clients. These relationships provide the potential for

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additional profitability, significantly longer in duration partnerships, but require additional capital compared to our historical approach.

We are generally paid by our clients on the basis of a negotiated fee per discharge or per patient day pursuant to contracts that are typically for terms of three to five years. These contracts are generally subject to termination or renegotiation in the event the hospital experiences a material change in the reimbursement it receives from government or other providers.

An acute rehabilitation unit affords the hospital the ability to offer rehabilitation services to patients who might otherwise be discharged to a setting outside the hospital. A unit typically consists of 20 beds and is staffed with a program director, a physician/medical director and clinical staff, which may include a psychologist, physical and occupational therapists, a speech/language pathologist, a social worker, a case manager, and other appropriate supporting personnel.

Skilled Nursing Units. In 1994, the inpatient division added a skilled nursing service line in response to client requests for management services and our strategic decision to broaden our inpatient services. As of December 31, 2004, we managed 29 inpatient skilled nursing units. The hospital-based skilled nursing unit enables patients to remain in a hospital setting where emergency needs can be met quickly as opposed to being sent to a freestanding skilled nursing facility. The unit is located within the acute-care hospital and is separately licensed.

We are paid by our clients on a flat monthly fee basis or on the basis of a negotiated fee per patient day pursuant to contracts that are typically for terms of three to five years. The hospital benefits by retaining patients who would be discharged to another setting, capturing additional revenue and utilizing idle space. A skilled nursing unit treats patients who require less intensive levels of rehabilitative care, but who have a greater need for nursing care. Patients’ diagnoses are typically long-term and medically complex, covering approximately 60 clinical conditions, including stroke, post-surgical conditions, pulmonary disease, cancer, congestive heart failure, burns and wounds.

Outpatient

In 1993, we began managing outpatient therapy programs that provide therapy services to patients with work-related and sports-related illnesses and injuries. As of December 31, 2004, we managed 39 hospital-based and satellite outpatient therapy programs. An outpatient therapy program complements the hospital’s occupational medicine initiatives and allows therapy to be continued for patients discharged from inpatient rehabilitation units and medical/surgical beds.An outpatient therapy program also attracts patients into the hospital and is conducted either on the client hospital’s campus or in satellite locations controlled by the hospital.

We believe our management of outpatient therapy programs delivers increased productivity through our scheduling, protocol and outcome systems, as well as through productivity training for existing staff. We also provide our clients with expertise in compliance and quality assurance. Typically, the program is staffed with a facility director, four to six therapists and two to four administrative and clerical staff. We are typically paid by our clients on the basis of a negotiated fee per unit of service.

During 2004, we further developed our capability to provide rehabilitation therapy services in a freestanding clinic setting. An example of this, is our contractual relationship with Signature Healthcare Foundation which provides us the opportunity to develop such clinics with a significant group of orthopedic surgeons.

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Contract Therapy

In 1997, we added therapy management for freestanding skilled nursing facilities to our service offerings. This program affords the client the opportunity to fulfill its continuing need for therapists on a full-time or part-time basis without the need to hire and retain full-time staff. As of December 31, 2004, we managed 690 contract therapy programs.

Our typical contract therapy client has 120 beds, a portion of which are licensed as skilled nursing beds. We manage therapy services, including physical and occupational therapy and speech/language pathology for the skilled nursing facility and in other settings that provide services to the senior population. Our broad base of staffing service offerings — full-time and part-time — can be adjusted at each location according to the facility’s and its patients’ needs.

We are generally paid by our clients on the basis of a negotiated patient per diem rate or a negotiated fee schedule based on the type of service rendered.Typically, our contract therapy program is led by a full-time program coordinator who is also a therapist, and two to four full-time professionals trained in physical and occupational therapy or speech/language pathology.

Strategy

We believe that there is significant growth opportunity for our program management services business as the marketplace continues to require hospitals and skilled nursing facilities to provide high-quality rehabilitation services in a cost-efficient and accountable manner. Outpatient therapy programs remain underdeveloped at most hospitals, while the aging population and pressures to control costs in all healthcare settings continue to drive demand for our management systems and expertise, especially within a prospective payment system.

Our operations are guided by a defined set of strategies aimed at advancing both the profitability and growth of our company. The strategies focus on several distinct areas:

Target Markets.  To leverage our resources and maximize economies of scale, we are targeting markets where we already have significant market share or where there are sufficient growth opportunities in post-acute healthcare. Our current target markets include Norfolk, Virginia, Philadelphia, Pennsylvania, and St. Louis, Missouri.

Acquisitions.  We will pursue an aggressive acquisition strategy over the next few years focusing on: 1) providers that fill in the service gaps within our target markets, 2) those that already have a strong presence within their markets, or 3) those that are “plug-and-play” with our existing operations. In 2004, we acquired CPR Therapies, LLC, American VitalCare, Inc., Phase 2 Consulting, Inc. and Cornerstone Rehabilitation, LLC, four companies that fit this criteria.

Joint Ownership Arrangements.  By forming joint ownership arrangements and other shared risk relationships with market-leading healthcare providers, we are creating larger, longer and potentially more profitable relationships.

Hospital-based Rehabilitation Stabilization/Growth.  To stabilize the net openings rate for our hospital-based programs, we are employing several strategies to retain existing business and attract new business. These strategies include utilizing our available capital to expand and enhance the programs we manage for clients thereby creating longer-term relationships with existing clients and linking together our hospital and non-hospital based programs to present a unified post-acute solution for patients.

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Skilled Nursing Facility-based Rehabilitation Profitability/Growth.  Through our target market approach, we are linking our programs at skilled nursing facilities with our hospital-based programs to create continuums of care and to share resources. In 2004, we added 222 new sites to this service line (110 by acquisition).

Clinical Research and Development.  Our clinicians treat about 14,000 patients daily and have captured data on more than 700,000 patients. Through this initiative, we are working to determine which treatments help patients most quickly regain their lives and at the lowest cost, thereby improving our outcomes.

Information Technology and Management.  To truly integrate all of our program sites, we need to expand our IT ability. By enhancing our handheld technology system, we will gain the ability to transfer patient data and clinical expertise among all of our sites.

Access to Capital.  Our balance sheet and credit line provides us with access to the capital required to carry out our other strategies. Our balance sheet includes $53 million in cash ($3.1 million of which is restricted) at December 31, 2004 and a $4 million average monthly operating cash flow for the year ended December 31, 2004. We also carry minimal debt and have a $90 million credit line, expandable to $125 million.

Government Regulation

Overview. The healthcare industry is required to comply with many complex federal and state laws and regulations and is subject to regulation by a number of federal, state and local governmental agencies, including those that administer the Medicare and Medicaid programs, those responsible for the licensure of healthcare providers and facilities and those responsible for administering and approving health facility construction, new services and high-cost equipment purchasing. The healthcare industry is also affected by federal, state and local policies developed to regulate the manner in which healthcare is provided, administered and paid for nationally and locally.

Laws and regulations in the healthcare industry are extremely complex and, in many instances, the industry does not have the benefit of significant regulatory or judicial interpretation. As a result, the healthcare industry is sensitive to legislative and regulatory changes and is affected by reductions and limitations in healthcare spending as well as changing healthcare policies. Moreover, our business is impacted not only by those laws and regulations that are directly applicable to us, but also by certain laws and regulations that are applicable to our hospital, skilled nursing facility and other clients.

If we fail to comply with the laws and regulations directly applicable to our business, we could suffer civil penalties, criminal penalties and/or be excluded from contracting with providers participating in Medicare, Medicaid and other federal and state healthcare programs. Likewise, if our hospital, skilled nursing facility and/or other clients fail to comply with the laws and regulations applicable to their businesses, they also could suffer civil penalties, criminal penalties and/or be excluded from participating in Medicare, Medicaid and other federal and state healthcare programs. In either event, such consequences could either directly or indirectly have an adverse impact on our business.

Facility Licensure, Medicare Certification, and Certificate of Need. Our clients are required to comply with state facility licensure, federal Medicare certification, and certificate of need laws in certain states that are not generally applicable to us.

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Generally, facility licensure and Medicare certification follow specific standards and requirements. Compliance is monitored by various mechanisms, including periodic written reports and on-site inspections by representatives of relevant government agencies.Loss of licensure or Medicare certification by a healthcare facility with which we have a contract would likely result in termination of that contract.

A few states require that healthcare facilities obtain state permission prior to entering into contracts for the management of their services.Some states also require that healthcare facilities obtain state permission in the form of a certificate of need prior to constructing or modifying their space, purchasing high-cost medical equipment, or adding new healthcare services.If a certificate of need is required, the process may take up to 12 months or more, depending on the state.The certificate of need application may be denied if contested by a competitor or if the new facility or service is deemed unnecessary by the state reviewing agency.A certificate of need is usually issued for a specified maximum expenditure and requires implementation of the proposed improvement or new service within a specified period of time. If our client is unable to obtain a certificate of need, we may not be able to implement a contract to provide therapy services.

Professional Licensure and Corporate Practice. Many of the healthcare professionals employed or engaged by us are required to be individually licensed or certified under the applicable state’s laws. We take steps to ensure that our licensed healthcare professionals possess all necessary licenses and certifications, and we believe that our employees and independent contractors comply with all applicable state laws.

In some states, for profit corporations are restricted from practicing therapy through the direct employment of therapists. In order to comply with the restrictions imposed in such states, we contract to obtain therapy services from an entity permitted to employ therapists.

Reimbursement. Federal and state laws and regulations establish payment methodologies and mechanisms for healthcare services covered by Medicare, Medicaid and other government healthcare programs. While applicable to our clients and not generally applicable to us, these laws and regulations still have an indirect impact on our business.

Medicare pays acute-care hospitals for most inpatient hospital services under a payment system known as the “prospective payment system.” Under this system, acute-care hospitals are paid a specific amount toward their operating costs based on the diagnosis-related or case-mix group to which each Medicare patient is assigned, regardless of the amount of services provided to the patient or the length of the patient’s hospital stay. The amount of reimbursement assigned to each diagnosis-related or case-mix group is established prospectively by the Centers for Medicare and Medicaid Services, an agency of the Department of Health and Human Services.

For certain Medicare beneficiaries who have unusually costly hospital stays, the Centers for Medicare and Medicaid Services will provide additional payments above those specified for the diagnosis-related or case-mix group. Under a prospective payment system, a hospital may keep the difference between its diagnosis-related or case-mix group payment and its operating costs incurred in furnishing inpatient services, but is at risk for any operating costs that exceed the applicable diagnosis-related or case-mix group payment rate. As a result, hospitals have an incentive to discharge Medicare patients as soon as it is clinically appropriate.

The prospective payment system for inpatient rehabilitation facilities is similar to the diagnosis-related group payment system used for acute-care hospital services but uses a case-mix

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group rather than a diagnosis-related group. Each patient is assigned to a case-mix group based on clinical characteristics and expected resource needs as a result of information reported on a “patient assessment instrument” which is completed upon patient admission and discharge. Under the prospective payment system, a hospital may keep the difference between its case-mix group payment and its operating costs incurred in furnishing patient services, but is at risk for operating costs that exceed the applicable case-mix group payment.

We believe that the prospective payment system for inpatient rehabilitation facilities favors low-cost, efficient providers, and that our efficiencies gained through economies of scale and our focus on cost management position us well in the current reimbursement environment.

Skilled nursing facilities and units are also subject to a prospective payment system based on resource utilization group classifications. This was targeted to reduce government spending on skilled nursing services.

Reimbursement for outpatient rehabilitation services is based on the lesser of the provider’s actual charge for such services or the applicable Medicare physician fee schedule amount established by the Centers for Medicare and Medicaid Services. This reimbursement system applies regardless of whether the therapy services are furnished in a hospital outpatient department, a skilled nursing facility, an assisted living facility, a physician’s office, or the office of a therapist in private practice. Under current law, an outpatient therapy program that is not designated as being hospital provider-based is subject to annual limits on payment for therapy services. These annual therapy caps have, however, been suspended through December 31, 2005.

On April 30, 2004, the Centers for Medicare and Medicaid Services announced a final rule revising criteria for classifying hospitals as inpatient rehabilitation facilities. We know this rule as the “modified 75% rule.” The final rule became effective for cost reporting periods beginning on or after July 1, 2004. The rule provides for a three-year transition period with increasing percentages of the total patient population that will be required to have one of the qualifying medical conditions. Commencing on July 1, 2004, the annual percentage phase-in will be 50%, 60%, 65% and finally 75% after July 1, 2007. As part of the 2004 appropriations bill, the “modified 75% rule” implementation was delayed until the General Accounting Office completes a study to confirm or challenge the rule’s basis. That study is likely due to the Centers for Medicare and Medicaid Services during the first quarter of 2005. Unless the study’s findings are inconsistent with the rule, implementation would begin no later than 60 days thereafter, but with the original cost report base year of July 1, 2004.

This rule is designed to manage the types of rehabilitation patients cared for in the acute rehabilitation unit and to save money for the program. As the transition progresses toward the ultimate goal of 75%/25% there is an increasing risk to the acute rehabilitation unit that patients will need to be turned away in order to comply with the rule. This in turn results in reduced revenues for the unit and the host hospital. The impact of the rule on any one unit depends upon its patient mix, referral patterns, clinical programs of the host hospital, subsequent instructions from CMS and fiscal intermediaries interpreting the rule and other factors. Steps that acute rehabilitation units can take to mitigate the impact of the rule include: clinical education and training to enhance capability of staff to provide care for patients with more complex medical conditions; new referral sources to support compliance; market models of care that foster movement of patients to the most clinically appropriate and cost effective setting; and bed expansions in units where appropriate.

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Health Information Practices. Subtitle F of the Health Insurance Portability and Accountability Act of 1996 was enacted to improve the efficiency and effectiveness of the healthcare system through the establishment of standards and requirements for the electronic transmission of certain health information. To achieve that end, the statute requires the Secretary of the Department of Health and Human Services to promulgate a set of interlocking regulations establishing standards and protections for health information systems, including standards for the following:

• the development of electronic transactions and code sets to be used in those transactions;

• the development of unique health identifiers for individuals, employers, health plans, and healthcare providers;

• the security of protected health information in electronic form;

• the transmission and authentication of electronic signatures; and

• the privacy of individually identifiable health information.

Final rules setting forth standards for electronic transactions and code sets, for the privacy of individually identifiable health information, enforcement actions and for the security of protected health information in electronic form have been promulgated. These rules apply to health plans, healthcare clearinghouses and healthcare providers who transmit any healthcare information in electronic form in connection with certain administrative and billing transactions. The electronic transaction and code set standards and rules with respect to the privacy of individually protected healthcare information are effective. Compliance with the final rules concerning the security of protected healthcare information in electronic form is required by April 20, 2005.

The final rule that adopts the standard for unique health identifiers for healthcare providers was published on January 23, 2004. Healthcare providers can begin applying for national provider identifiers on the effective date of the final rule, which is May 23, 2005. Healthcare providers covered by the Act must obtain and use provider identifiers by the compliance date of May 23, 2007.

We have reviewed the final rules and through the efforts of our company-based task force have instituted new policies and procedures designed to comply with these regulations. In addition, a

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company-wide training effort for all employees on the application of the regulations to their job role has been implemented and is ongoing as new regulations are implemented.

Fraud and Abuse. Various federal laws prohibit the knowing and willful submission of false or fraudulent claims, including claims to obtain payment under Medicare, Medicaid and other government healthcare programs. The federal anti-kickback statute also prohibits individuals and entities from knowingly and willfully paying, offering, receiving or soliciting money or anything else of value in order to induce the referral of patients or to induce a person to purchase, lease, order, arrange for or recommend services or goods covered by Medicare, Medicaid, or other government healthcare programs.

The anti-kickback statute is extremely broad and potentially covers many standard business arrangements. Violations can lead to significant criminal and civil penalties, including fines of up to $25,000 per violation, civil monetary penalties of up to $50,000 per violation, assessments of up to three times the amount of the prohibited remuneration, imprisonment, or exclusion from participation in Medicare, Medicaid, and other government healthcare programs. The Office of the Inspector General of the Department of Health and Human Services has published regulations that identify a limited number of specific business practices that fall within safe harbors guaranteed not to violate the anti-kickback statute. While many of our business relationships fall outside of the published safe harbors, conformity with the safe harbors is not mandatory and failure to meet all of the requirements of an applicable safe harbor does not by itself make conduct illegal.

A number of states have in place statutes and regulations that prohibit the same general types of conduct as that prohibited by the federal anti-kickback statute. Some states’ antifraud and anti-kickback laws apply only to goods and services covered by Medicaid. Other states’ antifraud and anti-kickback laws apply to all healthcare goods and services, regardless of whether the source of payment is governmental or private.

In recent years, federal and state government agencies have increased the level of enforcement resources and activities targeted at the healthcare industry. In addition, federal law allows individuals to bring lawsuits on behalf of the government in what are known as qui tam or “whistleblower” actions, alleging false or fraudulent Medicare or Medicaid claims and certain other violations of federal law. The use of these private enforcement actions against healthcare providers and their business partners has increased dramatically in the recent past, in part, because the individual filing the initial complaint is entitled to share in a portion of any settlement or judgment.

Anti-Referral Laws.   The federal Stark law generally provides that, if a physician or a member of a physician’s immediate family has a financial relationship with a healthcare entity, the physician may not make referrals to that entity for the furnishing of designated health services covered under Medicare or Medicaid unless one of several specific exceptions applies.For purposes of the Stark law, a financial relationship with a healthcare entity includes an ownership or investment interest in that entity or a compensation relationship with that entity. Designated health services include physical and occupational therapy services, durable medical equipment, home health services, and inpatient and outpatient hospital services. The Centers for Medicare and Medicaid Services have promulgated regulations interpreting the Stark law and, in instances where the Stark law applies to our activities, we have instituted policies which set standards intended to prevent violations of the Stark law.

The federal government will make no payment for designated health services provided in violation of the Stark law.In addition, sanctions for violating the Stark law include civil monetary

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penalties of up to $15,000 per prohibited service provided and exclusion from any federal, state, or other government healthcare programs. There are no criminal penalties for violation of the Stark law.

A number of states have in place statutes and regulations that prohibit the same general types of conduct as that prohibited by the federal Stark law described above.Some states’ Stark laws apply only to goods and services covered by Medicaid. Other states’ Stark laws apply to certain designated healthcare goods and services, regardless of whether the source of payment is a governmental or private payor.

Corporate Compliance Program. In recognition of the importance of achieving and maintaining regulatory compliance and establishing a culture of ethical conduct, we have a corporate compliance program that defines general standards of conduct and procedures that promote compliance with business ethics, regulations, law and accreditation standards. We have compliance standards and procedures to be followed by our employees that are reasonably capable of reducing the prospect of criminal conduct and encouraging the practice of ethical behavior. We have designed systems for the reporting of potential wrongdoing, intentional or unintentional, through various means including a toll-free hotline whereby individuals may report anonymously. We have a system of auditing and monitoring to detect potentially criminal acts as well as to assist us in determining the training needs of our employees.

A key element of our compliance program is ongoing communication and training of employees so that it becomes a part of our day-to-day business operations. A compliance committee consisting of three independent members of our board of directors has been established to oversee implementation and ongoing operations of our compliance program, to enforce our compliance 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. Our compliance officer has direct access to the board of directors and training efforts include members of the board. As a company, we keep informed of the Office of the Inspector General’s publications and are in the process of reviewing the Supplemental Compliance Program Guidance for Hospitals issued January 31, 2005 as it relates to our compliance efforts. We are not aware of the existence of any current activities on the part of any of our employees that would not be materially in compliance with our programs and policies.

Competition

                Our program management business competes with companies that may offer one or more of the same services. The fundamental challenge in this line of business is convincing our potential clients, primarily hospitals and skilled nursing facilities, that we can provide rehabilitation services more efficiently than they can themselves. Among our principal competitive advantages are our reputation for quality, cost effectiveness, a proprietary outcomes management system, innovation and price, and the location of programs within our clients’ facilities.

                We rely on our ability to attract, develop and retain therapists and program management personnel. We compete for these professionals with other healthcare companies, as well as actual and potential clients, some of whom seek to fill positions with either regular or temporary employees.

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Employees

As of December 31, 2004, we had approximately 9,600 employees, approximately 3,800 of which were full-time employees, in our program management services business. The physicians who are the medical directors of our acute rehabilitation units are independent contractors and not our employees. None of our employees is subject to a collective bargaining agreement.

Non-Audit Services Performed by Independent Accountants

                Pursuant to Section 10A(i)(2) of the Securities Exchange Act of 1934 and Section 202 of the Sarbanes-Oxley Act of 2002, we are responsible for disclosing to investors the non-audit services approved by our audit committee to be performed by KPMG LLP, our independent registered public accounting firm. Non-audit services are defined as services other than those provided in connection with an audit or a review of our financial statements. During the period covered by this Form 10-K, our audit committee pre-approved non-audit services related to tax compliance, assistance with documenting controls under Sarbanes-Oxley Section 404 and due diligence assistance on potential acquisitions and the disposition of our healthcare staffing division.

Web Site Access to Reports

                Our Form 10-K, Form 10-Qs, definitive proxy statements, Form 8-Ks, and any amendments to those reports are made available free of charge on our web site at www.rehabcare.com as soon as reasonably practicable after such reports are filed with the Securities and Exchange Commission.

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ITEM 2.      PROPERTIES

We currently lease approximately 71,000 square feet of executive office space in Clayton, Missouri under a lease that expires in the year 2007. In addition to the monthly rental cost, we are also responsible for specified increases in operating costs. In addition, we and our subsidiaries lease the following space used for offices and/or therapy units:

Location	Approximate Square Footage	Lease Expiration
Salt Lake City, UT	16,000	2012
Shreveport, LA	8,000	2011
Anaheim, CA	8,000	2005
Salt Lake City, UT	6,000	2006
Williamsburg, VA	3,000	2009
Austin, TX	2,000	2008
Tyler, TX	1,000	2005
Bowling Green, KY	1,000	2006

We also lease several additional locations each with less than 500 square feet of space.

ITEM 3.      LEGAL PROCEEDINGS  

We had been named as a defendant in two lawsuits in the United States District Court for the Eastern District of Missouri that alleged violations of the federal securities laws. Certain of our former and current directors and officers were also named in the action. On September 30, 2004, the court dismissed the suit with prejudice for failure to state a claim. The plaintiffs initially filed a notice of appeal with the Eighth Circuit Court of Appeals, but abandoned the appeal by submission of a motion for dismissal. The district court entered a final judgment dismissing the appeal on January 28, 2005.

                A derivative lawsuit is pending in the Circuit Court of St. Louis County, Missouri against us and certain of our former and current directors and is based upon substantially the same facts as were alleged in the federal securities class action. This suit was filed on behalf of the derivative plaintiff by a law firm that had earlier filed suit against us in the federal case. The federal court hearing the securities law class action had stayed discovery in the derivative proceeding until the federal court made its ruling on our motion to dismiss. We have recently been informed by the attorneys for the derivative plaintiff that they intend to request a hearing in the state case for the purpose of obtaining a scheduling order on discovery.

In July 2003, a former independent contractor of ours and a former Baxter County Regional Hospital physical therapist filed a civil action, under the qui tam and whistleblower provisions of the False Claims Act, in the United States District Court for the Eastern District of Arkansas. The plaintiffs seek back pay, civil penalties, treble damages, and special damages from us and Baxter. The allegations contained in the suit relate to the proper clinical diagnoses, for Medicare reimbursement purposes, of patients treated at the hospital’s acute rehabilitation unit for which Baxter received reimbursement in excess of $5,000,000. The plaintiffs filed the original action on August 21, 2000, under seal. After an investigation by the United States Department of Justice, on June 3, 2003, the government declined to intervene and the seal was lifted. The plaintiffs filed an amended complaint, and we and Baxter were served and notified of the civil action on July 15, 2003. We and Baxter also

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initiated an internal and external audit that concluded the allegations were unfounded and that we and Baxter were in compliance with Medicare regulations. We have agreed to indemnify Baxter for all fees and expenses on all counts arising out of the action except for the whistleblower count brought by Baxter’s therapist. We and Baxter both filed separate motions to dismiss the action. The Court denied Baxter’s motion to dismiss, but granted our motion to dismiss with respect to the individual claim under the whistleblower provisions of the False Claims Act but not the other claims against us under the False Claims Act. The parties are currently engaged in discovery with respect to the remaining claims.

On May 6, 2004 we filed a civil action against The Queen’s Medical Center, in the United States District Court for the District of Hawaii, for breach of contract, including past due service fees plus interest in the amount of approximately $300,000. On May 26, 2004, Queens filed an answer to our complaint and a counterclaim against us, alleging breach of contract and seeking indemnification for amounts of alleged incorrect billings submitted by the skilled nursing unit we managed, additional management fees already paid to us, and an estimate of their attorney’s fees, with respect to the counterclaim. Since that time, legal counsel for Queens advised the court and us that the Queen’s demand for indemnification and counterclaims against us were based on fabricated documents. The parties are engaged in settlement discussions pursuant to which we and Queens agreed that an independent third party would conduct an audit of a representative sample of medical records to determine if there were any incorrect billings. The independent third party has concluded that there were no incorrect billings. These findings were submitted to Queen’s Medicare fiscal intermediary who confirmed that there were no incorrect billings. Although the counterclaim against us has not been dismissed as yet, we do not believe that Queen’s counterclaim has any merit.

The Wage and Hour Division of the United States Department of Labor has been conducting an investigation of our former staffing division. The investigation is focused on minimum wage and overtime compensation of employees who worked as on-call coordinators. After a review by us of the staffing division’s wage and overtime practices with respect to office and field staff employees who also worked on-call shifts, we and the Department of Labor reached an agreement with respect to the payment by us of approximately $150,000 in the aggregate to these employees. Each employee will be sent a check, which if cashed, will release his or her claim under the Fair Labor Standards Act (but not any state law claims) for the period reviewed. These employees can also elect not to cash the check and file suit individually.

Several federal lawsuits have been filed by certain on-call, recruiting and staffing coordinators seeking overtime compensation and related damages under both federal and state law. These individuals were employed by our former staffing division. Three of these cases have been consolidated in the United States District Court for the Central District of California. The individuals sought to bring a collective or class action on behalf of all similarly situated persons. On January 3, 2005, the court granted plaintiffs’ motion to send notice of collective action to present and former staffing division employees although the court did not specify the exact group of employees to which the notice should be directed. At the same time, the court denied the plaintiffs’ request to proceed as class action under the California state law claims. Upon entry of the order allowing notices of collective action to be sent and the actual mailing of the notices, the employees to which the notices are directed will have the opportunity to opt into the case for claims dating back two years (three years if a willful violation is proven) from the date the employee files a consent to join the case. Plaintiffs’ counsel has informed us that it intends to file a separate state court class action reasserting the California state law claims, but we have no knowledge of such suit at this time.

In addition to the above matters, we are a party to a number of other claims and lawsuits. While these actions are being contested, the outcome of individual matters is not predictable with

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assurance. From time to time, and depending upon the particular facts and circumstances, we may be subject to indemnification obligations under our contracts with our hospital and healthcare facility clients relating to these matters. We do not believe that any liability resulting from any of the above matters, after taking into consideration our insurance coverage and amounts already provided for, will have a material adverse effect on our consolidated financial position, cash flows or liquidity. However, such matters could have a material effect on results of operations in a particular quarter or fiscal year as they develop or as new issues are identified.

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 our Common Stock is included under the heading “Stock Data” in our Annual Report to Stockholders for the year ended December 31, 2004 and is incorporated herein by reference.

ITEM 6.      SELECTED FINANCIAL DATA

                Our Six-Year Financial Summary is included in our Annual Report to Stockholders for the year ended December 31, 2004 and is incorporated herein by reference.

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ITEM 7.      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

                 During 2004, we primarily derived our revenue from our program management services segment, which includes inpatient programs (both acute rehabilitation and skilled nursing units), outpatient therapy programs and contract therapy programs and from healthcare management consulting. Prior to 2004, we also derived a significant portion of our revenue from our healthcare staffing segment. On February 2, 2004, we consummated the sale of the StarMed Staffing division to InteliStaf Holdings, Inc. and received approximately 25% of the equity of InteliStaf in return. After the consummation date, the financial condition and results of operations of the staffing division were no longer consolidated in our financial statements and our interest in InteliStaf has been accounted for under the equity method. Summarized information about our revenues and earnings from operations in each segment is provided below.

	Year Ended December 31,
	2004			2003			2002
	(in thousands)
Revenues from Unaffiliated Customers:
Program management:
Hospital rehabilitation services	$	190,731		$	185,831		$	179,746
Contract therapy		171,339			130,847			105,276
Program management total		362,070			316,678			285,022
Healthcare staffing		16,727			223,952			277,543
Healthcare management consulting (1)		5,367			—			—
Less intercompany revenues (2)		(318	)		(1,308	)		—
Total	$	383,846		$	539,322		$	562,565
Operating Earnings (Loss):
Program management:
Hospital rehabilitation services	$	33,065		$	33,557		$	32,256
Contract therapy		10,208			5,836			9,124
Program management total		42,273			39,393			41,380
Healthcare staffing (3)		(78	)		(52,503	)		(1,683	)
Healthcare management consulting (1)		224			—			—
Restructuring charge		(1,615	)		(1,286	)		—
Total	$	41,804		$	(14,396	)	$	39,697

(1)	Represents operating revenues and operating profits generated by Phase 2 Consulting, which was acquired on May 3, 2004.
(2)	Intercompany revenues represent sales of services, at market rates, between our operating divisions.
(3)	The 2004 operating loss for healthcare staffing contains a $485,000 gain realized on the sale of the business on February 2, 2004. The 2003 operating loss for healthcare staffing contains a $43.6 million loss to state net assets and liabilities held for sale at their fair value less estimated costs to sell.

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Revenues

We derive substantially all of our revenues from fees paid directly by healthcare providers rather than through payment or reimbursement by government or other third-party payers. Our inpatient and outpatient therapy programs are typically provided through agreements with hospital clients with three to five-year terms. Our contract therapy services are typically provided under one to two year agreements primarily with hospitals and skilled nursing facilities.

During the three year period ended December 31, 2004, we experienced annual declines in patient days of between 1.3% and 6.9% reflecting the continued trend of reduced inpatient rehabilitation lengths of stay. Under the per diem billing method used in 2002 and in all prior years (all prior to the Prospective Payment System for rehabilitation units in hospitals) our revenues would have been adversely affected by this trend, however, during 2002 we transitioned the majority of our contracts to a per discharge billing method mitigating the aforementioned negative impact. The per discharge billing method is now our preferred method as it aligns our interests with those of our hospital clients who bill government programs using a similar approach.

Material changes in the rates or methods of government reimbursements to our clients for services rendered in the programs that we manage could give us or our clients the right to renegotiate existing contracts to include terms that are more or less favorable to us. An example of a change in method includes the change in contracting methodology discussed above which changed from a per diem billing approach to a per discharge approach for a significant number of our contracts. An example of a change in government reimbursement is the modified 75% Rule as described in detail in the “Reimbursement” section of the Business Overview in Part I of this Form 10-K. We estimate that this new rule had a negative impact of approximately $600,000 on revenues in the fourth quarter of 2004. Furthermore, we believe the new rule may prevent us from achieving our historical same store growth rates in the immediate future.

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Results of Operations

The following table sets forth the percentage that selected items in the consolidated statements of earnings bear to operating revenues for the years ended December 31, 2004, 2003 and 2002:

	Year Ended December 31,
	2004			2003			2002
Operating revenues		100.0	%		100.0	%		100.0	%
Cost and expenses:
Operating		71.7			75.8			73.4
Selling, general and administrative:
Divisions		8.5			12.1			13.3
Corporate		6.4			4.9			4.7
Restructuring charge		.4			.2			—
Loss on assets held for sale		—			8.1			—
Depreciation and amortization		2.2			1.6			1.5
Gain on sale of business		(.1	)		—			—
Operating earnings (loss)		10.9			(2.7	)		7.1
Other expense, net		(.2	)		(.1	)		(.1	)
Earnings (loss) before income taxes and
equity in net loss of affiliate		10.7			(2.8	)		7.0
Income tax expense (benefit)		4.5			(.3	)		2.7
Equity in net loss of affiliate		(.2	)		—			—
Net earnings (loss)		6.0	%		(2.5	)%		4.3	%

Twelve Months Ended December 31, 2004 Compared to Twelve Months Ended December 31, 2003

Revenues
	2004			2003			% Change
	(dollars in thousands)
Hospital rehabilitation services	$	190,731		$	185,831			2.6	%
Contract therapy		171,339			130,847			30.9
Healthcare staffing		16,727			223,952			(92.5	)
Healthcare management consulting		5,367			—			N/A
Less intercompany revenues		(318	)		(1,308	)		(75.7	)
Consolidated revenues	$	383,846		$	539,322			(28.8	)%

                 The decline in consolidated operating revenues from 2003 to 2004 is primarily attributable to the sale of the healthcare staffing division which was consummated on February 2, 2004. Revenues for each of the other operating segments increased from 2003 as further discussed below.

Hospital Rehabilitation Services.  The March 1, 2004 acquisition of VitalCare contributed $11.1 million of revenue in 2004. This increase and an increase in average revenue per location were offset by a decline in the average number of units, excluding those added by the VitalCare acquisition, operated during 2004. The average number of outpatient units managed in fiscal year 2004 declined 13.7% from fiscal year 2003. This decline was the result of closures of certain smaller, less profitable units and from greater competition from physician practices. The average revenue per

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location in the outpatient business increased 6.7% year-over-year from $1.0 million to $1.1 million. Overall, the average number of hospital rehabilitation services locations managed by the division increased 1.2% from 181.5 in fiscal year 2003 to 183.7 in fiscal year 2004. The average revenue per unit in the inpatient business remained flat at $1.0 million per location. A 4.7% increase in same store discharges was offset by lower revenues per unit at the VitalCare units acquired in 2004 and at facilities opened during the year due to typical new unit ramp-up.

Contract Therapy.   The 30.9% increase in contract therapy revenues can be attributed to both strong business development efforts and to the $11.6 million of additional revenue attributable to the acquisitions of CPR Therapies and Cornerstone Rehabilitation in 2004. The average number of contract therapy locations, including those acquired during 2004, managed by the division during the period increased 27.8% from 460 in the twelve months ended December 31, 2003 to 588 in the twelve months ended December 31, 2004. The average revenue per location increased 2.4% year-over-year from $285,000 to $291,000. This increase was the result of strong growth in the division’s same store revenues for the periods being compared; however, some of this growth was offset by the termination of several large, mature programs in the second quarter of 2004 and the smaller average size of the sixty CPR Therapies facilities purchased in February 2004 and fifty Cornerstone Rehabilitation facilities purchased in December 2004.

Cost and Expenses
	2004			% of Revenue			2003		% of Revenue
	(dollars in thousands)
Consolidated costs and expenses:
Operating expenses	$	275,242			71.7	%	$	408,559		75.8	%
Division selling, general and administrative		32,499			8.5			65,055		12.1
Corporate selling, general and administrative		24,615			6.4			26,680		4.9
Restructuring charge		1,615			0.4			1,286		0.2
Loss on assets held for sale		—			—			43,579		8.1
Depreciation and amortization		8,556			2.2			8,559		1.6
Gain on sale of business		(485	)		(0.1	)		—		—
Total costs and expenses	$	342,042			89.1	%	$	553,718		102.7	%

                The ratios of operating expenses and selling, general and administrative expenses as a percentage of revenues were significantly affected by the sale of our healthcare staffing division. Historically, the healthcare staffing division’s operating and selling, general and administrative expenses as a percentage of division revenues were higher than our other divisions. As a result, with the divestiture of that division, we experienced improvements in those ratios on a year-over-year basis. However, despite a $2.1 million or 7.7% reduction in corporate selling, general and administrative expenses, the consolidated ratio of corporate selling, general and administrative expenses to revenue deteriorated as corporate overheads were allocated over the remaining operating units. Total depreciation and amortization expense was flat year-over-year as lower depreciation and amortization resulting from the divestiture of the healthcare staffing division was offset by increased amortization on intangible assets relating to the acquisitions of CPR, VitalCare and Cornerstone and the write-off of a software license that we no longer have plans to use. The gain on sale of business and loss on assets held for sale both pertain to the sale of the healthcare staffing division. In 2003, the net assets of that division were written down to their estimated fair value less costs to sell. When the division was sold in 2004, a gain was recognized representing the net impact of changes in the underlying asset and liability values and adjustments to the estimated costs to sell.

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In July 2003, we announced a comprehensive multifaceted restructuring program to return us to growth and improved profitability. As a result of the restructuring plan, we recognized a pre-tax restructuring expense of $1.3 million for severance, outplacement and exit costs. In connection with the sale of our healthcare staffing division in February 2004, we initiated a series of restructuring activities to reduce the cost of corporate overhead that had previously been absorbed by the staffing division. These activities included the elimination of approximately 40 positions, exiting a portion of leased office space at our corporate headquarters and the write-off of certain abandoned leasehold improvements associated with the office space consolidation. In addition, we modified the term of the stock options of certain StarMed employees to allow them additional time to exercise vested options. As a result of these actions, we recorded a pre-tax restructuring charge of approximately $1.7 million.

	2004			% of Unit Revenue			2003		% of Unit Revenue
	(dollars in thousands)
Hospital Rehabilitation Services:
Operating expenses	$	125,160			65.6	%	$	123,327		66.3	%
Division selling, general and administrative		15,922			8.4			15,173		8.2
Corporate selling, general and administrative		11,270			5.9			8,446		4.5
Depreciation and amortization		5,314			2.8			5,328		2.9
Total costs and expenses	$	157,666			82.7	%	$	152,274		81.9	%
Contract Therapy:
Operating expenses	$	132,850			77.5	%	$	103,723		79.3	%
Division selling, general and administrative		12,810			7.5			11,803		9.0
Corporate selling, general and administrative		12,253			7.1			8,150		6.2
Depreciation and amortization		3,218			1.9			1,335		1.0
Total costs and expenses	$	161,131			94.0	%	$	125,011		95.5	%
Healthcare Staffing:
Operating expenses	$	13,598			81.3	%	$	182,817		81.6	%
Division selling, general and administrative		2,757			16.5			38,079		17.0
Corporate selling, general and administrative		935			5.6			10,084		4.5
Depreciation and amortization		—			—			1,896		0.8
Loss on assets held for sale		—			—			43,579		19.5
Gain on sale of business		(485	)		(2.9	)		—		—
Total costs and expenses	$	16,805			100.5	%	$	276,455		123.4	%
Healthcare Management Consulting:
Operating expenses	$	3,952			73.7	%	$	—		—
Division selling, general and administrative		1,010			18.8			—		—
Corporate selling, general and administrative		157			2.9			—		—
Depreciation and amortization		24			0.4			—		—
Total costs and expenses	$	5,143			95.8	%	$	—		—

                Hospital Rehabilitation Services. The improvement in the ratio of direct operating expenses to division revenue is primarily due to lower direct operating expenses at the VitalCare units and an increase in management only contracts versus full staffing agreements, partially offset by an increase in our provision for doubtful accounts in fiscal year 2004 as a result of our normal assessment of payment risk. Division selling, general, and administrative costs increased as a percentage of revenue as savings resulting from the consolidation of inpatient and outpatient overhead activities were offset by higher general and administrative expenses associated with VitalCare operations. Depreciation and amortization expense as a percentage of operating revenues declined slightly as a result of a decline in

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the allocation of software amortization to the division, partially offset by an increase in amortization of certain intangible assets associated with the acquisition of VitalCare. The net effect of revenue growth, overall cost control improvements at the divisional level, and the absorption of additional corporate overhead during the twelve months ended December 31, 2004 compared to the twelve months ended December 31, 2003 was a $0.5 million decline in hospital rehabilitation service’s operating earnings from $33.6 million to $33.1 million.

Contract Therapy.   Total contract therapy costs and expenses increased in the twelve months ended December 31, 2004 compared to the twelve months ended December 31, 2003 primarily due to the increase in direct operating expenses resulting from the increased number of contract therapy locations being managed by the division. As a percentage of net revenues, the division’s direct operating expenses decreased year-over-year. Part of this improvement was due to the moratorium put on the Medicare Part B caps in December 2003. In addition to the benefit from the moratorium, the division also saw reductions in wages and wage related expenses, as a percentage of revenues, through improvements in therapist productivity and reduced benefit costs. Offsetting a portion of these improvements was an increase in our provision for doubtful accounts in 2004 to mitigate some of the risk associated with a few specific accounts in our receivables portfolio. Contract therapy has continued to leverage its division selling, general and administrative costs, which decreased as a percentage of revenues from 2003 to 2004. Much of the division’s growth has occurred in markets where there are already existing programs, making it easier to manage more programs per manager, thereby increasing selling, general and administrative wages at a rate considerably less than the rate revenues have increased. Depreciation and amortization expense as a percentage of operating revenues increased year-over-year due to the amortization of the division’s proprietary information system implemented in the second half of 2003, and the amortization related to certain intangible assets associated with the acquisitions of CPR and Cornerstone. The net effect of the revenue growth, overall cost control improvements at the divisional level and the absorption of additional corporate overhead during the twelve months ended December 31, 2004 compared to the twelve months ended December 31, 2003 was a $4.4 million increase in contract therapy’s operating earnings from $5.8 million to $10.2 million.

Non-operating Items

Interest income increased by $0.3 million from $0.1 million in 2003 to $0.4 million in 2004, primarily due to higher average invested balances and some increase in interest rates in the second half of the year.

Interest expense in 2004 primarily consists of interest related to subordinated promissory notes issued in connection with the CPR, VitalCare and Conerstone acquisitions, commitment fees paid on the unused portion of our line of credit, letter of credit fees and amortization of deferred loan origination fees. Compared to 2003, interest expense in 2004 increased as a result of the issuance of the subordinated promissory notes, higher amounts of letters of credit to support insurance programs and the write-off of approximately $0.1 million of deferred loan origination fees as a result of replacing our line of credit which, was scheduled to expire in August 2005. We had no outstanding balance against our line of credit as of December 31, 2004 and December 31, 2003.

The provision for income taxes in 2004 was an expense of $17.0 million compared to a benefit of $1.6 million in 2003, reflecting effective income tax rates of 41.6% and 10.5%, respectively. The effective rates for both 2004 and 2003 were significantly impacted by a component of the loss on the sale of the StarMed staffing division related to goodwill, which was not deductible for tax purposes.

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Diluted earnings per share was $1.38 in 2004 compared to diluted loss per share of $0.86 in 2003. This improvement was principally the result of improved contribution margins during 2004 as well as the $30.6 million after tax impairment charge in 2003 related to the net assets held for sale in our former staffing division.

Twelve Months Ended December 31, 2003 Compared to Twelve Months Ended December 31, 2002

Revenues

Consolidated operating revenues in 2003 decreased $23.2 million or 4.1% to $539.3 million as compared to $562.6 million in 2002. Revenue increases in contract therapy and hospital rehabilitation services were more than offset by revenue declines in healthcare staffing.

Hospital rehabilitation services revenues, consisting of hospital inpatient and outpatient programs, increased by $6.1 million to $185.8 million in 2003, or 3.4% from $179.7 million in 2002. Inpatient revenues increased $6.1 million, or 4.7% from $130.7 million in 2002 to $136.9 million in 2003. Revenue per program increased 5.8%, offsetting a 1.1% decline in the average number of programs operated. Growth in revenue per program is a result of the average number of discharges per unit increasing 2.6% year-over-year. Outpatient revenues remained flat year-over-year, reflecting an 11.7% decrease in the average number of programs operated, offset by a 13.2% increase in revenue per outpatient program. Growth in outpatient revenue per program is a result of termination of a number of smaller contracts with limited long-term opportunity and a 3.4% increase in average patient visits per location.

Contract therapy revenue increased by 24.3% from $105.3 million in 2002 to $130.8 million in 2003 despite the negative revenue impact of the Medicare Part B therapy caps that were in effect from September 1 through December 8 of 2003. The primary driver of this increase was the success in the division’s sales efforts, which increased the average number of contract therapy programs managed 21.6% from 378.1 in 2002 to 459.9 in 2003. Also contributing to the revenue increase was a 2.2% increase in the average revenue per location from approximately $278,000 to approximately $285,000, resulting from same store growth and the continued focus on opening larger programs.

                Healthcare staffing revenues decreased 19.3%, or $53.6 million in 2003, from $277.5 million in 2002 to $224.0 million in 2003 (including $1.3 million inter-company sales at market rates to the hospital rehabilitation services and contract therapy divisions). Supplemental staffing revenues decreased by $46.2 million, or 26.8%, to $125.9 million in 2003, reflecting the impact of branch consolidations in the first quarter of 2003 driven by a decline in the demand for staffing agency services. The average number of branch locations decreased 32.5%, from 107.9 in 2002 to 72.8 in 2003. The decrease in supplemental staffing revenues is attributable to a 29.2% decrease in weeks worked as a result of the consolidation of branch locations and a decline in demand, offset by a 3.4% increase in average revenue per week worked. The increase in average revenue per week worked was a result of placing more highly credentialed staff, such as registered nurses, as compared to certified nurse assistants, as well as increased bill rates for the certified nurse assistants. Travel staffing revenues decreased by 7.1% from $105.5 million in 2002 to $98.0 million in 2003 primarily as a result of a 7.3% decrease in weeks worked. Revenue per week worked improved slightly by 0.2%. The decline in weeks worked was driven by a decrease in demand for travelers while the increase in revenue per week is a result of increases in rates within nurse and therapist placements offset by a shift in sales mix to more radiologists, which saw a decrease in revenue per week worked.

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Cost and Expenses

Consolidated operating expenses in 2003 decreased by $4.5 million or 1.1% to $408.6 million compared to $413.1 million in 2002. As a percentage of sales, operating expenses (excluding provision for doubtful accounts) increased to 75.1% in 2003 versus 72.6% in 2002, primarily reflecting the migration of the skill mix in the staffing division to more highly credentialed professionals, lower productivity in the contract therapy division due to a complex information system conversion during the third quarter of 2003 and increased labor, benefit and insurance costs in all divisions. The provision for doubtful accounts as a percentage of operating revenues decreased from 0.8% in 2002 to 0.7% in 2003 due primarily to improvement in the aging categories of the staffing division’s accounts receivable primarily during the first half of the year. Division selling, general and administrative expenses as a percentage of operating revenues decreased from 13.3% in 2002 to 12.1% in 2003 primarily due to reductions of costs, as a percent of division operating revenues in contract therapy, the outpatient division of hospital rehabilitation services and healthcare staffing, partially offset by increases in the inpatient division of hospital rehabilitation services. Corporate selling, general and administrative expenses of $26.7 million in 2003 were flat year-over-year compared to 2002, but increased as a percentage of operating revenues to 4.9% in 2003 compared to 4.7% in 2002. The increase as a percentage of operating revenues was primarily attributable to increased costs for the arrangements entered into during the second quarter of 2003 with Phase 2 Consulting, Inc. and the former President and CEO of the Company. Under the terms of the Phase 2 agreement, we paid a monthly fee of $55,000 and reimbursement of business expenses. In addition, Phase 2 earned an incentive fee of $125,000 based on predetermined performance standards. The consulting agreement with the former CEO continued his monthly compensation and car allowance of approximately $45,000 until June 2004. In addition, we incurred higher legal fees during 2003 to research and comment on the Centers for Medicare and Medicaid Services 75% rule. These cost increases were offset by cost decreases resulting from tighter cost controls instituted in the second half of the year combined with the favorable impact of restructuring activities initiated during the third quarter. Depreciation and amortization expense as a percentage of operating revenues increased to 1.6% from 1.5% due to depreciation expense recorded on additional capital expenditures.

On July 30, 2003, we announced a comprehensive, multifaceted restructuring program to help return the Company to growth and improved profitability. As part of the restructuring program, we eliminated 61 positions in an effort to reduce corporate support functions and better align corporate overhead with the operating divisions. As a result of the restructuring plan, we recognized a pretax restructuring charge of $1.3 million. Included in this restructuring charge is $1.1 million of severance and outplacement costs and $0.2 million for exit costs related to the closing of five StarMed branches. The restructuring charge was reflected as a separate component of costs and expenses for 2003.

On December 30, 2003, we announced that we had entered into a Stock Purchase and Sale Agreement with InteliStaf pursuant to which InteliStaf would acquire our healthcare staffing division in exchange for approximately 25% of the common stock of InteliStaf on a fully diluted basis. This transaction subsequently closed on February 2, 2004. In accordance with the requirements of Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the assets and liabilities of the healthcare staffing operation were reported on our December 31, 2003 consolidated balance sheet as assets and liabilities held for sale and were measured at their net fair value less estimated costs to sell. We recognized a pretax impairment loss of $43.6 million to reduce the carrying value of goodwill associated with the staffing division and to accrue estimated selling costs. This impairment loss was recorded as a separate component of our costs and expenses for 2003.

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In the hospital rehabilitation services division, direct operating expenses (excluding provision for doubtful accounts) increased by 3.9%, or $4.6 million, primarily reflecting increased salaries and salary-related expenses in both inpatient and outpatient divisions as a result of higher workers compensation, professional liability and health insurance expenses. Provision for doubtful accounts as a percentage of operating revenues increased from 0.4% in 2002 to 0.5% for fiscal year 2003, primarily as a result of the normal evaluation of the creditworthiness of our clients. In the hospital rehabilitation services division, divisional selling, general, and administrative expense fell $0.7 million, or 4.7%, as a result of our third quarter restructuring and combination of the inpatient and outpatient divisions. Corporate general and administrative expenses allocated to the division increased $0.9 million, or 12.2%, to $8.4 million in 2003. Depreciation and amortization expense, as a percentage of operating revenues, declined slightly year-over-year.

Contract therapy direct operating expenses (excluding provisions for doubtful accounts) increased 32.6% from $76.6 million in 2002 to $101.5 million in 2003, which was due primarily to the increased number of contract therapy locations being managed by the division. As a percentage of net revenues, the division’s direct operating expenses increased from 72.7% of net revenues in 2002 to 77.6% of net revenues in 2003. Contributing to this increase in direct operating expenses was higher wages paid as a result of the tightening therapist labor market, as well as utilization of higher cost contract labor. In addition, productivity was negatively affected in the third quarter and early in the fourth quarter due to problems encountered during the implementation of our proprietary information system. The provision for doubtful accounts as a percentage of operating revenues increased from 1.5% of operating revenues in 2002 to 1.7% in 2003 as a result of our on-going review of accounts receivable risk. Contract therapy’s division selling, general and administrative expenses as a percentage of revenues decreased from 10.0% in 2002 to 9.0% in 2003 as the division increased revenues at a faster rate than its selling, general and administrative expenses. Corporate general and administrative expenses, which represent allocations of corporate office expenses based upon utilization by divisions, increased slightly as a percentage of operating revenues from 6.1% to 6.2%. Depreciation and amortization expense, as a percentage of operating revenues, remained flat at 1.0% of operating revenues year-over-year.

In the staffing division, direct operating expenses (excluding provision for doubtful accounts) decreased 15.1%, or $32.3 million, due to the decrease in weeks worked, offset by changes within certain operating expense categories as described below. Gross profit margins in the supplemental staffing division decreased from 23.5% in 2002 to 19.1% in 2003, while gross profit margins in the travel division decreased in 2003 to 18.3% compared to 21.7% in 2002. The decrease in gross profit margin in the supplemental staffing division is primarily the result of increases in workers compensation, professional and general liability and medical insurance claims cost. The decrease in gross profit margin within the travel staffing division was a result of changes to bonuses paid to travelers; market pricing decreases in radiologist bill rates and increases in workers compensation and professional and general liability. The provision for doubtful accounts decreased $1.2 million in 2003 compared to 2002, primarily as a result of the normal evaluation of the creditworthiness of our clients showing improvement in accounts receivable aging. Division selling, general and administrative expenses decreased by $10.1 million or 21.0% as a result of branch consolidations in the first quarter of 2003 and decreases in administrative personnel. This resulted in a decrease in divisional selling, general and administrative expenses as a percentage of operating revenues from 17.4% in 2002 to 17.0% in 2003. Corporate general and administrative expenses, which represent allocations of corporate office expenses based upon utilization by divisions, decreased for the division as a percentage of operating revenues from 4.7% to 4.5%. Depreciation and amortization expenses as a percentage of operating revenues increased from 0.7% in 2002 to 0.8% in 2003 primarily due to similar expense on less revenue.

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Non-operating Items

Interest income decreased by $0.2 million from $0.3 million in 2002 to $0.1 million in 2003, primarily due to lower interest rates.

Interest expense primarily represents commitment fees paid on the unused portion of our line of credit and letter of credit fees. Compared to 2002, interest expense in 2003 increased very slightly as a result of higher amounts of letters of credit to support insurance programs. We had no outstanding balance against our line of credit as of December 31, 2003 and December 31, 2002.

The provision for income taxes in 2003 was a benefit of $1.6 million compared to an expense of $15.0 million in 2002, reflecting effective income tax rates of 10.5% and 38.0%, respectively. The effective rate for 2003 was significantly impacted by a component of the loss on net assets held for sale related to goodwill, which is not deductible for tax purposes.

Diluted loss per share was $0.86 in 2003 compared to diluted earnings per share of $1.38 in 2002. This decline was principally the result of the $30.6 million after tax impairment charge in 2003 related to the net assets held for sale of our staffing division and the significant decline in demand for staffing agency services.

Liquidity and Capital Resources

As of December 31, 2004, we had $50.4 million in cash and cash equivalents and restricted cash of $3.1 million and a current ratio, the amount of current assets divided by current liabilities, of 2.3 to 1. Working capital decreased by $0.5 million to $76.5 million as of December 31, 2004 as compared to $77.0 million as of December 31, 2003. This decrease is primarily the result of an increase in the current portion of long-term debt attributable to the acquisitions of CPR, VitalCare and Cornerstone, increased accounts payable resulting primarily from computer software and hardware acquisitions near year end and increased accrued salaries and wages primarily for incentive accruals. The number of days’ average net revenue in net receivables was 66.5 and 72.0 (adjusted to exclude receivables related to the staffing division) at December 31, 2004 and 2003, respectively.

Operating cash flows constitute our primary source of liquidity and historically have been sufficient to fund working capital, capital expenditures, internal business expansion and debt service requirements. We expect to meet our future working capital, capital expenditures, internal and external business expansion and debt service requirements from a combination of internal sources and outside financing.

On October 12, 2004, we entered into an Amended and Restated Credit Agreement with Bank of America, N.A., U.S. Bank National Association, Harris Trust and Savings Bank, National City Bank, Comerica Bank and SunTrust Bank, as participating banks in the lending group. The Amended and Restated Credit Agreement is an expandable $90 million, five-year revolving credit facility that replaces our former $125 million revolving line of credit, dated August 29, 2000, which was scheduled to expire in August 2005. The new revolving credit facility is expandable to $125 million upon our notice to the lending group, subject to our continued compliance with the terms of the Amended and Restated Credit Agreement. The new credit facility features reduced bank fees and interest rate spreads and significantly enhances our financial flexibility. At December 31, 2004 and 2003, we had no balance outstanding against our line of credit.

We have approximately $10.0 million in letters of credit issued to insurance carriers as collateral for reimbursement of claims. The letters of credit reduce the amount we may borrow under

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the line of credit.  We also have a $4.2 million promissory note issued to our workers compensation carrier as additional collateral. The promissory note is not recorded as a liability on the consolidated balance sheet as it only becomes payable upon an event of default as defined in the security agreement with the workers compensation carrier. Finally, as additional collateral, we have a trust agreement with our professional and general liability insurance carrier under which we have deposited $3.1 million for their benefit in an escrow account. Our access to these funds is restricted and the insurance carrier may only draw on these funds in the event of a default as defined in the trust agreement.

As part of the purchases of CPR, VitalCare and Cornerstone, we issued long-term subordinated promissory notes to the respective selling parties. These notes bear interest at rates ranging from 6%-8%. As of December 31, 2004, approximately $6.9 million of these notes remained outstanding. In addition, as part of our arrangement with Signature Healthcare Foundation, we extended a $2.0 million line of credit to Signature. At December 31, 2004, Signature had drawn approximately $0.9 million against this line of credit.

In connection with the development and implementation of additional programs, including developing joint venture relationships, we may incur capital expenditures for acquisitions of property, renovations, equipment and deferred costs to begin operations. In addition, we expect to expend capital to implement our acquisition strategy. During 2004, we expended approximately $24.4 million in cash, net of cash acquired, for the acquisition of new businesses. These funds were all derived from cash generated from operations.

Inflation

Although inflation has abated during the last several years, the rate of inflation in healthcare related services continued to exceed the rate experienced by the economy as a whole. Our management contracts typically provide for an annual increase in the fees paid to us by our clients based on increases in various inflation indices.

Effect of Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board enacted Statement of Financial Accounting Standards No. 123 – revised 2004, “Share-Based Payment” (“Statement 123R”) which replaces Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Statement 123R requires the measurement of all share-based payments to employees using a fair value based method and the recognition of such fair value as expense in our consolidated statements of earnings. The provisions of Statement 123R are effective for fiscal periods beginning after June 15, 2005. Accordingly adoption of this standard is required for our third fiscal period in 2005, earlier adoption is encouraged. If we were to adopt the provisions of Statement 123R on January 1, 2005, based on our current estimates, we would recognize equity compensation expense, net of tax benefits, of between $2.5 to $3.0 million in 2005. This estimate is based on continuing to expense amounts computed under the provisions of Statement 123 for options granted prior to the adoption of Statement 123R and an estimate of the expense that will be recognized for new options that we expect to grant during 2005. This estimate is subject to change based on the actual grants of stock options in 2005 and the fair value of those stock options as determined on the date of grant.

In December 2004, the Financial Accounting Standards Board enacted Statement of Financial Accounting Standards No. 153, “Exchanges of Nonmonetary Assets – An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions (“Statement 153”). Statement 153

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eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, “Accounting for Nonmonetary Transactions,” and replaces it with an exception for exchanges that do not have commercial substance. Statement 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. Statement 153 is effective for fiscal periods beginning after June 15, 2005. We are currently evaluating the effect that the adoption of Statement 153 will have on our consolidated results and financial condition but we do not expect it to have a material impact.

Commitments and Contractual Obligations

                The following table summarizes our scheduled contractual commitments, exclusive of interest, as of December 31, 2004 (in thousands):

	Total		Less than 1 year		2-3 years		4-5 years		More than 5 years		Other
Operating leases	$	8,903	$	2,705	$	4,460	$	931	$	807	$	—
Purchase obligations		1,295		1,275		20		—		—		—
Long-term debt		6,873		4,731		2,142		—		—		—
Other long-term liabilities (1)		4,088		—		—		—		—		4,088
Total	$	21,159	$	8,711	$	6,622	$	931	$	807	$	4,088

⁽¹⁾ We maintain a nonqualified deferred compensation plan for certain employees. Under the plan, participants may defer up to 100% of their base cash compensation. The amounts are held in trust in designated investments and remain our property until distribution. Because distribution of funds is at the election of the participants, we are not able to predict the timing of payments against this obligation. At December 31, 2004, we owned trust assets with a value approximately equal to the total amount of this obligation.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our estimates, judgments and assumptions are continually evaluated based on available information and experience. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates. Management has discussed and will continue to discuss its critical accounting policies with the Audit Committee of our Board of Directors.

Certain of our accounting policies require higher degrees of judgment than others in their application. These include estimating the allowance for doubtful accounts, impairment of goodwill and other intangible assets and establishing accruals for known and incurred but not reported health, workers compensation and professional liability claims. In addition, Note 1 to the consolidated financial statements includes further discussion of our significant accounting policies.

Management believes the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

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Allowance for Doubtful Accounts. We make estimates of the collectability of our accounts receivable balances. We determine an allowance for doubtful accounts based upon an analysis of the collectability of specific accounts, historical experience and the aging of the accounts receivable. We specifically analyze customers with historical poor payment history and customer creditworthiness when evaluating the adequacy of the allowance for doubtful accounts. Our accounts receivable balance as of December 31, 2004 was $69.6 million, net of allowance for doubtful accounts of $5.1 million. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. We continually evaluate the adequacy of our allowance for doubtful accounts and make adjustments in the periods any excess or shortfall is identified.

Goodwill and Other Intangibles .The cost of acquired companies is allocated first to their identifiable assets, both tangible and intangible, based on estimated fair values. Costs allocated to identifiable intangible assets are generally amortized on a straight-line basis over the remaining estimated useful lives of the assets. The excess of the purchase price over the fair value of identifiable assets acquired, net of liabilities assumed, is recorded as goodwill.

Under Statement of Financial Accounting Standards (“Statement”) No. 142 “Goodwill and Other Intangible Assets,” goodwill and intangible assets with indefinite lives are not amortized but must be reviewed at least annually for impairment. If the impairment test indicates that the carrying value of an intangible asset exceeds its fair value, then an impairment loss would be recognized in the consolidated statement of earnings in an amount equal to the excess carrying value.

On December 30, 2003, we announced that we had entered into a Stock Purchase and Sale Agreement with InteliStaf pursuant to which InteliStaf would acquire our healthcare staffing division, in exchange for approximately 25% of the common stock of InteliStaf on a fully diluted basis. This transaction subsequently closed on February 2, 2004. In accordance with the requirements of Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the assets and liabilities of our healthcare staffing operation were reported on our December 31, 2003 consolidated balance sheet as assets and liabilities held for sale and were measured at their net fair value less estimated costs to sell. We recognized an impairment loss of $43.6 million to reduce the carrying value of goodwill associated with the staffing division and to accrue estimated selling costs. This impairment loss was computed in accordance with the provisions of Statement No. 142. We engaged a third party valuation firm to assist us in determining the fair value of consideration given and received in the contemplated transaction with InteliStaf. This value, less estimated costs to sell, was compared to the carrying value of the healthcare staffing division to ascertain if any impairment existed. Because the estimated fair value less costs to sell was less than the carrying value of the staffing business, we performed the second step of the goodwill impairment test to determine the amount of the implied fair value of goodwill and in turn the amount of impairment. The impairment loss was recorded as a separate component of costs and expenses in our consolidated statement of earnings for the year ended December 31, 2003.

As required by Statement No. 142, we also conducted an annual impairment assessment of goodwill related to our hospital rehabilitation services, contract therapy and healthcare management consulting businesses and determined that goodwill is not impaired. The test required comparison of the estimated fair value of these businesses to our book value. The estimated fair value was based on a discounted cash flow analysis. Assumptions and estimates about future cash flows and discount rates are often subjective and can be affected by a variety of factors, including external factors such as economic trends and government regulations, and internal factors such as changes in our forecasts or in our business strategies. We believe the assumptions used in our impairment analysis are reasonable and appropriate; however, different assumptions and estimates could affect the results of our

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impairment analysis and in turn result in an impairment charge. If an impairment loss should occur in the future, it could have a material adverse impact on our results of operations. At December 31, 2004, unamortized goodwill related to our hospital rehabilitation services, contract therapy and healthcare management consulting businesses was $42.9 million, $21.3 million and $4.1 million, respectively.

Health, Workers Compensation, and Professional Liability Insurance Accruals. We maintain an accrual for our health, workers compensation and professional liability claim costs that are partially self-insured and are classified in accrued salaries and wages (health insurance) and accrued expenses (workers compensation and professional liability) in our consolidated balance sheets. At December 31, 2004, the combined amount of these accruals was approximately $12.7 million. We determine the adequacy of these accruals by periodically evaluating our historical experience and trends related to health, workers compensation, and professional liability claims and payments, based on actuarial computations and industry experience and trends. In analyzing the accruals, we also consider the nature and severity of the claims, analyses provided by third party claims administrators, as well as current legal, economic and regulatory factors. If such information indicates that our accruals are overstated or understated, we reduce or provide for additional accruals as appropriate in the period in which we make such a determination. The ultimate cost of these claims may be greater than or less than the established accruals. While we believe that the recorded amounts are appropriate, there can be no assurances that changes to management’s estimates will not occur due to limitations inherent in the estimation process.

                We are subject to various claims and legal actions in the ordinary course of our business. Some of these matters include professional liability and employee-related matters. Our hospital and healthcare facility clients may also become subject to claims, governmental inquiries and investigations and legal actions to which we may become a party relating to services provided by our professionals. From time to time, and depending upon the particular facts and circumstances, we may be subject to indemnification obligations under our contracts with our hospital and healthcare facility clients relating to these matters. Although we are currently not aware of any such pending or threatened litigation that we believe is reasonably likely to have a material adverse effect on us, if we become aware of such claims against us, we will evaluate the probability of an adverse outcome and provide accruals for such contingencies as necessary.

                Investment in Unconsolidated Affiliate.  We account for our 25% equity investment in InteliStaf Holdings, Inc. using the provisions of APB Opinion No. 18 “The Equity Method of Accounting for Investments in Common Stock.” Our investment in InteliStaf was initially recorded at cost and we have since adjusted the carrying amount of the investment for our share of InteliStaf’s losses after the date of acquisition. In accordance with the provisions of APB 18, we must assess whether factors exist that may indicate a decrease in the value of our investment has occurred that is other than temporary. During 2004, InteliStaf incurred operating losses and the healthcare staffing industry as a whole continued a cyclical downturn. Accordingly, we concluded that an assessment was warranted to determine whether an other than temporary loss of value in our investment had occurred. We performed this assessment using several valuation techniques including discounted cash flows and multiples of earnings, revenues and cash flows. Additionally, we reviewed qualitative and quantitative evidence, both positive and negative, to assess whether a decline in value, if any, was other than temporary. Based on this analysis, we concluded there has not been an other than temporary decline in the value of our equity investment in InteliStaf and we made no adjustment to the carrying value of our investment, which is $39.3 million at December 31, 2004. We will continue to monitor the valuation of our investment in InteliStaf and will update our analysis as circumstances warrant. We believe the assumptions used in our analysis are reasonable and appropriate; however, different assumptions and estimates could affect the results of our analysis and in turn reflect a

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reduction in the carrying value of our investment and result in a charge to our statement of earnings. If such a reduction in investment value should occur in the future, it could have a material adverse impact on our net earnings.

ITEM 7A.      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

                Our borrowing capacity consists of a line of credit with interest rates that fluctuate based upon market indexes. As of December 31, 2004, we did not have any outstanding borrowings under this line of credit. As such, risk relating to interest rate fluctuations is considered minimal.

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ITEM 8A.       FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Registered Public Accounting Firm	36
Consolidated Balance Sheets as of December 31, 2004 and 2003	37
Consolidated Statements of Earnings for the years ended            December 31, 2004, 2003 and 2002	38
Consolidated Statements of Stockholders’ Equity for the years ended            December 31, 2004, 2003 and 2002	39
Consolidated Statements of Cash Flows for the years ended            December 31, 2004, 2003 and 2002	40
Notes to the Consolidated Financial Statements	41

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Report of Independent Registered Public Accounting Firm

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, 2004 and 2003, and the related consolidated statements of earnings, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004. 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 the standards of the Public Company Accounting Oversight Board (United States). 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, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.

                As discussed in Note 6 to the consolidated financial statements, effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.”

                We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 16, 2005 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

/s/ KPMG LLP

St. Louis, Missouri
March 16, 2005

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REHABCARE GROUP, INC.
Consolidated Balance Sheets
(dollars in thousands, except per share data)

	December 31,
	2004			2003
Assets
Current assets:
Cash and cash equivalents	$	50,405		$	28,320
Restricted cash		3,073			—
Marketable securities, available-for-sale		—			10,065
Accounts receivable, net of allowance for doubtful
accounts of $5,074 and $3,422, respectively		69,565			62,744
Deferred tax assets		10,252			14,706
Other current assets		1,690			1,912
Total current assets		134,985			117,747
Marketable securities, trading		4,076			3,665
Equipment and leasehold improvements, net		15,149			14,063
Excess of cost over net assets acquired, net		68,340			48,729
Intangible assets, net		11,884			48
Assets held for sale		—			46,171
Investment in unconsolidated affiliate		39,269			—
Other		3,963			3,203
Total assets	$	277,666		$	233,626
Liabilities and Stockholders’ Equity
Current liabilities:
Current portion of long-term debt	$	4,731		$	—
Accounts payable		3,521			763
Accrued salaries and wages		29,859			24,035
Income taxes payable		4,495			1,197
Accrued expenses		15,928			14,800
Total current liabilities		58,534			40,795
Long-term debt, less current portion		2,142			—
Deferred compensation		4,088			3,682
Deferred tax liabilities		5,874			1,423
Liabilities held for sale		—			9,771
Total liabilities		70,638			55,671
Stockholders’ equity:
Preferred stock, $.10 par value; authorized 10,000,000 shares,
none issued and outstanding		—			—
Common stock, $.01 par value; authorized 60,000,000 shares,
issued 20,553,232 shares and 20,144,577 shares as of
December 31, 2004 and 2003, respectively		206			201
Additional paid-in capital		120,592			114,704
Retained earnings		140,934			117,753
Less common stock held in treasury at cost,
4,002,898 shares as of December 31, 2004
and 2003		(54,704	)		(54,704	)
Accumulated other comprehensive earnings		—			1
Total stockholders’ equity		207,028			177,955
Total liabilities and stockholders’ equity	$	277,666		$	233,626

See accompanying notes to consolidated financial statements.

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REHABCARE GROUP, INC.
Consolidated Statements of Earnings
(in thousands, except per share data)

	Year Ended December 31,
	2004			2003			2002
Operating revenues	$	383,846		$	539,322		$	562,565
Costs and expenses:
Operating		275,242			408,559			413,081
Selling, general and administrative:
Divisions		32,499			65,055			74,621
Corporate		24,615			26,680			26,832
Restructuring charge		1,615			1,286			—
Loss on assets held for sale		—			43,579			—
Depreciation and amortization		8,556			8,559			8,334
Gain on sale of business		(485	)		—			—
Total costs and expenses		342,042			553,718			522,868
Operating earnings (loss)		41,804			(14,396	)		39,697
Interest income		393			140			319
Interest expense		(1,181	)		(714	)		(676	)
Other income (expense), net		(55	)		(338	)		9
Earnings (loss) before income taxes and
equity in net loss of affiliate		40,961			(15,308	)		39,349
Income tax expense (benefit)		17,049			(1,609	)		14,954
Equity in net loss of affiliate		(731	)		—			—
Net earnings (loss)	$	23,181		$	(13,699	)	$	24,395
Net earnings (loss) per common share:
Basic	$	1.42		$	(0.86	)	$	1.45
Diluted	$	1.38		$	(0.86	)	$	1.38

See accompanying notes to consolidated financial statements.

38

REHABCARE GROUP, INC.
Consolidated Statements of Stockholders’ Equity
(in thousands)

	Common Stock				Additional Paid-in capital		Retained earnings								Accumulated other compre- hensive earnings (loss)			Total stockholders’ equity
										Treasury
	Issued shares		Amount
										Shares		Amount
Balance, December 31, 2001		19,631	$	196	$	109,522	$	107,057			2,303	$	(17,757	)	$	18		$	199,036
Components of comprehensive
earnings:
Net earnings		—		—		—		24,395			—		—			—			24,395
Change in unrealized gain (loss) on
marketable securities, net of tax		—		—		—		—			—		—			(21	)		(21	)
Total comprehensive earnings																			24,374
Purchase of treasury stock		—		—		—		—			1,700		(36,947	)		—			(36,947	)
Exercise of stock options
(including tax benefit)		215		2		2,149		—			—		—			—			2,151
Balance, December 31, 2002		19,846		198		111,671		131,452			4,003		(54,704	)		(3	)		188,614
Components of comprehensive
earnings (loss):
Net loss		—		—		—		(13,699	)		—		—			—			(13,699	)
Change in unrealized gain (loss) on
marketable securities, net of tax		—		—		—		—			—		—			4			4
Total comprehensive loss																			(13,695	)
Exercise of stock options
including tax benefit)		299		3		3,033		—			—		—			—			3,036
Balance, December 31, 2003		20,145		201		114,704		117,753			4,003		(54,704	)		1			177,955
Components of comprehensive
earnings:
Net earnings		—		—		—		23,181			—		—			—			23,181
Change in unrealized gain (loss) on
marketable securities, net of tax		—		—		—		—			—		—			(1	)		(1	)
Total comprehensive earnings																			23,180
Modification of stock options		—		—		114		—			—		—			—			114
Exercise of stock options
(including tax benefit)		408		5		5,774		—			—		—			—			5,779
Balance, December 31, 2004		20,553	$	206	$	120,592	$	140,934			4,003	$	(54,704	)	$	—		$	207,028

See accompanying notes to consolidated financial statements.

39

REHABCARE GROUP, INC.
Consolidated Statements of Cash Flows
(in thousands)

	Year Ended December 31,
	2004			2003			2002
Cash flows from operating activities:
Net earnings (loss)	$	23,181		$	(13,699	)	$	24,395
Adjustments to reconcile net earnings (loss) to net cash
provided by operating activities:
Depreciation and amortization		8,556			8,559			8,334
Provision for doubtful accounts		4,392			4,036			4,511
Equity in net loss of affiliate		731			—			—
Write-down of investments		—			50			—
Loss on assets held for sale		—			43,579			—
Income tax benefit realized on exercise of
employee stock options		2,450			903			770
Restructuring charge		1,615			1,286			—
Gain on sale of business		(485	)		—			—
Change in assets and liabilities:
Deferred compensation		260			(448	)		407
Accounts receivable, net		(7,508	)		(5,480	)		(98	)
Other current assets		222			32			(1,485	)
Other assets		(227	)		73			464
Net assets held for sale		1,903			—			—
Accounts payable		2,354			(1,111	)		(1,608	)
Accrued expenses		(855	)		7,195			(7,742	)
Accrued salaries and wages		4,446			944			1,438
Income taxes payable and deferred taxes		9,046			(12,100	)		6,667
Net cash provided by operating activities		50,081			33,819			36,053
Cash flows from investing activities:
Additions to equipment and leasehold improvements, net		(7,142	)		(5,337	)		(8,546	)
Purchase of marketable securities		(31,282	)		(10,735	)		(596	)
Proceeds from sale/maturities of marketable securities		41,082			1,121			1,030
Increase in restricted cash		(3,073	)		—			—
Disposition of business		(4,532	)		—			—
Purchase of businesses, net of cash acquired		(24,440	)		—			—
Cash in net assets held for sale		—			(1,550	)		—
Other, net		(828	)		(711	)		(1,329	)
Net cash used in investing activities		(30,215	)		(17,212	)		(9,441	)
Cash flows from financing activities:
Principal payments on long-term debt		(540	)		—			—
Purchase of treasury stock		—			—			(36,947	)
Debt issuance costs		(570	)		—			—
Exercise of stock options		3,329			2,133			1,381
Net cash provided by (used in) financing activities		2,219			2,133			(35,566	)
Net increase (decrease) in cash and cash
equivalents		22,085			18,740			(8,954	)
Cash and cash equivalents at beginning of year		28,320			9,580			18,534
Cash and cash equivalents at end of year	$	50,405		$	28,320		$	9,580

See accompanying notes to consolidated financial statements.

40

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002

(1)           Overview of Company and Summary of Significant Accounting Policies

                Overview of Company

                RehabCare Group, Inc. (“the Company”) is a leading provider of program management services for inpatient rehabilitation and skilled nursing units, outpatient therapy programs and contract therapy services in conjunction with over 800 hospitals and skilled nursing facilities throughout the United States.

                On February 2, 2004, the Company consummated a Stock Purchase and Sale Agreement with InteliStaf Holdings, Inc. (“InteliStaf”) pursuant to which InteliStaf acquired all of the outstanding common stock of our former staffing division, StarMed Health Personnel, Inc. (“StarMed”). In return, the Company received a 25% equity interest, on a fully diluted basis, in InteliStaf.

                Principles of Consolidation

                The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The Company accounts for its investment in a less than 50% owned affiliate using the equity method. All significant inter-company balances and transactions have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform with current year presentation.

                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, 2004 and 2003 consist of marketable equity and debt 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 taxes, is recorded as other accumulated comprehensive earnings. Unrealized gains or losses on such securities are not recognized in the consolidated statements of earnings until the securities are sold. All marketable securities in non-current assets are classified as trading, with all investment income, including unrealized gains or losses recognized in the consolidated statements of earnings. Non-current marketable securities include assets held in trust for the Company’s deferred compensation plan that are not available for operating purposes.

                Credit Risk

               The Company 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 anticipated credit losses. The Company determines its allowance for doubtful accounts based upon an analysis of the collectability of specific accounts, historical experience and the aging of the accounts receivable. The Company specifically analyzes customers with historical poor payment history and customer creditworthiness when evaluating the

41

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

adequacy of the allowance for doubtful accounts. The Company continually evaluates the adequacy of its allowance for doubtful accounts and makes adjustments in the periods any excess or shortfall is identified.

Equipment and Leasehold Improvements

                Equipment and leasehold improvements are initially recorded at cost. Depreciation and amortization of equipment and leasehold improvements are computed using the straight-line method over the estimated useful lives of the related assets, principally: equipment – three to seven years and leasehold improvements – life of lease or life of asset, whichever is less. Upon retirement or disposition, the cost and related accumulated depreciation are removed from the accounts and any gain or loss is included in the results of operations. Repairs and maintenance are expensed as incurred.

                Excess of Cost Over Net Assets Acquired and Other Identifiable Intangible Assets

The excess of cost over net assets acquired relates to business combinations. Under Statement No. 142, “Goodwill and Other Intangible Assets,” goodwill and intangible assets with indefinite lives are not amortized to expense, but instead tested for impairment at least annually and any related losses recognized in earnings when identified. See Note 6, “Excess of Costs Over Net Assets Acquired and Other Identifiable Intangible Assets” and Note 14, “Sale of Business” for further discussion. Other identifiable intangible assets with a finite life are amortized on a straight-line basis over their estimated lives.

Long-Lived Assets

Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” addresses financial accounting and reporting for the impairment of long-lived assets to be disposed of. The Company reviews identified intangible and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable. If such events or changes in circumstances are present, an impairment loss would be recognized if the sum of the expected future net cash flows was less than the carrying amount of the asset. See Note 14, “Sale of Business.”

                Disclosure About Fair Value of Financial Instruments

                The carrying amounts of cash and cash equivalents, receivables, prepaid expenses and other current assets, accounts payable, accrued salaries and wages and accrued expenses approximate fair value because of the short maturity of these items.

                Revenues and Costs

                The Company recognizes revenues and related costs in the period in which services are performed. Costs related to marketing and development are expensed as incurred.

                Health, Workers Compensation and Professional Liability Insurance Accruals

                The Company maintains an accrual for our health, workers compensation and professional liability claim costs that are partially self-insured and are classified in accrued salaries and wages (health insurance) and accrued expenses (workers compensation and professional liability). The Company determines the adequacy of these accruals by periodically evaluating historical experience

42

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

and trends related to claims and payments based on actuarial computations and industry experiences and trends. At December 31, 2004 and 2003, the balances for accrued health, workers compensation and professional liability were $3.0 million, $4.2 million, $5.5 million and $3.9 million, $4.5 million, $5.4 million, respectively.

Stock-Based Compensation

                The Company accounts for stock-based employee compensation plans using the intrinsic value method under APB Opinion No. 25, “Accounting for Stock Issued to Employees” and related Interpretations as permitted by Statement No. 123, “Accounting for Stock-Based Compensation.” Accordingly, stock-based employee compensation cost is not reflected in net earnings, as all stock options granted under the Company’s stock compensation plans have an exercise price equal to the market value of the underlying common stock on the date of grant. 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 Statement No. 123,the Company’s net earnings and earnings per share would have been reduced to the pro forma amounts indicated below:

	Year Ended December 31,
	2004			2003			2002
	(in thousands, except per share data)
Net earnings (loss), as reported	$	23,181		$	(13,699	)	$	24,395
Add: Modification of stock options		114			—			—
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects		(3,399	)		(3,657	)		(5,130	)
Pro forma net earnings (loss)	$	19,896		$	(17,356	)	$	19,265
Basic earnings (loss) per share:       As reported	$	1.42		$	(0.86	)	$	1.45
Pro forma	$	1.22		$	(1.08	)	$	1.15
Diluted earnings (loss) per share:   As reported	$	1.38		$	(0.86	)	$	1.38
Pro forma	$	1.18		$	(1.08	)	$	1.09

The per share weighted-average fair value of stock options granted during 2004, 2003 and 2002 was $9.60, $11.19 and $13.49 on the dates of grant using the Black Scholes option-pricing model with the following weighted-average assumptions: 2004 – expected dividend yield 0%, volatility of 35%-57%, risk free interest rate of 2.7%-3.8% and an expected life of 5 to 8 years; 2003 - expected dividend yield 0%, volatility of 55%-58%, risk free interest rate of 2.3%-3.5% and an expected life of 6 to 9 years; 2002 - expected dividend yield 0%, volatility of 55%, risk free interest rate of 3.8% and an expected life of 6 to 8 years.

                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

43

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

enacted tax rates in effect for the year in which those differences are expected to be recovered or settled.

                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.

Use of Estimates

                The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, 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 consolidated financial statements. Estimates also affect the reported amounts of revenues and expenses during the period. Actual results may differ from those estimates.

 (2)          Marketable Securities

                Current marketable securities at December 31, 2003 consisted entirely of variable rate demand notes. Noncurrent marketable securities consist primarily of marketable equity securities ($1.1 million and $0.9 million at December 31, 2004 and 2003, respectively), corporate and government bonds ($1.3 million and $0.5 million at December 31, 2004 and 2003, respectively) and money market securities ($1.7 million and $2.3 million at December 31, 2004 and 2003, respectively) held in trust under the Company’s deferred compensation plan.

(3)           Allowance for Doubtful Accounts

                Activity in the allowance for doubtful accounts is as follows:

	Year Ended December 31,
	2004			2003			2002
	(in thousands)
Balance at beginning of year	$	3,422		$	5,181		$	5,902
Provisions for doubtful accounts		4,392			4,036			4,511
Allowance transferred to assets held for sale		—			(2,134	)		—
Accounts written off, net of recoveries		(2,740	)		(3,661	)		(5,232	)
Balance at end of year	$	5,074		$	3,422		$	5,181

(4)           Equipment and Leasehold Improvements

                Equipment and leasehold improvements, at cost, consist of the following:

	December 31,
	2004		2003
	(in thousands)
Equipment	$	31,913	$	25,886
Leasehold improvements		3,134		3,188
		35,047		29,074
Less accumulated depreciation and amortization		19,898		15,011
	$	15,149	$	14,063

44

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

(5)           Restricted Cash and Other Insurance Collateral Commitments

Under the terms of the Company’s general and professional liability insurance policy, the insurance carrier requires that we provide collateral for reimbursement of claim payments. As one component of the collateral, we have entered into a trust agreement with our insurance carrier under which we have deposited $3.1 million for its benefit in an escrow account with a bank. We can access this cash no sooner than two business days after we and the insurance carrier notify the bank that suitable replacement collateral has been moved to the insurance carrier. The insurance carrier may only draw on these funds in the event of a default as defined in the trust agreement. The Company also has $10.0 million in letters of credit issued to insurance carriers as collateral for reimbursement of claims. The letters of credit reduce the amount the Company may borrow against its line of credit. Finally, the Company has a $4.2 million promissory note issued to its workers compensation carrier as additional collateral. The promissory note is not recorded as a liability on the balance sheet as it only becomes payable upon an event of default as defined in the workers compensation security agreement.

(6)           Excess of Cost Over Net Assets Acquired and Other Identifiable Intangible Assets

In accordance with the provisions of Statement No. 142, “Goodwill and Other Intangible Assets,” the Company performs an annual test of impairment for goodwill and other indefinite lived intangible assets. The impairment analysis is performed more frequently if events or changes in circumstances indicate that the carrying amount of such assets may exceed fair value. The Company performed a test for impairment for goodwill and other intangible assets as of December 31, 2004 and 2003. Based upon the results of the tests performed, the Company determined that goodwill and other indefinite lived intangible assets related to all of its reporting units, with the exception of healthcare staffing, were not impaired as of December 31, 2004 and 2003.

On December 30, 2003, a Stock Purchase and Sale Agreement was entered into with InteliStaf pursuant to which InteliStaf would acquire all of the outstanding common stock of the Company’s healthcare staffing division. Subsequently, this sale closed on February 2, 2004. During 2003, the Company performed impairment tests on the long-lived assets (including goodwill) related to this division on a quarterly basis, as current market conditions for this division were leading to revenue and operating performance declines. At December 31, 2003, the Company reported the assets and liabilities of the healthcare staffing division as assets and liabilities held for sale. The assets and liabilities held for sale were measured at their estimated fair value less costs to sell, resulting in a pretax charge during 2003 of $43.6 million. The carrying amount of goodwill related to StarMed was $12.9 million at December 31, 2003 compared to $53.0 million prior to the charge. See further discussion in Note 14, “Sale of Business.” On February 2, 2004, the Company consummated the sale of StarMed and recognized a gain on the sale of $0.5 million.

45

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

At December 31, 2004 and 2003, the Company had the following excess of cost over net assets acquired and other intangible asset balances:

	December 31,
	2004					2003
	(in thousands)
	Gross Carrying Amount		Accumulated Amortization			Gross Carrying Amount		Accumulated Amortization
Amortized Intangible Assets:
Noncompete agreements	$	455	$	(84	)	$	—	$	—
Trade names		550		(9	)		—		—
Contractual customer
relationships		10,600		(1,458	)		100		(52	)
Total	$	11,605	$	(1,551	)	$	100	$	(52	)
Unamortized Intangible Assets:
Trade names	$	1,830				$	—

Amortized intangible assets have the following weighted average useful lives as of December 31, 2004: noncompete agreements – 3.7 years; amortizing trade names – 5 years; and contractual customer relationships – 6.4 years.

Amortization expense was approximately $1.5 million and $26,000 for years ended December 31, 2004 and 2003, respectively. Estimated annual amortization expense for the next 5 years is: 2005 - $2.2 million; 2006 – $2.1 million; 2007 - $1.4 million; 2008 - $1.3 million and 2009 - $1.2 million.

The changes in the carrying amount of excess of cost over net assets acquired for the year ended December 31, 2004 are as follows:

	(in thousands)
	Hospital Rehabilitation Services		Contract Therapy		Healthcare Management Consulting		Total
Balance at December 31, 2003	$	35,739	$	12,990	$	—	$	48,729
Acquisitions		7,136		8,331		4,144		19,611
Balance at December 31, 2004	$	42,875	$	21,321	$	4,144	$	68,340

46

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

(7)           Business Combinations

A key component of the Company’s strategy is to aggressively pursue growth opportunities by acquiring businesses that enable us to fill in service gaps within our target markets, increase our presence in certain markets and supplement our existing businesses. During 2004, as further discussed below, the Company acquired four businesses that met these strategic goals.

On February 2, 2004, the Company purchased the assets of CPR Therapies, LLC. (“CPR”) for cash and $1.4 million of subordinated promissory notes. CPR, headquartered in Denver, Colorado, is a contract therapy services company for skilled nursing and assisted living facilities with a significant market presence in Colorado and California. CPR’s annual operating revenues are approximately $9 million. The purchase price, including estimated direct acquisition costs, of CPR has been allocated as follows (in thousands of dollars):

Equipment and leasehold improvements, net	$	16
Identifiable intangibles, principally
trade name, customer relationships
and noncompete agreements		1,660
Excess of cost over net assets acquired		2,595
	$	4,271

In accordance with the terms of the purchase agreement, the seller is entitled to additional earn-out consideration up to, but not exceeding, $799,000. The payment of this earn-out is contingent upon the execution of new therapy contracts as defined in the agreement. On July 31, 2004, the first of two earn-out calculations was performed resulting in an increase to the purchase price of approximately $159,000 and a corresponding increase to the excess of cost over net assets acquired. Any additional contingent consideration paid as a result of this contract provision will be recorded at the time the contingency is resolved.

                  Effective March 1, 2004, the Company purchased from Health Net, Inc. all of the outstanding common stock of American VitalCare, Inc. and its sister company, Managed Alternative Care, Inc. (collectively “VitalCare”) for cash and $3 million of subordinated promissory notes. VitalCare provides management services to hospital based specialty care units in the state of California generating annual operating revenues of approximately $14 million. The purchase price, including estimated direct acquisition costs, of VitalCare has been allocated as follows (in thousands of dollars):

Accounts receivable, net of allowance	$	2,382
Equipment and leasehold improvements, net		39
Other long-term assets		12
Identifiable intangibles, principally
trade name, customer relationships,
contractual customer relationships
and noncompete agreements		8,790
Excess of cost over net assets acquired		7,136
Net deferred tax liabilities		(3,157	)
Accounts payable		(272	)
Accrued salaries and wages		(535	)
	$	14,395

47

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

During the second quarter of 2004, the purchase price was adjusted based on the balances contained in the closing balance sheet of VitalCare as agreed to by the parties and was further adjusted in the fourth quarter for accounts receivable collections in accordance with the terms of the purchase agreement. These adjustments are reflected in the balances reported above. The final purchase price may be further increased or decreased for an adjustment, as defined in the agreement, related to the retention and/or termination of customer contracts for a period of time after the purchase date.

On May 3, 2004, the Company purchased the assets of Phase 2 Consulting, Inc. (“Phase 2”) for cash. Phase 2, with offices in Salt Lake City, Utah and Austin, Texas is a management consulting firm to the healthcare industry with annual operating revenues of approximately $8 million. The purchase price, including estimated direct acquisition costs, has been allocated as follows (in thousands of dollars):

Current assets	$	1,324
Long-term assets		100
Trade name		400
Excess of cost over net assets acquired		4,144
Accounts payable		(133	)
Accrued expenses		(412	)
	$	5,423

The purchase price was subject to modification based on a final settlement of the closing balance sheet. The final settled purchase price is reflected in the balances above.

John Short, Ph.D., the managing director and majority owner of Phase 2, is President and Chief Executive Officer of the Company and a member of the Company’s Board of Directors.

                   On December 1, 2004, the Company purchased the assets of Cornerstone Rehabilitation, LLC (“Cornerstone”) for cash and $2.8 million of subordinated promissory notes. Cornerstone, headquartered in Shreveport, Louisiana, is a contract therapy services company for skilled nursing and assisted living facilities with a significant market presence in Louisiana and Texas. Cornerstone’s annual operating revenues are approximately $12 million. The purchase price, including estimated direct acquisition costs, of Cornerstone has been allocated as follows (in thousands of dollars):

Equipment and automobiles, net	$	330
Identifiable intangibles, principally
trade name, customer relationships
and noncompete agreements		2,485
Excess of cost over net assets acquired		5,736
Accrued expenses		(196	)
	$	8,355

The allocation of purchase price for Cornerstone is subject to change pending the completion of the Company’s valuation of tangible and intangible assets acquired. The Company does not expect any such changes to be material.

In accordance with the terms of the purchase agreement, the seller is entitled to additional earn-out consideration contingent upon the generation of operating profit from net new therapy contracts as defined in the agreement. The determination of any contingent consideration to be paid is

48

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

to take place on the second anniversary of the purchase date. Any contingent consideration paid as a result of this contract provision will be recognized at the time the contingency is resolved.

The tax goodwill resulting from the CPR, Phase 2 and Cornerstone acquisitions is expected to be fully deductible for tax purposes.

                  The following pro forma information assumes the acquisitions of CPR, VitalCare, Phase 2 and Cornerstone occurred at the beginning of the fiscal years presented. This information is not necessarily indicative either of results of operations that would have occurred had the purchases actually been made at the beginning of the periods presented, or of the future results of the Company.

	Year ended December 31, 2004				Year Ended December 31, 2003
	As Reported		Pro Forma		As Reported			Pro Forma
	(in thousands, except per share data)
Operating revenues	$	383,846	$	400,323	$	539,322		$	583,586
Net earnings (loss)	$	23,181	$	23,917	$	(13,699	)	$	(11,324	)
Diluted net earnings (loss) per share	$	1.38	$	1.42	$	(0.86	)	$	(0.71	)

(8)            Long-Term Debt

On October, 12, 2004, the Company entered into an Amended and Restated Credit Agreement with Bank of America, N.A., U.S. Bank National Association, Harris Trust and Savings Bank, National City Bank, Comerica Bank and SunTrust Bank, as participating banks in the lending group. The Amended and Restated Credit Agreement is an expandable $90 million, five-year revolving credit facility that replaces the former $125 million Credit Agreement, dated as of August 29, 2000, which was scheduled to expire in August 2005. The new revolving credit facility is expandable to $125 million upon the Company’s notice to the lending group, subject to continuing compliance by the Company with the terms of the Amended and Restated Credit Agreement. As a result of replacing the August 29, 2000 Credit Agreement prior to its termination date, the Company expensed approximately $140,000 of deferred loan origination costs that had been amortizing over the life of the line of credit.

The Amended and Restated Credit Agreement contains certain administrative covenants that are ordinary and customary for similar credit facilities. The credit facility also contains financial covenants, including requirements for the Company to comply on a consolidated basis with a maximum ratio of senior funded debt to earnings before interest, taxes, depreciation and amortization (EBITDA), a maximum ratio of total funded debt to EBITDA, a minimum ratio of adjusted EBITDA to fixed charges and a minimum level of net worth. Borrowings under the credit facility are secured primarily by the Company’s assets and future income and profits.

The annual commitment fees and interest rates to be charged in connection with the credit facility and any outstanding principal balance are variable based on the Company’s consolidated leverage ratios. The interest rates are set based on either a base rate plus 0.50% to 1.25% or a Eurodollar rate plus 1.50% to 2.25%. The base rate is the higher of the Federal Funds Rate plus .50% or the prime rate. The Eurodollar rate is defined as (a) the British Banker’s Association LIBOR Rate divided by (b) 1 minus the Eurodollar Reserve Percentage. The range of commitment fee rates the Company pays on the unused portion of the line of credit is 0.375% to 0.50%.

49

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

The average outstanding borrowings under the revolving credit facilities for 2004, 2003 and 2002 were $0, $0 and $0.2 million. As of December 31, 2004 and 2003 there was no balance outstanding on the revolving credit facility.

Interest paid for 2004, 2003 and 2002 was $0.7 million, $0.5 million and $0.8 million, respectively. Included in the interest paid amounts are commitment fees on the unused portion of the revolving credit facility of $0.3 million, $0.5 million and $0.6 million for 2004, 2003 and 2002, respectively.

The Company has a $4.2 million letter of credit and a $4.2 million promissory note issued to its workers compensation carrier as collateral for reimbursement of claims. The Company also has $5.8 million of letters of credit issued to its professional and general liability insurance carrier for collateral for reimbursement of claims. The letters of credit reduce the amount the Company may borrow under the line of credit. The promissory note is not recorded as a liability on the consolidated balance sheet as it only becomes payable upon an event of default as defined in the security agreement with the workers compensation carrier.

As part of the purchases of CPR, VitalCare, and Cornerstone, the Company issued long-term subordinated promissory notes to the respective selling parties. In the case of CPR, the Company issued a promissory note with a face value of $1.4 million and a stated interest rate of 8%. Principal is due in eight equal quarterly installments that started on May 1, 2004 along with accrued but unpaid interest. In accordance with the earn-out provisions of the CPR purchase agreement, the Company incurred an additional liability in the amount of approximately $159,000 as a purchase price adjustment. The interest rate on the earn-out is 8% per annum. Principal and interest will be paid in 24 equal monthly installments beginning February 28, 2005. On December 31, 2004, the remaining aggregate principal balance on the notes was $1.1 million.

In the VitalCare acquisition, the Company issued a promissory note with a face value of $3 million and a stated interest rate of 7%. The principal balance and all remaining interest are payable in full on August 31, 2005.

In connection with the Cornerstone acquisition, the Company issued subordinated promissory notes with an aggregate face value of $2.8 million and a stated interest rate of 6%. Principal on the notes is payable in eight equal quarterly installments of $234,500 starting on January 1, 2005. After the quarterly installments, the remaining unpaid principal balance is due and payable on December 1, 2006. Each payment of principal will be accompanied by payment of accrued but unpaid interest to the date of payment.

(9)           Stockholders’ Equity

                During the third quarter of 2002, the Company repurchased 1,700,000 shares of its common stock at a cost of $36.9 million. These shares are presented as treasury stock in the Company’s consolidated balance sheet.

                The Company has various long-term performance plans for the benefit of employees and nonemployee directors. Under the plans, employees may be granted incentive stock options or nonqualified stock options and nonemployee directors may be granted nonqualified stock options. The plans also provide for the granting of stock appreciation rights, restricted stock, performance awards, or stock units. Stock options may be granted for a term not to exceed 10 years and must be

50

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

granted within 10 years from the adoption of the respective plan. The exercise price of all stock options must be at least equal to the fair market value of the shares on the date of grant. Except for options granted to nonemployee directors that become fully exercisable after six months, substantially all remaining stock options become fully exercisable after four years from date of grant. At December 31, 2004, 2003 and 2002, a total of 1,109,128, 1,137,646 and 1,058,270 shares, respectively, were available for future issuance under the plans.

                A summary of the status of the Company’s stock option plans as of December 31, 2004, 2003 and 2002, and changes during the years then ended is presented below:

	2004					2003					2002
	Shares			Weighted- Average Exercise Price		Shares			Weighted- Average Exercise Price		Shares			Weighted- Average Exercise Price
Outstanding at
beginning of year		2,781,904		$	18.92		3,167,834		$	18.31		2,935,575		$	16.99
Granted		431,400			22.40		203,300			18.98		664,700			22.66
Exercised		(413,742	)		8.36		(306,554	)		7.36		(214,565	)		6.49
Forfeited		(404,757	)		33.52		(282,676	)		24.68		(217,876	)		25.66
Outstanding at
end of year		2,394,805		$	18.90		2,781,904		$	18.92		3,167,834		$	18.31
Options exercisable at
end of year		1,746,155					1,990,029					2,011,184

                The following table summarizes information about stock options outstanding at December 31, 2004:

		Options Outstanding					Options Exercisable
Range of Exercise Prices		Number Outstanding	Weighted-AverageRemaining Contractual Life		Weighted-Average Exercise Price		Number Exercisable	Weighted-Average Exercise Price
$	4.70 -   9.40	722,382	2.3	years	$	8.33	722,382	$	8.33
	9.40 - 14.10	345,600	3.7			11.65	341,850		11.63
	14.10 - 18.80	21,500	8.6			17.71	14,000		17.98
	18.80 - 23.50	797,100	8.3			21.62	227,950		21.43
	23.50 - 28.20	130,000	7.9			24.96	94,500		24.91
	28.20 - 32.90	7,500	5.3			29.50	5,000		29.63
	32.90 - 37.60	142,100	5.4			34.00	142,100		34.00
	37.60 - 42.30	181,416	5.2			39.80	151,166		39.76
	42.30 - 47.00	47,207	1.4			44.06	47,207		44.06
		2,394,805	5.3		$	18.90	1,746,155	$	17.50

The Company has a stockholder rights plan pursuant to which preferred stock purchase rights were distributed as a dividend on each share of the Company’s outstanding common stock. Each right, when exercisable, will entitle the holders to purchase one one-hundredth of a share of series B junior participating preferred stock of the Company at an initial exercise price of $150.00 per one one-hundredth of a share.

51

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

The rights are not exercisable or transferable until a person or affiliated group acquires beneficial ownership of 20% or more of the Company’s common stock or commences a tender or exchange offer for 20% or more of the stock, without the approval of the board of directors. In the event that a person or group acquires 20% or more of the Company’s stock or if the Company or a substantial portion of the Company’s assets or earning power is acquired by another entity, each right will convert into the right to purchase shares of the Company’s or the acquiring entity’s stock, at the then-current exercise price of the right, having a value at the time equal to twice the exercise price.

The series B preferred stock is non-redeemable and junior of any other series of preferred stock that the Company may issue in the future. Each share of series B preferred stock, upon issuance, will have a preferential dividend in the amount equal to the greater of $1.00 per share or 100 times the dividend declared per share on the Company’s common stock. In the event of a liquidation of the Company, the series B 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 one-hundredth of a share of series B preferred stock will have one vote on all matters submitted to the stockholders and will vote together as a single class with the Company’s common stock.

 (10)        Earnings per Share

                The following table sets forth the computation of basic and diluted earnings (loss) per share:

	Year Ended December 31,
Numerator:	2004		2003			2002
	(in thousands, except per share data)
Numerator for basic and diluted earnings per share –
earnings (loss) available to common stockholders
(net earnings (loss))	$	23,181	$	(13,699	)	$	24,395
Denominator:
Denominator for basic earnings (loss) per share –
weighted-average shares outstanding		16,292		16,000			16,833
Effect of dilutive securities:
Stock options		543		—			809
Denominator for diluted earnings (loss) per share –
adjusted weighted-average shares and assumed
conversions		16,835		16,000			17,642
Basic earnings (loss) per share	$	1.42	$	(0.86	)	$	1.45
Diluted earnings (loss) per share	$	1.38	$	(0.86	)	$	1.38

In 2003, the effect of stock options was antidilutive because of the Company’s net loss position.

(11)         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. Effective June 1, 2004, the Company changed the plan eligibility requirements to allow all employees who are at least 21 years of age to immediately participate in the plan. Prior to June 1, 2004,

52

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

employees who had attained the age of 21 and completed 12 consecutive months of employment with a minimum of 1,000 hours worked were eligible to participate in the plan. Each participant may contribute from 2% to 20% of his or her annual 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 are at rates of up to 50% of the first 4% of employee contributions. Expense in connection with the Employee Savings Plan for 2004, 2003 and 2002 totaled $1.5 million, $1.7 million and $1.9 million, respectively.

                The Company maintains a nonqualified deferred compensation plan for certain employees. Under the plan, participants may defer up to 100% of their base cash compensation. The amounts are held by a trust in designated investments and remain the property of the Company until distribution. At December 31, 2004 and 2003, $4.1 million and $3.7 million, respectively, were payable under the nonqualified deferred compensation plan and approximated the value of the trust assets owned by the Company.

                The Company has a Profit Sharing Plan, which is a defined contribution plan under Section 401(k) of the Internal Revenue Code, for the benefit of eligible Phase 2 employees. Phase 2 employees attaining the age of 21 and performing 1 hour of service are eligible to participate in the plan. Each participant may make elective contributions to the plan within the annual limits established by the Internal Revenue Service. The Company makes discretionary contributions to the plan. During the period from May 3, 2004 to December 31, 2004, discretionary contributions were made on the following basis: a range of $10,000 - $40,000 for associates and partners and 6% of wages for all other employees. During the period from May 3, 2004 to December 31, 2004, the Company made discretionary contributions in the amount of approximately $86,000.

(12)         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, 2004, were as follows:

2005	$	2,705
2006		2,506
2007		1,954
2008		524
2009		407
Thereafter		807
Total	$	8,903

Rent expense for 2004, 2003 and 2002 was approximately $3.7 million, $5.1 million and $5.5 million, respectively.

As part of an agreement with Signature HealthCare Foundation (“Signature”) we extended a $2.0 million line of credit to Signature. At December 31, 2004, Signature had drawn approximately $0.9 million against this line of credit.

53

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

(13)         Income Taxes

                Income tax expense (benefit) consist of the following:

	Year Ended December 31,
	2004		2003			2002
	(in thousands)
Federal - current	$	10,199	$	12,556		$	6,918
Federal - deferred		4,390		(13,980	)		6,265
State		2,460		(185	)		1,771
	$	17,049	$	(1,609	)	$	14,954

                A reconciliation between expected income taxes, computed by applying the statutory Federal income tax rate of 35% to earnings before income taxes, and actual income tax is as follows:

	Year Ended December 31,
	2004			2003			2002
	(in thousands)
Expected income taxes (benefit)	$	14,336		$	(5,358	)	$	13,773
Tax effect of interest income from municipal
bond obligations exempt from Federal taxation		(121	)		(18	)		(29	)
State income taxes, net of Federal
income tax benefit		1,599			(120	)		790
Nondeductible goodwill related to net assets
held for sale		1,098			3,406			—
Other, net		137			481			420
	$	17,049		$	(1,609	)	$	14,954

                The tax effects of temporary differences that give rise to the deferred tax assets and liabilities are as follows:

	December 31,
	2004			2003
	(in thousands)
Deferred tax assets:
Allowance for doubtful accounts	$	1,961		$	1,890
Accrued insurance, bonus, deferred
compensation and vacation expense		9,486			5,792
Loss on assets held for sale		—			12,947
Other		2,368			2,815
Total gross deferred tax assets		13,815			23,444
Valuation allowance		(282	)		—
Net deferred tax assets		13,533			23,444
Deferred tax liabilities:
Acquired goodwill and intangibles		5,041			7,145
Depreciation and amortization		3,367			2,313
Other		747			703
Total deferred tax liabilities		9,155			10,161
Net deferred tax asset	$	4,378		$	13,283

54

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

                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 all of the available information, management has concluded that a valuation allowance is needed for the deferred tax asset resulting from the accumulated losses in the Company’s less than majority owned affiliate due to the fact that it is considered more likely than not that the tax benefit related to the capital loss generated from the accumulated losses of the unconsolidated affiliate will not be realized in the future. For all other deferred tax assets, management has concluded that it is more likely than not that the deferred tax assets will be realized in the future.

                Income taxes paid by the Company for 2004, 2003 and 2002 were $5.6 million, $9.6 million and $7.5 million, respectively.

(14)         Sale of Business

On December 30, 2003, we announced that we had entered into a Stock Purchase and Sale Agreement with InteliStaf pursuant to which InteliStaf would acquire all of the outstanding common stock of StarMed in exchange for approximately 25% of the common stock of InteliStaf on a fully diluted basis. This transaction subsequently closed on February 2, 2004. Upon consummating the sale on February 2, 2004, the Company recorded a gain of $485,000 as a result of adjusting the estimated costs to sell for then current information, recording a liability for the estimated fair value of the indemnification provided to InteliStaf in accordance with the sale agreement and as a result of changes in the underlying asset and liability balances between December 31, 2003 and February 2, 2004.

In accordance with the requirements of Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the assets and liabilities of StarMed were reported on the December 31, 2003 consolidated balance sheet as assets and liabilities held for sale and were measured at their net fair value less estimated costs to sell. To state the assets and liabilities held for sale at their estimated net fair value less costs to sell, the Company recognized an impairment loss of $43.6 million to reduce the carrying value of goodwill associated with StarMed and to accrue estimated selling costs. This impairment loss was computed in accordance with the provisions of Statements No. 142 and No. 144. The Company engaged a third party valuation firm to assist it in determining the fair value of consideration given and received in the transaction with InteliStaf. This value, less estimated costs to sell, was compared to the carrying value of the healthcare staffing division to ascertain if any impairment existed. Because the estimated fair value less costs to sell was less than the carrying value of the staffing business, the Company performed the second step of the goodwill impairment test to determine the amount of the implied fair value of goodwill and in turn the amount of impairment. The impairment loss was recorded as a separate component of operating earnings in the consolidated statement of earnings for the year ended December 31, 2003.

55

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

The assets and liabilities of the healthcare staffing division were presented in the consolidated balance sheet as of December 31, 2003 under the captions: “Assets held for sale” and “Liabilities held for sale.” The carrying amounts of the major classes of these assets and liabilities at December 31, 2003 were:

	(in thousands)
Assets:
Cash and cash equivalents	$	1,550
Marketable securities, available for sale		8
Accounts receivable, net		25,921
Prepaid and other current assets		1,680
Equipment and leasehold improvements, net		3,765
Excess of cost over net assets acquired		12,891
Other long-term assets		356
Total assets held for sale	$	46,171
Liabilities:
Accounts payable	$	85
Accrued salaries and wages		5,488
Accrued expenses		4,198
Total liabilities held for sale	$	9,771

As stated above, as part of the sale agreement, the Company indemnified InteliStaf from certain obligations and liabilities, whether known or unknown, which arose out of the operation of StarMed prior to February 2, 2004. The Company accrued approximately $1.1 million for this indemnification liability on the date of sale. As of December 31, 2004, the Company has approximately $0.4 million remaining accrued for this indemnification. This liability is reported in accrued expenses on the December 31, 2004 consolidated balance sheet.

(15)          Investment in Unconsolidated Affiliate

As stated in note 14, the Company sold its StarMed staffing business to InteliStaf on February 2, 2004 in exchange for a 25% interest in InteliStaf on a fully diluted basis. The Company uses the equity method to account for its investment in InteliStaf and recorded its initial investment at its fair value of $40 million, as determined by a third party valuation firm. A summary of the results of operations for the eleven month period from February 2, 2004 to December 31, 2004 and financial position as of December 31, 2004 follows:

	Period from February 2, 2004 to December 31, 2004
	(in thousands)
Net operating revenues		$     287,041
Operating loss		(1,147	)
Net loss		(2,921	)

56

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

	December 31, 2004
	(in thousands)
Current assets	$	59,091
Noncurrent assets		97,363
Total assets	$	156,454
Current liabilities	$	29,463
Noncurrent liabilities		40,215
Total liabilities	$	69,678

The value of the Company’s investment in InteliStaf at the transaction date exceeded its share of the book value of InteliStaf’s stockholders’ equity by approximately $17.8 million. This excess has been accounted for as excess cost over net assets acquired (although reported as a component of investment in unconsolidated affiliate) and is reviewed for impairment in accordance with the terms of APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.” To comply with the provisions of APB 18, the Company must assess whether factors exist that may indicate a decrease in the value of the investment has occurred that is other than temporary. During 2004, InteliStaf incurred operating losses and the healthcare staffing industry as a wh ole continued a cyclical downturn. Accordingly, the Company concluded that an assessment was warranted to determine whether an other than temporary loss of value in the investment had occurred. The Company performed this assessment using several valuation techniques including discounted cash flows and multiples of earnings, revenues and cash flows. Additionally, the Company reviewed qualitative and quantitative evidence, both positive and negative, to assess whether a decline in value, if any, was other than temporary. Based on this analysis, the Company concluded there has not been an other than temporary decline in the value of its equity investment in InteliStaf and no adjustment has been made to the carrying value of our investment at December 31, 2004. The Company will continue to monitor the valuation of its investment in InteliStaf and will update its analysis as circumstances warrant.

(16)          Restructuring Costs

On July 30, 2003, the Company announced a comprehensive multifaceted restructuring program to return the Company to growth and improved profitability. As a result of the restructuring plan, the Company recognized a pre-tax restructuring expense of $1.3 million for severance, outplacement and exit costs.

As reported in note 14, the Company sold its StarMed staffing division to InteliStaf on February 2, 2004. In connection with this sale, the Company initiated a series of restructuring activities to reduce the cost of corporate overhead that had previously been absorbed by the staffing division. These activities included the elimination of approximately 40 positions, exiting a portion of leased office space at the Company’s corporate headquarters and the write-off of certain abandoned leasehold improvements associated with the office space consolidation. In addition, the Company modified the term of the stock options of certain StarMed employees to allow them additional time to exercise vested options after leaving the employment of the Company. This action triggered a new measurement date for the modified options. The corresponding expense of $114,000 has been included in the severance component of the restructuring charge. As a result of these actions, the Company recorded a pre-tax restructuring charge in the first quarter of 2004 of approximately $1.7 million.

57

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

During the second quarter of 2004, the Company reassessed the restructuring reserve remaining related to the actions taken during the third quarter of 2003 and determined that the reserve for severance costs was in excess of the remaining estimated costs. Accordingly, approximately $51,000 of the reserve was reversed to income. Additionally, the Company determined that the reserve remaining for lease exit costs was approximately $50,000 less than the remaining expected costs. A portion of the excess severance cost reserve was reclassified to the lease exit cost reserve.

The following table summarizes the activity for 2004 and 2003 with respect to these restructuring activities:

	(dollars in thousands)
	Severance			Exit Costs			Leasehold Improvement Write-off			Total
Restructuring charge – 2003	$	1,094		$	192		$	—		$	1,286
Cash payments		(743	)		(47	)		—			(790	)
Balance at December 31, 2003		351			145			—			496
Restructuring charge – 2004		736			520			359			1,615
Reclassification		(50	)		50			—			—
Cash payments and   non-cash utilization		(1,037	)		(214	)		(359	)		(1,610	)
Balance at December 31, 2004	$	—		$	501		$	—		$	501

(17)          Related Party Transactions

Beginning in the third quarter of 2003, the Company retained a software vendor for various computer related activities. John H. Short, President and Chief Executive Officer and a director of the Company and Theodore M. Wight, a director of the Company, are also directors of the software company. Messrs. Wight and Short and their affiliated entities own 27.3% and 5.5% of the fully diluted capitalization of the software company, respectively. The Company paid the software vendor approximately $330,000 and $245,000 in 2004 and 2003, respectively. The Company continues to utilize the software vendor for website hosting services at an approximate annual cost of $73,000. This contract is cancelable upon 60 days notice.

Prior to the Company’s acquisition of Phase 2 on May 3, 2004, Phase 2 entered into a joint marketing arrangement with the aforementioned software vendor. This agreement remains in force.

During 2003, the Company entered into an agreement with Phase 2 to provide the Company with management, consulting and advisory services, including having John H. Short, Ph.D., the managing director of Phase 2 and a member of the Company’s Board of Directors, serve as Interim President and Chief Executive Officer of the Company. A monthly consulting fee of $55,000 was paid to Phase 2 during the term of the agreement plus reimbursement of business expenses. In addition, Phase 2 was entitled to an incentive fee based on predetermined performance standards. On May 3, 2004, the Company acquired Phase 2 and elected Dr. Short as President and Chief Executive Officer of the Company. The advisory services agreement with Phase 2 was terminated at that time. The Company incurred approximately $505,000 and $680,000 of expense related to this agreement in 2004 and 2003, respectively.

58

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

Prior to the Company’s acquisition of Phase 2 on May 3, 2004, the Company engaged Phase 2 for several consulting projects for services ranging from long-term information technology strategy, staffing analysis and acquisition target analysis, separate from the agreement described above. The total cost of these projects, which were paid in full, was approximately $75,000.

As a result of Dr. Short’s relationship to Phase 2, the terms and conditions of the acquisition agreement between the Company and Phase 2 were negotiated on behalf of the Company by the independent members of the Board of Directors. The independent board members retained an independent financial advisor to assist them during this process.

In accordance with the terms of the Transition Services Agreement between the Company and InteliStaf, the Company agreed to provide certain accounting and back-office services to InteliStaf until such time as those activities were fully integrated by InteliStaf. These services are being billed at cost. During the period from February 2, 2004, to December 31, 2004, the Company performed services under this agreement with an aggregate cost of approximately $1.5 million. These costs have been netted against reimbursements from InteliStaf in the Company’s statements of earnings.

During the period from May 3, 2004 to December 31, 2004, the Company purchased air transportation services from 55JS Limited, Co. in the amount of approximately $190,000. 55JS Limited, Co. is owned by the Company’s President and Chief Executive Officer, John Short. The air transportation services are billed to the Company, at cost, for hourly usage of 55JS’s plane for Company business.

During the third quarter of 2004, the management of Phase 2 had a senior management retreat at the Diamond D Ranch. The Diamond D Ranch is 25% owned by John Short. The total cost of the retreat was approximately $40,000. This entire amount was pre-funded by Phase 2 prior to the Company’s acquisition of Phase 2 on May 3, 2004. The pre-funded balance was reported as a current asset on the closing balance sheet of Phase 2.

59

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

(18)         Industry Segment Information

                Prior to February 2, 2004, when the Company sold its healthcare staffing division, the Company operated in two business segments that were managed separately based on fundamental differences in operations: program management services and healthcare staffing services. Program management includes hospital rehabilitation services (including inpatient acute rehabilitation and skilled nursing units and outpatient therapy programs) and contract therapy programs. On May 3, 2004, with the acquisition of Phase 2 Consulting, the Company added a new segment – healthcare management consulting. Virtually 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 (loss)
	(in thousands)								(in thousands)
	2004			2003			2002		2004			2003			2002
Program management:
Hospital
rehabilitation
services	$	190,731		$	185,831		$	179,746	$	33,065		$	33,557		$	32,256
Contract therapy		171,339			130,847			105,276		10,208			5,836			9,124
Program
management total		362,070			316,678			285,022		43,273			39,393			41,380
Healthcare staffing		16,727			223,952			277,543		(78	)		(52,503	)		(1,683	)
Healthcare management
consulting		5,367			—			—		224			—			—
Less intercompany
revenues(1)		(318	)		(1,308	)		—		N/A			N/A			N/A
Restructuring charge		N/A			N/A			N/A		(1,615	)		(1,286	)		—
Total	$	383,846		$	539,322		$	562,565	$	41,804		$	(14,396	)	$	39,697

	Depreciation and Amortization						Capital Expenditures
	(in thousands)						(in thousands)
	2004		2003		2002		2004		2003		2002
Program management:
Hospital
rehabilitation
services	$	5,314	$	5,328	$	5,436	$	3,696	$	2,212	$	4,784
Contract therapy		3,218		1,335		1,090		3,405		1,614		3,195
Program
management total		8,532		6,663		6,526		7,101		3,826		7,979
Healthcare staffing		—		1,896		1,808		—		1,511		567
Healthcare management
consulting		24		—		—		41		—		—
Total	$	8,556	$	8,559	$	8,334	$	7,142	$	5,337	$	8,546

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REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

	Total Assets						Unamortized Goodwill
	(in thousands)						(in thousands)
	as of December 31,						as of December 31,
	2004		2003		2002		2004		2003		2002
Program management:
Hospital
rehabilitation
services		160,240		146,016		110,354		42,875		35,739		35,739
Contract therapy		71,923		41,439		32,625		21,321		12,990		12,990
Program
management total		232,163		187,455		142,979		64,196		48,729		48,729
Healthcare staffing(2)		—		46,171		92,551		—		12,891		52,956
Healthcare management
consulting		6,234		—		—		4,144		—		—
Corporate – investment      in  unconsolidated      affiliate		39,269		—		—		—		—		—
Total	$	277,666	$	233,626	$	235,530	$	68,340	$	61,620	$	101,685

(1)	Intercompany revenues represent sales of services, at market rates, between the Company’s operating segments.
(2)	At December 31, 2003, the total assets, including unamortized goodwill, of the healthcare staffing business are reported as assets held for sale in the balance sheet. See Note 14 “Sale of Business” for further discussion.

(19)         Quarterly Financial Information (Unaudited)

	Quarter Ended
2004	December 31		September 30		June 30		March 31
	(in thousands, except per share data)
Operating revenues	$	95,128	$	93,277	$	90,944	$	104,497
Operating earnings		11,385		10,725		10,203		9,491
Earnings before income taxes
and equity in net loss of affiliate		11,140		10,549		9,949		9,323
Net earnings		6,297		6,075		5,703		5,106
Net earnings per common share:
Basic		.38		.37		.35		.32
Diluted		.37		.36		.34		.31

	Quarter Ended
2003	December 31			September 30		June 30		March 31
	(in thousands, except per share data)
Operating revenues	$	129,475		$	134,962	$	136,043	$	138,842
Operating earnings (loss)		(34,541	)		5,672		7,646		6,827
Earnings (loss) before income taxes		(34,941	)		5,538		7,439		6,656
Net earnings (loss)		(25,523	)		3,323		4,457		4,044
Net earnings (loss) per common share:
Basic		(1.58	)		.21		.28		.26
Diluted		(1.58	)		.20		.27		.25

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REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

(20)         Recently Issued Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board enacted Statement of Financial Accounting Standards No. 123 – revised 2004, “Share-Based Payment” (“Statement 123R”) which replaces Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Statement 123R requires the measurement of all share-based payments to employees using a fair value based method and the recognition of such fair value as expense in our consolidated statements of earnings. The provisions of Statement 123R are effective for fiscal periods beginning after June 15, 2005. Accordingly adoption of this standard is required for the Company’s third fisca l period in 2005, earlier adoption is encouraged. If the Company was to adopt the provisions of Statement 123R on January 1, 2005, based on current estimates, the Company would recognize equity compensation expense, net of tax benefits, of between $2.5 to $3.0 million in 2005. This estimate is based on continuing to expense amounts computed under the provisions of Statement 123 for options granted prior to the adoption of Statement 123R and an estimate of the expense that will be recognized for new options that the Company expects to grant during 2005. This estimate is subject to change based on the actual grants of stock options in 2005 and the fair value of those stock options as determined on the date of grant.

In December 2004, the Financial Accounting Standards Board enacted Statement of Financial Accounting Standards No. 153, “Exchanges of Nonmonetary Assets – An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions (“Statement 153”). Statement 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, “Accounting for Nonmonetary Transactions,” and replaces it with an exception for exchanges that do not have commercial substance. Statement 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. Statement 153 is effective for fiscal periods b eginning after June 15, 2005. The Company is currently evaluating the effect that the adoption of Statement 153 will have on its consolidated results and financial condition but it is not expected to have a material impact.

(21)         Contingencies

A derivative lawsuit is pending in the Circuit Court of St. Louis County, Missouri against the Company and certain of its former and current directors and is based upon alleged breaches of fiduciary duties by the named directors associated with alleged violations of the federal securities law. We have recently been informed by the attorneys for the derivative plaintiff that they intend to request a hearing in the state case for the purpose of obtaining a scheduling order on discovery.

In July 2003, a former independent contractor of the Company and a former Baxter County Regional Hospital physical therapist filed a civil action, under the qui tam and whistleblower provisions of the False Claims Act, in the United States District Court for the Eastern District of Arkansas. The plaintiffs seek back pay, civil penalties, treble damages, and special damages from the Company and Baxter. The allegations contained in the suit relate to the proper clinical diagnoses, for Medicare reimbursement purposes, of patients treated at the hospital’s acute rehabilitation unit, for which Baxter received reimbursement in excess of $5,000,000. The plaintiffs filed the original action on August 21, 2000, under seal. After an investigation by the Unit ed States Department of Justice, on June 3, 2003, the government declined to intervene and the seal was lifted. The plaintiffs filed an amended complaint, and the Company and Baxter were served and notified of the civil action on July 15, 2003. The Company and Baxter also initiated an internal and external audit that concluded

62

REHABCARE GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
December 31, 2004, 2003 and 2002

the allegations were unfounded and that the Company and Baxter were in compliance with Medicare regulations. The Company has agreed to indemnify Baxter for all fees and expenses on all counts arising out of the action except for the whistleblower count brought by Baxter’s therapist. The Company and Baxter both filed separate motions to dismiss the action. The Court denied Baxter’s motion to dismiss, but granted the Company’s motion to dismiss with respect to the individual claim under the whistleblower provisions of the False Claims Act but not the other claims against the Company under the False Claims Act. The parties are currently engaged in discovery with respect to the remaining claims.

The Wage and Hour Division of the United States Department of Labor has been conducting an investigation of the Company’s former staffing division. The investigation is focused on minimum wage and overtime compensation of employees who worked as on-call coordinators. After a review by the Company of the staffing division’s wage and overtime practices with respect to office and field staff employees who also work on-call shifts, the Company and the Department of Labor have reached an agreement with respect to the payment by the Company of approximately $150,000 in the aggregate to these employees. Each employee will be sent a check, which if cashed, will release his or her claim under the Fair Labor Standards Act (but not any state law claims) for the period reviewed. These employees can also elect not to cash the check and file suit individually.

Several federal lawsuits have been filed by certain on-call, recruiting and staffing coordinators seeking overtime compensation and related damages under both federal and state law. These individuals were employed by the Company’s former staffing division. Three of these cases have been consolidated in the United States District Court for the Central District of California. The individuals sought to bring a collective or class action on behalf of all similarly situated persons. On January 3, 2005, the court granted plaintiffs’ motion to send notice of collective action to present and former staffing division employees although the court did not specify the exact group of employees to which the notice should be directed. At the same time, the court denied the plaintiffs’ request to proceed as class action under the California state law claims. Upon entry of the order allowing notices of collective action to be sent and the actual mailing of the notices, the employees to which the notices are directed will have the opportunity to opt into the case for claims dating back two years (three years if a willful violation is proven) from the date the employee files a consent to join the case. Plaintiffs’ counsel has informed the Company that it intends to file a separate state court class action reasserting the California state law claims, but the Company has no knowledge of such suit at this time.

In addition to the above matters, the Company is a party to a number of other claims and lawsuits. While these actions are being contested, the outcome of individual matters is not predictable with assurance. From time to time, and depending upon the particular facts and circumstances, the Company may be subject to indemnification obligations under the Company’s contracts with its hospital and healthcare facility clients relating to these matters. The Company does not believe that any liability resulting from any of the above matters, after taking into consideration the Company’s insurance coverage and amounts already provided for, will have a material adverse effect on the Company’s consolidated financial position, cash flows or liquidity. However, such matters could have a ma terial effect on results of operations in a particular quarter or fiscal year as they develop or as new issues are identified.

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ITEM 9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.	CONTROLS AND PROCEDURES

                Evaluation of Controls and Procedures

                Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the Company’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures as of December 31, 2004 were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission’s rules and forms.

                Management’s Report on Internal Control Over Financial Reporting

                Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. Under the supervision and with the participation of our management, including the Chief Executive Officer and the Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2004. All internal control systems have inherent limitations, including the possibility of circumvention and overriding the control. Accordingly, even effective internal control can provide only reasonable assurance as to the reliability of financial statement preparation and presentation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.

                In making its evaluation, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Based upon this evaluation, our management has concluded that our internal control over financial reporting as of December 31, 2004 is effective.

                In its evaluation of our internal control over financial reporting, management has excluded the recent acquisitions of American VitalCare, Inc. (revenues of $11.1 million and operating earnings of $1.0 million), Phase 2 Consulting, Inc. (revenues of $5.4 million and operating earnings of $0.5 million) and Cornerstone Rehabilitation, LLC (revenues of $1.0 million and operating earnings of $0.1 million), each of which was acquired in a purchase acquisition during the past year.

                Our independent registered public accounting firm, KPMG LLP, has audited management’s evaluation of the effectiveness of our internal control over financial reporting, as stated in its report which is included herein.

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Report of Independent Registered Public Accounting Firm
on Internal Control Over Financial Reporting

The Board of Directors
RehabCare Group, Inc.:

        We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that RehabCare Group, Inc. and subsidiaries (the Company) maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

        We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

        A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

        In our opinion, management’s assessment that RehabCare Group, Inc. maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, RehabCare Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

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        RehabCare Group, Inc. excluded the recent acquisitions of American VitalCare, Inc. (revenues of $11.1 million and operating earnings of $1.0 million), Phase 2 Consulting, Inc. (revenues of $5.4 million and operating earnings of $0.5 million) and Cornerstone Rehabilitation, LLC (revenues of $1.0 million and operating earnings of $0.1 million), each of which was acquired in a purchase acquisition during the past year. Our audit of internal control over financial reporting of RehabCare Group, Inc. also excluded an evaluation of the internal control over financial reporting of American VitalCare, Inc., Phase 2 Consulting, Inc. and Cornerstone Rehabilitation, LLC.

        Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

        We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of RehabCare Group, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of earnings, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004, and our report dated March 16, 2005 expressed an unqualified opinion on those consolidated financial statements.

/s/ KPMG LLP

St. Louis, Missouri
March 16, 2005

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PART III

ITEM 10.       DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

                Certain information regarding our directors and executive officers is included in our Proxy Statement for the 2005 Annual Meeting of Stockholders under the captions “Item 1 – Election of Directors” and “Compliance with Section 16(a) of the Securities Exchange Act of 1934” and is incorporated herein by reference.

                The following table sets forth the name, age and position of each of our executive officers. There is no family relationship between any of the following individuals.

Name	Age	Position
John H. Short, Ph.D	60	President and Chief Executive Officer
Mark A. Bogovich	35	Vice President, Chief Accounting Officer
Tom E. Davis	55	Executive Vice President and Chief Development Officer
Vincent L. Germanese	53	Senior Vice President, Chief Financial Officer and Secretary
Patricia M. Henry	52	Executive Vice President, Traditional Business

The following paragraphs contain biographical information about our executive officers.

John H. Short, Ph.D. has been President and Chief Executive Officer since May 2004, having served as Interim President and Chief Executive Officer since June 2003 and a director of the company since 1991. Prior to May 2004, Dr. Short was the managing partner of Phase 2 Consulting, Inc., a healthcare management consulting firm, for more than 18 years.

Mark A. Bogovich has been Vice President and Chief Accounting Officer of the Company since September 2003. Mr. Bogovich joined the Company in March of 2000 and served most recently as Vice President Finance, contract therapy division.

Tom E. Davis has been Executive Vice President and Chief Development Officer since September 2004, having served most recently as President of our hospital rehabilitation services division since January 1998. Mr. Davis joined the Company in January 1997 as Senior Vice President, Operations.

Vincent L. Germanese, CPA, has been Senior Vice President, Chief Financial Officer and Secretary of the Company since November 2002. Prior to joining the Company, Mr. Germanese was Vice President of Cap Gemini Ernst & Young and partner at Ernst & Young for more than five years.

Patricia M. Henry has been Executive Vice President, Traditional Business since September 2004, having served most recently as President of our contract therapy division since November 2001. Ms. Henry joined the Company in October 1998 and served most recently as Senior Vice President of Operations, Contract Therapy Services.

                The Company has adopted a Code of Ethics that applies to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. The Code of Ethics is available through the Company’s web site at www.rehabcare.com.

                During 2004, the Company submitted a Section 12(a) CEO certification to the New York Stock Exchange as required by the Exchange’s corporate governance rules.

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ITEM 11.       EXECUTIVE COMPENSATION

                Information regarding executive compensation is included in our Proxy Statement for the 2005 Annual Meeting of Stockholders under the captions “Compensation of Executive Officers”, and “Section 16(a) Beneficial Ownership Reporting Compliance” and is incorporated herein by reference.

ITEM 12.       SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
                        MANAGEMENT AND RELATED STOCKHOLDER MATTERS

                Information regarding security ownership of certain beneficial owners and management is included in our Proxy Statement for the 2005 Annual Meeting of Stockholders under the captions “Voting Securities and Principal Holders Thereof” and “Security Ownership by Management” and is incorporated herein by reference.

The following table provides information as of fiscal year ended December 31, 2004 with respect to the shares of common stock that may be issued under our existing equity compensation plans:

Plan category	Number of securities to be issued upon exercise of outstanding options, warrants and rights	Weighted- average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
	(a)		(b)	(c)
Equity compensation plans approved by security holders	2,394,805	$	18.90	1,109,128
Equity compensation plans not approved by security
holders	—		—	—
Total	2,394,805	$	18.90	1,109,128

ITEM 13.        CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Beginning in the third quarter of 2003, the Company retained a software vendor for various computer related activities. John H. Short, President and Chief Executive Officer and a director of the Company and Theodore M. Wight, a director of the Company, are also directors of the software company. Messrs. Wight and Short and their affiliated entities own 27.3% and 5.5% of the fully diluted capitalization of the software company, respectively. The Company paid the software vendor approximately $330,000 and $245,000 in 2004 and 2003, respectively. The Company continues to utilize the software vendor for website hosting services at an approximate annual cost of $73,000. This contract is cancelable upon 60 days notice.

Prior to the Company’s acquisition of Phase 2 on May 3, 2004, Phase 2 entered into a joint marketing arrangement with the aforementioned software vendor. This agreement remains in force.

During 2003, the Company entered into an agreement with Phase 2. Per the terms of the agreement, Phase 2 provided the Company with management, consulting and advisory services, including having John H. Short, Ph.D., the managing director of Phase 2 and a member of the Company’s Board of Directors, serve as Interim President and Chief Executive Officer of the Company. A monthly consulting fee of $55,000 was paid to Phase 2 during the term of the agreement plus reimbursement of business expenses. In addition, Phase 2 was entitled to an incentive fee based

68

on predetermined performance standards. On May 3, 2004, the Company acquired Phase 2 and elected Dr. Short as President and Chief Executive Officer of the Company. The advisory services agreement with Phase 2 was terminated at that time. The Company incurred approximately $505,000 and $680,000 of expense related to this agreement in 2004 and 2003, respectively.

Prior to the Company’s acquisition of Phase 2 on May 3, 2004, the Company engaged Phase 2 for several consulting projects for services ranging from long-term information technology strategy, staffing analysis and acquisition target analysis, separate from the agreement described above. The total cost of these projects, which were paid in full, was approximately $75,000.

As a result of Dr. Short’s relationship to Phase 2, the terms and conditions of the acquisition agreement between the Company and Phase 2 were negotiated on behalf of the Company by the independent members of the Board of Directors. The independent board members retained an independent financial advisor to assist them during this process.

In accordance with the terms of the Transition Services Agreement between the Company and InteliStaf, the Company agreed to provide certain accounting and back-office services to InteliStaf until such time as those activities were fully integrated by InteliStaf. These services are being billed at cost. During the period from February 2, 2004, to December 31, 2004, the Company performed services under this agreement with an aggregate cost of approximately $1.5 million. These costs have been netted against reimbursements from InteliStaf in the Company’s statements of earnings.

During the period from May 3, 2004 to December 31, 2004, the Company purchased air transportation services from 55JS Limited, Co. in the amount of approximately $190,000. 55JS Limited, Co. is owned by the Company’s President and Chief Executive Officer, John Short. The air transportation services are billed to the Company, at cost, for hourly usage of 55JS’s plane for Company business.

During the third quarter of 2004, the management of Phase 2 had a senior management retreat at the Diamond D Ranch. The Diamond D Ranch is 25% owned by John Short. The total cost of the retreat was approximately $40,000. This entire amount was pre-funded by Phase 2 prior to the Company’s acquisition of Phase 2 on May 3, 2004. The pre-funded balance was reported as a current asset on the closing balance sheet of Phase 2.

ITEM 14.        PRINCIPAL ACCOUNTANT FEES AND SERVICES

Information regarding principal accountant fees and services is included in our Proxy Statement for the 2005 Annual Meeting of Stockholders under the caption “Ratification of Appointment of Independent Auditors” and is incorporated herein by reference.

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PART IV

ITEM 15.       EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
                        FORM 8-K

                (a)       The following documents are filed as part of this Annual Report on Form 10-K:

                           (1)    Financial Statements

                                                Report of Independent Registered Public Accounting Firm
                                                Consolidated Balance Sheets as of December 31, 2004 and 2003
                                                Consolidated Statements of Earnings for the years ended December 31, 2004,
                                                            2003 and 2002
                                                Consolidated Statements of Stockholders’ Equity for the years ended
                                                            December 31, 2004, 2003 and 2002
                                                Consolidated Statements of Cash Flows for the years ended December 31,
                                                            2004, 2003 and 2002
                                                Notes to Consolidated Financial Statements

                            (2)   Financial Statement Schedules:

                                                None

                            (3)   Exhibits:

                                                See Exhibit Index on page 72 of this Annual Report on Form 10-K.

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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 16, 2005
	REHABCARE GROUP, INC. (Registrant)
	By:	/s/ JOHN H. SHORT
		John H. Short  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/ JOHN H. SHORT	President, Chief Executive	March 16, 2005
	Officer and Director
John H. Short
(Principal Executive Officer)
/s/ VINCENT L. GERMANESE	Senior Vice President,	March 16, 2005
	Chief Financial Officer and
Vincent L. Germanese	Secretary
(Principal Financial Officer)
/s/ MARK A . BOGOVICH	Vice President and	March 16, 2005
	Chief Accounting Officer
Mark A. Bogovich
(Principal Accounting Officer)
/s/ WILLIAM G. ANDERSON	Director	March 16, 2005
William G. Anderson
/s/ C. R. HOLMAN	Director	March 16, 2005
C. R. Holman
/s/ H. EDWIN TRUSHEIM	Director	March 16, 2005
H. Edwin Trusheim
/s/ COLLEEN CONWAY -WELCH	Director	March 16, 2005
Colleen Conway-Welch
/s/ THEODORE M. WIGHT	Director	March 16, 2005
Theodore M. Wight

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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 Quarterly Report on Form 10-Q for the quarter ended May 31, 1995 and incorporated herein by reference)
3.3	Amended and Restated Bylaws (filed as Exhibit 3.3 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2002 and incorporated herein by reference)
4.1	Rights Agreement, dated August 28, 2002, by and between the Registrant and Computershare Trust Company, Inc. (filed as Exhibit 1 to the Registrant’s Registration Statement on Form 8-A filed September 5, 2002 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	Consulting Arrangement with Phase II Consulting, LLC (filed as Exhibit 10.1 to the Registrant’s Quarterly Report on form 10-Q for the quarter ended June 30, 2003 and incorporated herein by reference) *
10.4	Consulting Arrangement with Alan C. Henderson (filed as Exhibit 10.2 to the Registrant’s Quarterly Report on form 10-Q for the quarter ended June 30, 2003 and incorporated herein by reference) *
10.5	Termination Compensation Agreement, dated May 3, 2004 by and between RehabCare Group, Inc. and John H. Short, Ph.D. (filed as Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2004 and incorporated herein by reference)*
10.6	Form of Termination Compensation Agreement for other executive officers (filed as Exhibit 10.5 to the Registrant’s Report on Form 10-K, dated March 15, 2002, 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) *

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EXHIBIT INDEX (CONT’D)

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) *
10.10	RehabCare Directors’ Stock Option Plan (filed as Appendix A to Registrant’s definitive Proxy Statement for the 1994 Annual Meeting of Stockholders and incorporated herein by reference) *
10.11	Second Amended and Restated 1996 Long-Term Performance Plan (filed as Appendix B to Registrant’s definitive Proxy Statement for the 2004 Annual Meeting of Stockholders and incorporated herein by reference) *
10.12	Amended and Restated Credit Agreement, dated October 12, 2004, by and among RehabCare Group, Inc., as borrower, certain subsidiaries and affiliates of the borrower, as guarantors, and Bank of America, N.A., U.S. Bank National Association, Harris Trust and Savings Bank, National City Bank, Comerica Bank and SunTrust Bank, as participating banks in the lending group (filed as Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 and incorporated herein by reference)
10.13	Pledge Agreement, dated as of October 12, 2004, by and among RehabCare Group, Inc. and Subsidiaries, as pledgors, and Bank of America, N.A., as Administrative Agent (filed as Exhibit 10.2 to Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 and incorporated herein by reference)
10.14	Security Agreement, dated as of October 12, 2004, by and among RehabCare Group, Inc. and Subsidiaries, as grantors, and Bank of America, N.A., as Administrative Agent (filed as Exhibit 10.3 to Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 and incorporated herein by reference)
10.15	Asset Purchase Agreement by and among RehabCare Group, Inc., Phase 2 Consulting, Inc., a Delaware corporation, Phase 2 Consulting, Inc., a Utah corporation, and John H. Short, Peter F. Singer and Howard W. Salmon.
10.16	Stock Purchase and Sale Agreement, dated December 30, 2003, by and among InteliStaf Holdings, Inc., RehabCare Group, Inc., StarMed Health Personnel, Inc. and StarMed Management, Inc. (filed as Exhibit 2 to the Registrant’s Current Report on Form 8-K dated December 31, 2003)
13.1	Those portions of the Registrant’s Annual Report to Stockholders for the year ended December 31, 2004 included in response to Items 5 and 6 of this Annual Report on Form 10-K
21.1	Subsidiaries of the Registrant

73

EXHIBIT INDEX (CONT’D)

23.1	Consent of KPMG LLP
31.1	Certification by Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
31.2	Certification by Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
32.1	Chief Executive Officer certification of periodic financial report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. U.S.C. Section 1350.
32.2	Chief Financial Officer certification of periodic financial report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. U.S.C. Section 1350.

—————————————
*	Management contract or compensatory plan or arrangement.

74

EX-10.15

                                                                  Execution Copy


                            ASSET PURCHASE AGREEMENT
                            ------------------------

     THIS ASSET PURCHASE AGREEMENT (this "Agreement") is entered into as of this
3rd day of May, 2004, by and among REHABCARE GROUP, INC., a Delaware corporation
("Parent"),  PHASE 2 CONSULTING,  INC., a Delaware  corporation and wholly-owned
subsidiary of Parent  ("Buyer"),  PHASE 2 CONSULTING,  INC., a Utah  corporation
("Seller")  and each of JOHN H.  SHORT,  PETER F.  SINGER and  HOWARD W.  SALMON
("Shareholders").

                                    RECITALS
                                    --------

     WHEREAS,  Shareholders own 100% of the issued and outstanding capital stock
of Seller; and

     WHEREAS,  Seller is in the business of providing healthcare  management and
economic  consulting to healthcare  organizations,  physician practices and long
term care and behavioral health providers and specializes in strategic planning,
clinical operations and productivity improvement,  business planning, market and
financial feasibility studies and market research and analysis (the "Business");
and

     WHEREAS,  Seller  and  Shareholders  desire  to sell,  assign,  convey  and
transfer to Buyer,  and Buyer  desires to acquire from Seller and  Shareholders,
certain of Seller's assets  associated  with the Business  pursuant to the terms
and conditions of this Agreement; and

     WHEREAS,   each  of  the  parties  hereto  desires  to  set  forth  certain
representations,   warranties,  covenants  and  indemnity  obligations,  and  to
establish  certain closing  conditions,  made to induce the other to execute and
deliver this Agreement and to consummate the transactions contemplated hereby.

     NOW,  THEREFORE,  in  consideration  of the  premises,  the  covenants  and
agreements  herein  contained,  and other good and valuable  consideration,  the
receipt and  sufficiency  of which hereby are  acknowledged,  the parties hereto
agree as follows:

                                   ARTICLE 1
                                   ---------

                           SALE AND PURCHASE OF ASSETS
                           ---------------------------

1.1   Description of Purchased Assets; Closing.
      ----------------------------------------

(a)  At the  Closing on the  Closing  Date (each term as defined in Section  3.1
     hereof),  subject to the terms and conditions set forth in this  Agreement,
     Seller shall sell to Buyer,  and Buyer shall  purchase  from  Seller,  only
     those assets of Seller,  tangible or intangible,  wherever located, used in
     the conduct of the  Business,  which are set forth in this Section  1.1(a),
     free and clear of all liens, mortgages, security interests and encumbrances
     (collectively, the "Purchased Assets"):

     (i)  All right,  title and interest of Seller in and to all client accounts
          and client  contracts  existing in connection  with the Business which
          are set forth on Schedule  1.1(a)(i),  including,  but not limited to,
          all claims and rights under such client  contracts,  written and oral,
          all claims and rights relating to such clients served by Seller in the
          Business but not under written contracts,  all client lists,  records,
          computer  records  and other  similar  data  relating  to such  client
          accounts (collectively the "Client Contracts" and the Business clients
          the "Client Accounts");


     (ii) Subject to any required consents, all right, title and interest in and
          to all Leases (as  defined  in  Section  4.4(b)) of real and  personal
          property set forth on Schedule  1.1(a)(ii)  attached hereto,  together
          with all deposits relating thereto;

     (iii)All property and equipment and other tangible  personal  property used
          or usable by Seller in the  Business  which are set forth on  Schedule
          1.1(a)(iii),  including,  without limitation,  leasehold improvements,
          furniture,   furnishings,   machinery,   equipment,  vehicles,  office
          supplies,  together  with all manuals,  records,  written  warranties,
          licenses and similar documents and rights relating thereto;

     (iv) All  right,  title and  interest  in and to all  written  bids,  sales
          orders,  purchase orders, sales contracts,  supply contracts and other
          contract  rights,  oral or written,  of Seller related to the Business
          which  are  set  forth  on   Schedule   1.1(a)(iv)   attached   hereto
          (collectively, the "Assumed Contracts");

     (v)  All accounts  receivable,  net of reserves for bad debt,  with current
          active  clients  arising from  transactions  of Seller in the Business
          outstanding  as of the Closing Date and those billed after the Closing
          Date for services rendered by Seller prior to the Closing Date whether
          such accounts  receivable  have been fully reserved for as uncollected
          accounts  receivable  or written off as  uncollectible  accounts  (the
          "Accounts Receivable");

     (vi) All  right,  title and  interest  of  Seller  in and to the  following
          intellectual   property  used  in  the  Business:   (i)  all  patents,
          trademarks,  service marks, artwork designs, trade dress, logos, trade
          names,  including the trade name "Phase 2  Consulting,"  and corporate
          names,  together with all translations,  adaptations,  derivations and
          combinations  thereof and including all goodwill associated  therewith
          and  all  applications,   registrations  and  renewals  in  connection
          therewith,  (ii)  all  copyrightable  works,  all  copyrights  and all
          applications,  registrations and renewals in connection therewith, and
          (iii)  all  trade  secrets  and  confidential   business   information
          (including technical data, know-how, mailing lists, customer files and
          account  histories,  customer  and  supply  lists,  pricing  and  cost
          information and business and marketing plans and proposals)  which are
          set forth on Schedule  1.1(a)(vi) attached hereto  (collectively,  the
          "Intellectual Property");

     (vii)All files,  books and records  (including  computer records) of Seller
          relating to the foregoing items; and

     (viii) The Business as a going concern, including all goodwill thereof.

(b)  Excluded Assets.  Notwithstanding  the provisions of Section 1.1(a),  Buyer
     shall not be entitled to  purchase,  nor shall  Seller be required to sell,
     whether  or not  relating  to the  Business,  any  other  asset of  Seller,
     including  without  limitation,  the following  assets  (collectively,  the
     "Excluded Assets"):


                                      -2-


     (i)  Income  and  franchise  tax  returns,  information  returns,  reports,
          elections  and work  papers of Seller (it being  understood  that upon
          request,  Buyer  shall  have  reasonable  access to copies of any such
          documents   relating  to  the  Business   subject  to  any  applicable
          confidentiality  obligations  of Seller with respect to such documents
          imposed by applicable  law),  and any rights to income tax refunds and
          prepaid income taxes;

     (ii) Any right and  interest  of  Seller  in this  Agreement  and any other
          agreements and instruments to be executed by Seller in connection with
          the sale of the Purchased Assets and other  transactions  contemplated
          by this Agreement;

     (iii)Except  as  otherwise   provided  herein,  any  and  all  of  Seller's
          insurance policies, including all rights to coverage, all proceeds and
          all prepaid insurance under such policies;

     (iv) The cash, cash  equivalents,  investments and securities of Seller and
          accounts  receivables  of Seller not related to the Business (it being
          understood  that Buyer is  purchasing  the Accounts  Receivable as set
          forth in Section 1.1(a)(v));

     (v)  All real  property  owned or  leased  by  Seller  and  whether  or not
          relating to the Business,  except as specifically set forth in Section
          1.1(a);

     (vi) All of Seller's rights and liabilities  under the Verus stock purchase
          agreement,  which shall include any subsequent  investment in Verus by
          Seller;

     (vii)All  contracts and  agreements  of Seller,  whether or not relating to
          the  Business,  other  than  the  Client  Contracts  and  the  Assumed
          Contracts set forth in Section 1.1(a);

     (viii) Seller's corporate seal, charter and minutes and stock record books;

     (ix) All motor  vehicles  owned or leased by Seller whether or not relating
          to the Business; and

     (x)  All assets and rights of Seller,  whether used in the Business or not,
          not set forth in Section 1.1(a).

1.2   Purchase Price.
      ---------------
The  aggregate  consideration  to be paid by Buyer to Seller  for the  Purchased
Assets shall be cash in the aggregate  amount of Five Million and 00/100 Dollars
($5,000,000.00)  (the "Purchase  Price"),  subject to adjustment as set forth in
Section 1.3, payable as follows:

(a)  by delivery to Seller on the Closing  Date the amount of  $4,709,277.33  by
     wire  transfer of  immediately  available  funds  pursuant to written  wire
     transfer instructions provided to Buyer by Seller at least two (2) business
     days prior to the Closing Date; and

(b)  by delivery to U.S Bank on the Closing  Date the amount of  $290,722.67  by
     wire  transfer of  immediately  available  funds  pursuant to written  wire
     transfer instructions provided to Buyer by U.S. Bank.


                                      -3-


1.3   Purchase Price Adjustment for Closing Working Capital.
      ------------------------------------------------------

(a)  Subject to the adjustments  set forth below in this Section 1.3(a),  Seller
     shall use its reasonable best efforts to have on the Closing Date,  Working
     Capital (as  defined in this  Section  1.3(a)) in an amount  equal to Eight
     Hundred  Seventy-Four  Thousand Dollars  ($874,000.00) (the "Agreed Working
     Capital").  For purposes of this Section  1.3(a),  the term Working Capital
     shall mean the amount by which the aggregate book value of Seller's current
     assets  exceeds the aggregate book value of Seller's  current  liabilities,
     all as  determined  in accordance  with United  States  generally  accepted
     accounting  principles as in effect on the date of this Agreement  ("GAAP")
     applied  on a  consistent  basis  throughout  the  periods  covered by such
     statements,  except  for the  exclusion  of  deferred  bonus  and  deferred
     partnership distribution liabilities,  and consistent with the presentation
     in the balance  sheet as of March 31,  2004 as attached  hereto on Schedule
     1.3(a) (the "Reference Balance Sheet"),  but  notwithstanding any provision
     of GAAP to the contrary,  specifically including in Seller's current assets
     all  work-in-process  as of the Closing Date and specifically  including in
     Seller's  current  liabilities  the aggregate  amount of all obligations of
     Seller under any long-term  capital  leases and  specifically  including in
     Seller's  current  assets  any  deposits  associated  with  the  management
     retreat. For purposes of determining  Seller's current liabilities,  in the
     event that the  Closing  shall occur on a date not the end of the month the
     amount of each expense historically accrued by Seller on a monthly or other
     non-daily basis,  including any expense for Taxes,  shall,  notwithstanding
     any  provision of GAAP to the  contrary,  be calculated by (i) dividing the
     aggregate  amount  of such  historical  monthly  accrual  by 30,  and  (ii)
     multiplying such per diem amount by the number of days expired in the month
     up to and  including  the Closing  Date.  To the extent,  if any,  that the
     Actual  Working  Capital (as defined in Section  1.3(b) below) is less than
     the Agreed Working Capital,  Seller and/or  Shareholders  shall, within the
     earlier to occur of ninety  (90)  calendar  days  after the  Closing or the
     final  determination  (as set forth in Section  1.3(c) below) of the Actual
     Working  Capital,  deliver to Buyer a check in the amount required to bring
     the Actual Working  Capital up to the Agreed Working  Capital level. In the
     event the Actual Working Capital exceeds the Agreed Working Capital,  Buyer
     shall  deliver a check to Seller in an amount  equal to the Actual  Working
     Capital in excess of the Agreed Working Capital within the same timeframe.

(b)  Not more than 60 days after the  Closing  Date,  Buyer  shall  prepare  and
     deliver to  Shareholders  a balance  sheet of Seller as of the Closing Date
     (the "Closing Balance Sheet")  indicating,  among other things, the Working
     Capital of Seller as of the Closing  Date (the "Actual  Working  Capital").
     Such  Closing   Balance  Sheet  shall  be  prepared   consistent  with  the
     presentation  in the Reference  Balance Sheet and in accordance  with GAAP,
     applied  on a  consistent  basis  throughout  the  periods  covered by such
     statement,  subject  to the  exceptions  specifically  set forth in Section
     1.3(a).  Seller  and/or  Shareholders  shall  have  thirty  (30) days after
     receipt of the  Closing  Balance  Sheet to  independently  verify  that the
     information  contained  thereon is both  accurate  and complete and to give
     written notice to Buyer of any  discrepancies.  Buyer shall  cooperate with
     Seller  and  Shareholders  during  the  verification  period  by  providing
     documentation  and  other  information  which  Seller or  Shareholders  may
     reasonably request to assist in verifying the information  contained on the
     Closing  Balance Sheet.  The costs and expenses  related to the preparation
     and  verification  of the Closing  Balance  Sheet as  contemplated  in this
     Section  1.3(b)  shall  be  borne  by the  party  incurring  such  costs or
     expenses.

(c)  The parties  shall in good faith attempt to resolve the  discrepancies,  if
     any, in the Closing  Balance  Sheet.  Should the parties be unable to agree
     within five (5) days after the end of the  verification  period,  then such
     dispute  shall be  submitted  for  resolution  to the St. Louis office of a
     nationally  recognized public accounting firm acceptable to the parties and
     the determination of such firm shall be binding upon the parties. Buyer and
     Shareholders  shall  direct  such  firm to  render a  determination  on any
     submitted  dispute within thirty (30) days after its retention.  Buyer,  on
     the one hand, and  Shareholders,  on the other,  shall each pay one-half of
     such firm's fees and expenses in connection with such services.


                                      -4-


1.4   Purchase Price Allocation.
      --------------------------
Following  the  Closing,  Buyer and Seller  agree to use their  best  efforts to
allocate the Purchase  Price  between and among the  Purchased  Assets.  Neither
Buyer nor  Seller  shall take a  position  in any Return (as  defined in Section
4.3), examination or other administrative or judicial proceeding relating to any
Return, that is inconsistent with such allocation.

1.5   Further Assurances.
      -------------------
At any time and from time to time before and after the  Closing,  at the request
of any party and  without  further  consideration,  each  party  promptly  shall
execute and deliver such instruments of sale, transfer,  conveyance,  assignment
assumption and  confirmation,  and take such other action,  as may be reasonably
requested to more effectively carry out the intent of this Agreement.

                                   ARTICLE 2

                        ASSUMPTION OF CERTAIN LIABILITIES

2.1   Assumed Liabilities.
      --------------------
At the Closing,  Seller shall  assign,  and Buyer shall assume and agree to pay,
discharge or perform, as applicable,  pre-closing liabilities to the extent that
such   liabilities  are  included  in  the  Closing  Balance  Sheet  as  current
liabilities,  and those  obligations and liabilities  accruing after the Closing
Date under the Client  Contracts and Assumed  Contracts  transferred and validly
assigned to Buyer in accordance  with Section 1.1(a) hereof  (collectively,  the
"Assumed Liabilities").

2.2   Excluded Liabilities.
      ---------------------
Notwithstanding  the  provisions  of Section  2.1,  Buyer shall not assume,  and
Seller shall remain liable for, any and all liabilities, obligations, claims and
commitments of or against Seller which are not  specifically set forth herein as
being  expressly  assumed by Buyer (and  regardless  of whether set forth on any
Schedule hereto),  whether the same are known or unknown,  existing,  contingent
upon future events or circumstances, accrued, funded, unfunded or otherwise (the
"Excluded Liabilities"), including, without limitation:

(a)  any Taxes (as defined in Section  4.3)  imposed on Seller  (including  with
     respect to the  Excluded  Assets at any time) or relating  to the  Business
     (including the Purchased Assets) for any period (or portion thereof) ending
     on or prior to the Closing Date;

(b)  any liability or obligation resulting from any formal or informal,  written
     or unwritten,  agreement with respect to employee  compensation,  severance
     pay, bonus, partner  distributions,  pension,  retirement,  profit sharing,
     health or medical  benefit,  welfare plan, or any other employee benefit or
     fringe  benefit  plan  and  any  stock  option  arrangements,  warrants  or
     employment  agreements  for services for periods on or prior to the Closing
     Date;

(c)  any  liability or obligation  relating to the Business or Purchased  Assets
     arising  out of any event or  occurrence  or a claim  arising  prior to the
     Closing Date;

(d)  any liabilities or obligations of Seller relating to the Excluded Assets;

(e)  any  liability or  obligation  of Seller  arising or incurred in connection
     with the  negotiation,  preparation and execution of this Agreement and the
     consummation of the transactions  contemplated  hereby,  including  without
     limitation,  fees  and  expenses  of its  counsel,  accountants  and  other
     advisors;


                                      -5-


(f)  any  liabilities  of Seller for  commissions  or fees owed to any finder or
     broker   retained  by  Seller  or   Shareholders  in  connection  with  the
     transactions contemplated hereby;

(g)  any obligation,  liability,  injury or damage arising, accruing or existing
     prior to the Closing  Date with  respect to Seller's  employees,  including
     without  limitation  any matters  arising  under laws  governing  wages and
     hours, employment  discrimination,  sexual harassment,  occupational safety
     and  health,   workers'  compensation,   the  payment  and  withholding  of
     employment taxes and any alleged violations of law;

(h)  any liability of Seller or with respect to the Business for any  violations
     of any law, regulation or rule to the extent arising from acts or omissions
     prior to the Closing Date, including, without limitation, applicable health
     care laws, rules and  regulations,  including those relating to the payment
     or receipt of illegal  remuneration,  including  42 U.S.C.  ss.1395nn  (the
     Stark Statute), 42 U.S.C. ss.1320a-7a, 42 U.S.C. ss.1320a-7b(a),  42 U.S.C.
     ss.1320a-7b(c)  and any  applicable  state  laws  governing  kickbacks  and
     matters  similar to such  federal  statutes  (collectively,  the "Fraud and
     Abuse Laws"); and

(i)  any liability that  represents  amounts owed by Seller that are past due or
     contractually  due on or prior to the Closing  Date,  including any amounts
     owing by Seller under any of the Client Contracts on or prior to Closing.

                                   ARTICLE 3
                                   ---------

                            CLOSING AND CLOSING DATE
                            ------------------------

3.1   Closing.
      --------
The  closing  ("Closing")  of  the  sale  of  the  Purchased  Assets  and  other
transactions  contemplated  by this Agreement shall take place at the offices of
Thompson Coburn LLP, One US Bank Plaza, St. Louis,  Missouri 63101 commencing at
9:00 a.m.,  local time, on May 3, 2004 or on such other date  ("Closing  Date"),
not later  than  June 30,  2004,  or at such  other  place as Buyer  and  Seller
mutually shall agree.

3.2   Simultaneous Closing.
      ---------------------
All actions taken at the Closing shall be deemed to be performed  simultaneously
and the Closing shall not be deemed to have occurred until all required  actions
of the parties pursuant to this Agreement have been performed. The parties shall
deliver  such  additional  documents  and take such  additional  actions  as may
reasonably be deemed necessary to complete the transactions contemplated by this
Agreement.

                                   ARTICLE 4
                                   ---------

            REPRESENTATIONS AND WARRANTIES OF SELLER AND SHAREHOLDERS
            ---------------------------------------------------------

     Seller and Shareholders  hereby jointly and severally represent and warrant
to Buyer on the date of this Agreement, and again on and as of the Closing Date,
as follows:


                                      -6-


4.1   Status of Seller.
      -----------------

(a)  Existence and Status.  Seller is a corporation duly organized,  entitled to
     conduct  business and validly  existing in good standing  under the laws of
     the State of Utah.

(b)  Articles of Incorporation and Bylaws of Seller.  Attached to this Agreement
     as Exhibit A and Exhibit B,  respectively,  are copies of: (i) the original
     Articles  of  Incorporation  of Seller  and all  amendments,  restatements,
     articles of merger,  or other  filings with respect  thereto,  and (ii) the
     currently  effective  Bylaws of Seller.  All amendments to, and articles of
     merger and other filings with respect to, the Articles of  Incorporation of
     Seller were made in accordance  with the Articles of  Incorporation  (as in
     effect  before  the  amendment  of the  articles  or filings  with  respect
     thereto),  and the Bylaws and applicable law of Seller without violation of
     any preemptive  rights, and Seller has otherwise complied with its Articles
     of Incorporation and Bylaws as in effect at the applicable time.

(c)  Corporate  Power of  Seller.  Seller  has the  power to own and  lease  the
     Purchased  Assets  and  otherwise  to conduct  the  Business  as  currently
     conducted.

(d)  Ownership  Interests.  Seller has no subsidiaries or any equity  securities
     of, investment in or loans or advances to any business enterprise or person
     or any agreements or commitments  for such (other than trade terms extended
     to  customers  in the ordinary  course of  business),  or is subject to any
     arrangement  that could be treated as a partnership  for federal income tax
     purposes.

(e)  Foreign  Qualification.  Schedule 4.1(e) lists the  jurisdictions  in which
     Seller is  qualified to do business as a foreign  corporation,  and nothing
     (including  the  nature  of or the  manner  in which  Seller  conducts  its
     business,  the character or location of the  properties  which Seller owns,
     leases or uses or the actions or location of  employees  or agents)  either
     requires  Seller to be  qualified  in any other  jurisdiction  or  subjects
     Seller to any cost, restriction or penalty for failing to qualify.

(f)  Authorization.

     (i)  Seller and each  Shareholder  has the right,  power and  authority  to
          enter into this  Agreement  and each other  agreement,  instrument  or
          other  document  contemplated  hereunder  (collectively,   the  "Other
          Agreements")  to  which  they  are a  party,  and  to  consummate  the
          transactions contemplated by, and otherwise to comply with and perform
          their  respective  obligations  under,  this Agreement and each of the
          Other Agreements referred to herein;

     (ii) The execution  and delivery by Seller of this  Agreement and the Other
          Agreements to which it is a party,  and the  consummation by Seller of
          the  transactions  contemplated  by,  and  other  compliance  with and
          performance of its obligations  under,  this Agreement and each of the
          Other Agreements, have been duly authorized by all necessary corporate
          action  on the part of  Seller  in  compliance  with the  Articles  of
          Incorporation  and Bylaws  (each as amended) of Seller and  applicable
          law; and

     (iii)This  Agreement  and each of the Other  Agreements to which Seller and
          each  Shareholder  are  parties,  constitute  the  valid  and  binding
          agreement of Seller and each Shareholder, as the case may be, that are
          enforceable  against Seller and each Shareholder,  as the case may be,
          in accordance with its terms.


                                      -7-


(g)  Absence of Violations or Conflicts. Except as disclosed in Schedule 4.1(g),
     the  execution and delivery of this  Agreement and the Other  Agreements by
     Seller  and   Shareholders   and  the   consummation  of  the  transactions
     contemplated  by,  or other  compliance  with or  performance  under,  this
     Agreement and the Other  Agreements do not and will not with the passage of
     time or giving of notice or both:

     (i)  constitute a violation of, be in conflict  with,  constitute a default
          or require any payment  under,  permit a termination  of,  require any
          consent or approval  under, or result in the creation or imposition of
          any lien,  encumbrance  or other adverse claim or interest upon any of
          the Purchased  Assets under (A) any contract,  agreement,  commitment,
          undertaking or  understanding to which any of the Purchased Assets are
          subject  or  bound,   (B)  any  judgment,   decree  or  order  of  any
          governmental  authority to which Seller, any of Shareholders or any of
          the Purchased  Assets are subject or bound, (C) any applicable law, or
          (D) any  governing  or  applicable  agreements,  instruments  or other
          documents to which Seller (including its Articles of Incorporation and
          Bylaws (each as amended)) is a party; or

     (ii) create,  result in a Material  Adverse  Change (as  defined in Section
          4.2(c)(i))  to or cause  the  acceleration  of the  maturity  of,  any
          Assumed Liabilities.

(h)  No  Governmental  Consents  Required.  No  consent,   approval,   order  or
     authorization  of,  or  registration,   declaration  or  filing  with,  any
     governmental authority on the part of Seller is required in connection with
     the execution or delivery of this  Agreement,  the Other  Agreements or the
     consummation of the transactions  contemplated by, or other compliance with
     or performance under, this Agreement or the Other Agreements.

4.2   Financial Matters.
      ------------------

(a)  Seller Financial  Statements.  Copies of the unaudited financial statements
     of Seller as of and for the fiscal  years ended  December 31, 2003 and 2002
     and the three  months  ended  March 31, 2004 (all of which,  including  the
     notes  thereto,  are  collectively  referred  to in this  Agreement  as the
     "Seller Financial Statements," with the balance sheet of Seller as of March
     31, 2004 referred to separately as the "Seller Balance Sheet") are attached
     hereto as  Schedule  4.2.  Seller  Financial  Statements  were  prepared in
     accordance  with the  books and  records  of Seller  and are  complete  and
     accurate in all material respects,  fairly present the financial  condition
     of Seller as of their  respective  dates and the results of  operations  of
     Seller for the  respective  periods  then ended and have been  prepared  in
     accordance with GAAP applied on a consistent  basis  throughout the periods
     covered by such statements,  except for the exclusion of deferred bonus and
     deferred partnership distribution liabilities.

(b)  Absence of Undisclosed  Liabilities.  Except as and to the extent expressly
     reflected  in Seller  Financial  Statements  or reserved  against in Seller
     Balance Sheet, there are no other liabilities of any nature relating to the
     Purchased Assets, whether accrued, direct, indirect, absolute,  contingent,
     changing,  known,  unknown,   determinable,   indeterminable,   liquidated,
     unliquidated or otherwise and whether due or to become due, relating to any
     existing or prior act, omission, condition or state of facts.

(c)  Absence of Certain  Changes.  Since March 31, 2004,  there has not been any
     activity  with  respect  to Seller  other  than in the  ordinary  course of
     business and, without limiting the foregoing, there has not been:


                                      -8-


     (i)  any material  adverse change in or loss to the Purchased Assets or the
          operations,   liabilities,   earnings,   relationships  with  existing
          clients,  business  or  condition  (financial  or  otherwise)  of  the
          Business  which  have  been or could  reasonably  be  expected  to be,
          individually  or in  the  aggregate  with  other  changes,  materially
          adverse to the Business or the Purchased  Assets (a "Material  Adverse
          Change");

     (ii) any increase in the  compensation  payable by Seller to any officer of
          Seller or Retained  Employee  (as defined  herein)  other than routine
          increases made in the ordinary course of business consistent with past
          practice  and not in  excess  of five  percent  (5%) of such  Retained
          Employee's  annual  salary,  or  any  bonus,  incentive  compensation,
          service  award  or  other  like  benefit,  granted,  made or  accrued,
          contingently or otherwise, to or for the credit of any of such officer
          or Retained Employee, or any employee welfare, pension,  retirement or
          similar  payment or  arrangement  made or agreed to by Seller in which
          any such officer or Retained Employee participates;

     (iii)any capital  expenditure  or commitment to make a capital  expenditure
          with respect to the Purchased  Assets  (exclusive of expenditures  for
          repair or maintenance in the ordinary course of business);

     (iv) any  incurrence  of any  extraordinary  loss or knowing  waiver of any
          rights  of value by  Seller  in  connection  with  any  aspect  of the
          Business, whether or not in the ordinary course of business;

     (v)  any  cancellation,  termination or amendment by Seller of any contract
          or agreement included in the Purchased Assets and to which Seller is a
          party or by which Seller is bound;

     (vi) any  failure  on the part of Seller to  operate  the  Business  in the
          ordinary  course so as to preserve its business  organization  intact,
          including  the  services of Seller's  present  officers,  professional
          staff and employees and the goodwill of Seller's suppliers,  customers
          and others having business relations with Seller;

     (vii)any sale, assignment or transfer (including,  without limitation,  any
          collateral  assignment  or the  granting  or  permitting  of any lien,
          encumbrance or other claim) of any of the Purchased  Assets other than
          in the ordinary course of business and consistent with past practices;

     (viii) any amendment, modification, waiver or cancellation of any debt owed
          to, or claim  of,  Seller,  or  settlement  by  Seller of any  dispute
          involving any payment or other  obligation due to or owed by Seller to
          be made or performed after the Closing Date which constitutes an Asset
          or an Assumed Liability; or

     (ix) any  agreement by or  commitment  of Seller to do or permit any of the
          foregoing.

4.3   Taxes.
      ------
Notwithstanding  anything in this  Agreement to the  contrary,  this Section 4.3
shall not apply with  respect to any Tax or Taxes (as such terms are  defined in
this  Section  4.3) to the extent  that from and after  Closing,  the  Purchased
Assets  are not  subject  to a lien  for  such Tax or  Taxes,  and  Buyer or its
affiliates are not liable for such Tax or Taxes.


                                      -9-


(a)  Definitions. For purposes of this Agreement:

     (i)  the term  "Code"  shall mean the  Internal  Revenue  Code of 1986,  as
          amended.  All citations to the Code or to the regulations  promulgated
          thereunder shall include any amendments or any substitute or successor
          provisions thereto;

     (ii) the  term   "Returns"   shall   mean,   collectively,   all   reports,
          declarations,  estimates, returns, information statements, and similar
          documents  relating  to, or  required  to be filed in respect  of, any
          Taxes; and

     (iii)the term "Taxes" shall mean (A) all income, net income,  gross income,
          gross receipts, sales, use, ad valorem,  franchise,  profits, license,
          lease, service, service use, withholding, employment, payroll, excise,
          severance,  transfer,  documentary,   mortgage,  registration,  stamp,
          occupation,   environmental,  premium,  property,  windfall,  profits,
          customs,  duties, and other taxes, fees, assessments or charges of any
          kind  whatever,  together  with  any  interest,  penalties  and  other
          additions with respect thereto,  imposed by any federal,  territorial,
          state, local or foreign government;  and (B) any penalties,  interest,
          or other additions to tax for the failure to collect, withhold, or pay
          over any of the foregoing,  or to accurately file any Return;  and the
          term "Tax" shall mean any one of the foregoing  Taxes.  When used with
          reference  to specified  persons (for example and without  limitation,
          "Taxes of  Seller"),  the terms  "Taxes" and "Tax" shall  include only
          amounts of, or in respect of, Taxes for which such person is, or could
          become,  liable in whole or part (including,  without limitation,  any
          obligation in connection with a duty to collect, withhold, or pay over
          any Taxes,  any  obligation  to contribute to the payment of any Taxes
          determined  on  a  consolidated,   combined,  or  unitary  basis,  any
          liability as a transferee, or any liability as a result of any express
          or implied  obligation  to  indemnify  or pay the Tax  obligations  of
          another person).

(b)  Returns  Filed and Taxes  Paid.  Except  as set forth on  Schedule  4.3(b),
     Seller duly filed or caused to be filed,  on or before the due date thereof
     (as appropriately  extended) with the appropriate taxing  authorities,  all
     Returns that it is required to file,  and each such Return  (including  any
     amendment thereto) is true, correct, and complete in all material respects.
     All Taxes of Seller due with  respect  to, or shown to be due on, each such
     Return (or amendment) or subsequent  assessment with regard  thereto,  have
     been  timely  paid.  There  is no valid  basis  for the  assessment  of any
     deficiency  with  regard  to any such  Return  and  except  as set forth on
     Schedule 4.3(b), there are no extensions of time to file which are pending.
     No other  Taxes of Seller are due with  respect to any  taxable  periods or
     portions  of periods  ending on or before the  Closing  Date.  There are no
     liens, attachments,  or similar encumbrances on any of the Purchased Assets
     of Seller  with  respect to any Taxes,  other than liens for Taxes that are
     not yet due and payable. Seller has collected or withheld all Taxes that it
     is required to collect or withhold.

(c)  Audit  History  and  Other  Proceedings.  There are no  pending  or, to the
     Knowledge  (as  defined in  Section  4.15(b))  of Seller and  Shareholders,
     threatened (either in writing or verbally,  formally or informally) audits,
     investigations,  claims,  suits or other proceedings for or relating to any
     material liability in respect of Taxes of Seller. No material  deficiencies
     for Taxes of Seller have been  claimed,  proposed or assessed by any taxing
     or other  governmental  authority and there are no matters under discussion
     with any governmental  authorities with respect to Taxes, that could result
     in any  additional  amount of Taxes of Seller and that could  reasonably be
     expected to affect the Business or the Purchased  Assets. No extension of a
     statute of limitations  (whether  arising by reason of a waiver,  claim for
     refund,  or  otherwise) in respect of such Taxes is in effect and there are
     no  requests  for rulings or  determinations  in respect of Taxes of Seller
     pending with any governmental authority.


                                      -10-


4.4   Title to and Condition of Purchased Assets.
      ------------------------------------------

(a)  Title to  Purchased  Assets.  Except as set forth on Schedule  4.4(a):  (i)
     Seller has good and marketable  title to all of the Purchased  Assets;  and
     (ii) none of the  Purchased  Assets is subject to any lien,  claim or other
     encumbrance whatsoever, except (A) liens for taxes not yet due and payable,
     (B) liens shown and described in Seller Balance Sheet, (C) liens imposed by
     law and incurred in the ordinary course of business for obligations not yet
     due and payable to landlords, carriers, warehousemen, laborers, materialmen
     and the like,  and (D) liens to secure  repayment  of the  indebtedness  of
     Seller under any of the Debt  Instruments (as defined in Section 4.6(a) and
     more  fully  described  on  Schedule  4.6(a)  hereto)  (collectively,   the
     "Permitted Liens").

(b)  Leases;  Subleases.  For  purposes  of this  Agreement,  "Lease"  means any
     written  or oral  lease,  sublease  or rental  agreement  (and any  related
     contract and agreement)  included as part of the Purchased Assets,  and all
     amendments,  modifications and supplements thereof and waivers and consents
     thereunder pursuant to which Seller leases,  subleases or rents any real or
     personal  property  included  in the  Purchased  Assets,  either as lessor,
     lessee,  landlord or tenant.  Schedule 1.1(a)(ii) lists all Leases included
     in the Purchased  Assets,  except those which (i) can be canceled by Seller
     upon 30 or fewer  days'  notice  without  penalty  or the  acceleration  of
     rentals,  (ii) do not grant an option to purchase the leased property,  and
     (iii)  involve an annual  rental of $15,000  or less.  Schedule  1.1(a)(ii)
     describes all oral Leases required to be disclosed in Schedule  1.1(a)(ii),
     and true and complete copies of all written Leases required to be disclosed
     have been  heretofore  delivered  to  Buyer.  With  respect  to each of the
     Leases:  (A) neither Seller nor, to the best of Seller's and  Shareholders'
     Knowledge, any other party is in default in connection with such Lease; (B)
     no act or event has occurred  which,  with notice or lapse of time or both,
     would  constitute a default  under such Lease with respect to Seller or, to
     the best of Seller's and  Shareholders'  Knowledge,  any other  party;  (C)
     there is no basis for any claim of default under such Lease with respect to
     Seller or, to the best of Seller's and Shareholders'  Knowledge,  any other
     party;  (D) Seller has not given or received any notice of  cancellation or
     termination in connection with such Lease;  (E) such Lease is the valid and
     binding agreement of Seller, and, to the best of Seller's and Shareholders'
     Knowledge, the other party thereto which is in full force and effect and is
     enforceable  in  accordance  with its terms,  except,  with respect to such
     other party, to the extent that such  enforceability  may be limited by, or
     subject  to:  (i) the  effect  of any  applicable  bankruptcy,  insolvency,
     reorganization,  fraudulent  conveyance,  moratorium  or other similar laws
     affecting  the  enforcement  of  creditors'  rights  generally;   (ii)  the
     availability of the remedies of specific  performance or injunctive relief,
     which  may be  subject  to the  discretion  of the court  before  which any
     proceeding for such remedies may be brought;  and (iii) the exercise by any
     court of equitable  judicial  discretion before which any proceeding may be
     brought; (F) except as disclosed on Schedule 4.4(b), such Lease will not be
     affected  by, or require  the  consent of or payment to any other  party to
     avoid an event of default,  an event of termination or other adverse effect
     with  respect to such by reason of the  transactions  contemplated  by this
     Agreement;  and (G) such  Lease is a "true"  lease for  federal  income tax
     purposes.

(c)  Adequacy;  Condition.  Except  as set  forth in  Schedule  4.4(c):  (i) the
     Purchased  Assets are fit for use in the  business  of Seller as  presently
     conducted;  (ii) the  Purchased  Assets are in good  repair  and  operating
     condition, normal wear and tear excepted, and structurally and mechanically
     sound,  as  applicable;  (iii)  Seller is in material  compliance  with all
     applicable  building,  zoning,  land use or other similar  statutes,  laws,
     ordinances,   regulations,  permits,  health  and  safety  codes  or  other
     requirements  in respect of any of the Purchased  Assets subject to a Lease
     (and  Seller's  current  use of  such  properties  does  not  constitute  a


                                      -11-


     nonconforming  use) and Seller has not received any notice  alleging such a
     violation;  (iv) to the Knowledge of Seller and  Shareholders,  none of the
     Purchased  Assets  subject to a Lease has ever been used as a  landfill  or
     otherwise  been used for the  disposal,  storage or treatment of any waste,
     trash, garbage,  industrial by-product,  chemical or hazardous substance of
     any  nature;  (v) Seller has not  caused  the  installation  of any of such
     property with asbestos  insulation or any electrical  equipment  containing
     polychlorinated  biphenyls  and, to Seller's and  Shareholders'  Knowledge,
     none  of  the  Purchased  Assets  subject  to  a  Lease  contains  asbestos
     insulation or electrical  equipment containing  polychlorinated  biphenyls;
     and (vi) to Seller's and Shareholders' Knowledge,  there are no outstanding
     requirements or  recommendations by fire underwriters or rating boards, any
     insurance  companies or holders of mortgages  or other  security  interests
     requiring or recommending  any repairs or work to be done with reference to
     any of the Purchased Assets subject to a Lease.

(d)  All  Necessary   Properties.   The  Purchased  Assets  (together  with  the
     intangible properties disclosed, or not required to be disclosed,  pursuant
     to Sections 4.5 and 4.6 of this Agreement) constitute all of the properties
     which  Seller uses in  connection  with the  operation  of the  Business as
     presently  conducted and the consummation of the transactions  contemplated
     by this  Agreement  (provided  that all consents  relating to the Purchased
     Assets have been  obtained) will not alter the rights or impair the ability
     of Seller to use such Purchased Assets in the conduct of the Business as it
     is now being conducted.  4.5 Intellectual  Property;  Patents;  Trademarks,
     Trade  Names.  All  Intellectual  Property and all  contracts,  agreements,
     commitments, arrangements,  undertakings and understandings relating to the
     use or license of technology, know-how or processes by Seller that are part
     of the Purchased Assets (the "Intellectual  Property  Licenses") are listed
     in Schedule 1.1(a)(vi). Except as disclosed in Schedule 4.5 with respect to
     all  Intellectual  Property that is included in the Purchased  Assets;  (a)
     Seller owns, or has the sole and exclusive  right to use, all  Intellectual
     Property,  whether under Intellectual Property Licenses or otherwise,  used
     in or  necessary  for  the  ordinary  conduct  of  its  business;  (b)  the
     consummation  of the  transactions  contemplated by this Agreement will not
     alter or impair any such rights;  and (c) no  Intellectual  Property owned,
     licensed or used by Seller,  or Intellectual  Property License of Seller is
     the  subject  of a  lawsuit  or any  other  proceeding,  nor has any  party
     challenged  or, to Seller's  and  Shareholders'  Knowledge,  threatened  to
     challenge  Seller's  respective right to use such Intellectual  Property or
     Intellectual Property License or application for any of the foregoing; and,
     to Seller's  and  Shareholders'  Knowledge,  there is no basis for any such
     challenge.

4.6   Loans and Contracts.
      --------------------

(a)  Indebtedness.  Schedule  4.6(a) sets forth (i) a complete and accurate list
     or description of all instruments or other documents  ("Debt  Instruments")
     relating  to any direct or  indirect  indebtedness  for  borrowed  money of
     Seller,  as well as indebtedness  by way of capital leases,  lease-purchase
     arrangements,  guarantees,  undertakings  on which others rely in extending
     credit and all conditional  sales  contracts,  chattel  mortgages and other
     security  arrangements  with respect to personal  property used or owned by
     Seller  and (ii) a list of all loans of money to the  respective  officers,
     affiliates  employees  of Seller or  Shareholders  (specifically  excluding
     travel and similar advances in the ordinary course of business).

(b)  Client Contracts; Client Accounts.

     (i)  Seller has  delivered to Buyer true,  complete and accurate  copies of
          all  of  the  Client  Contracts  and  Assumed  Contracts.  All  Client
          Contracts and Assumed  Contracts are legal,  valid,  binding,  in full
          force and effect and enforceable against Seller, and, to the Knowledge
          of Seller and  Shareholders,  against each other party thereto.  There


                                      -12-


          does not exist  under any  Client  Contract  or Assumed  Contract  any
          violation,  breach or event of default,  or event or  condition  that,
          after notice or lapse of time or both,  would  constitute a violation,
          breach or event of  default  thereunder,  on the part of Seller or, to
          the  Knowledge  of Seller  and  Shareholders,  any other  person.  The
          enforceability  of all Client Contracts and Assumed Contracts will not
          be affected in any manner by the execution, delivery or performance of
          this Agreement  (except that any Client Contract and Assumed  Contract
          assumed by Buyer may be enforceable  by Buyer and not Seller),  and no
          Client Contract or Assumed Contract  contains any assignment or change
          in control or similar terms or conditions that will become  applicable
          as a result of the  consummation of the  transactions  contemplated by
          this Agreement;  provided,  however,  it is understood that certain of
          the Client Contracts  and/or Assumed  Contracts may
          require the consent of the other  parties  thereto to assign the same,
          which consents Seller shall obtain prior to the Closing.

     (ii) Except  as set  forth  on  Schedule  4.6(b),  no  Client  Account  has
          materially  delayed or  decreased  or  terminated,  or to  Seller's or
          Shareholders' Knowledge, threatened to materially delay or decrease or
          terminate,  or given notice of its  intention to  materially  delay or
          decrease or terminate its usage of Seller's services.

     (iii)All consents (if they are required)  from Seller's  present  customers
          needed to enable Buyer to assume the Client  Contracts and the Assumed
          Contracts  and  continue the Business  without  interruption  shall be
          received prior to the Closing.  Only those Client  Accounts  listed on
          Schedule  4.6(b) hereto require consent before the assignment of their
          Client Contract.

(c)  Insurance.  All  insurance  policies  of  Seller  now in  force  (including
     comprehensive  general  liability,  personal  and  professional  liability,
     comprehensive  general casualty and extended coverage,  automobile,  boiler
     and machinery, fire and lightning,  marine,  endowment,  life, and worker's
     compensation)  ("Insurance  Policies") are listed in Schedule  4.6(c),  and
     such policies will be through Closing.

(d)  Status. Except as disclosed on Schedule 4.6(d): (i) Seller has not assigned
     any of its rights or obligations under (and is not otherwise restricted for
     any reason from enjoying the full benefits under) any Intellectual Property
     License, Debt Instrument, Client Contract or Assumed Contract; (ii) neither
     Seller nor, to Seller's and Shareholders'  Knowledge, any other party is in
     material default in connection with any Intellectual Property License, Debt
     Instrument,  Client  Contract or Assumed  Contract;  (iii) to Seller's  and
     Shareholders' Knowledge, no act or event has occurred which, with notice or
     lapse of time or both,  would  constitute  a  material  default  under  any
     Intellectual Property License, Debt Instrument,  Client Contract or Assumed
     Contract; (iv) to Seller's and Shareholders'  Knowledge,  there is no basis
     for any claim of material default under any Intellectual  Property License,
     Debt  Instrument,  Client  Contract  or Assumed  Contract;  (v) there is no
     outstanding  notice of  cancellation  or termination  received by Seller in
     connection with any Intellectual Property License, Debt Instrument,  Client
     Contract or Assumed Contract; (vi) each Intellectual Property License, Debt
     Instrument,  Client Contract and Assumed  Contract is the valid and binding
     agreement of the parties  thereto  which is in full force and effect and is
     enforceable in accordance with its terms except, with respect to such other
     party, to the extent that such enforceability may be limited by, or subject
     to:   (A)   the   effect   of  any   applicable   bankruptcy,   insolvency,
     reorganization,  fraudulent  conveyance,  moratorium  or other similar laws
     affecting  the  enforceability  of  creditors'  rights  generally,  (B) the
     availability  of specific  performance or injunctive  relief,  which may be
     subject to the discretion of the court before which any proceeding for such
     remedies  may be brought,  and (C) the  exercise by any court of  equitable
     judicial  discretion before which any proceeding may be brought;  and (vii)
     neither  Seller nor any of  Shareholders  has  received  any  communication
     proposing any termination, material amendment or change to any Intellectual
     Property License, Debt Instrument, Client Contract or Assumed Contract.


                                      -13-


4.7   Officers and Managers; Employment Relationships. Schedule 4.7
      ------------------------------------------------ ------------
sets forth a true and  complete  list of all of the  officers  and  managers  of
Seller, specifying their office and annual rate of compensation,  and a true and
complete list of employees of Seller as of the date of this  Agreement,  setting
forth each such employee's  title,  compensation and date of hire.  Schedule 4.7
sets forth  Seller's  policies  and  practices  with respect to  scheduling  and
eligibility of employee  compensation  increases and bonuses.  All  compensation
increases and bonuses  awarded by Seller during the twelve month period prior to
the date hereof have been in compliance with such policies and practices.

4.8   Employee and Fringe Benefit Plans.
      ----------------------------------
Except as set forth in Schedule 4.8, Seller,  with respect to employees,  former
employees or agents of Seller, does not maintain,  is not required to contribute
to and does  not  otherwise  participate  in (and has not  since  its  inception
maintained,  contributed  to or  otherwise  participated  in)  either:  (i)  any
employee  pension benefit plan  ("Pension/Profit  Sharing  Plan"),  any employee
welfare   benefit   plan   ("Welfare   Plan")   or   any   multi-employer   plan
("Multi-Employer  Plan") (as such terms are defined in the  Employee  Retirement
Income  Security  Act of 1974,  as amended  ("ERISA")),  including  any pension,
profit sharing, retirement, thrift, stock purchase or stock option plan; or (ii)
any other  compensation,  welfare,  fringe benefit or retirement plan,  program,
policy,  understanding or arrangement of any kind whatsoever,  whether formal or
informal, providing for benefits for or the welfare of any or all of the current
or former employees or agents of Seller or their beneficiaries or dependents.

     True and complete  copies of the  following  documents  with respect to the
plans  set forth on  Schedule  4.8 have been  delivered  to Buyer:  (i) the most
recent plan document and trust agreement  (including any amendments  thereto and
prior plan  documents,  if amended  within the last three years),  (ii) the last
five years IRS Form 5500 filings and  schedules  thereto,  (iii) the most recent
IRS determination  letter, (iv) all summary plan descriptions,  (v) each written
communication  to employees  intended to describe a plan or any benefit provided
in such plans, and (vi) all  correspondence  with the IRS or Department of Labor
concerning any controversy with respect to such plans.

     Each plan listed on Schedule 4.8 is and has been  maintained  in compliance
in all material respects with applicable law, including but not limited to ERISA
and the Code and with any other applicable contractual obligations.

     Each plan listed on Schedule 4.8 that is intended to be tax qualified under
Code section 401(a) has been  determined by the Internal  Revenue  Service to be
exempt from tax under the provisions of Code section 501(a) and, to Seller's and
Shareholders' Knowledge, nothing has occurred, including the adoption or failure
to adopt any plan amendment,  which would adversely affect its  qualification or
tax-exempt status.

     Except as reflected on Schedule 4.10,  there are no pending or, to Seller's
or Shareholders'  Knowledge,  threatened claims, actions or lawsuits, other than
routine  claims for  benefits in the  ordinary  course,  asserted or  instituted
against  (i) any plan or its assets or (ii) any  fiduciary  with  respect to any
plan for with Seller,  it  subsidiaries  or affiliates,  may be directly  liable
through indemnification obligations or otherwise.


                                      -14-


4.9   Labor Relations.
      ----------------
Seller is (and, at all times, has been) in material compliance with all federal,
state,  local and other  applicable  laws  respecting  employment and employment
practices,  terms and  conditions  of employment  and wages and hours.  There is
(and, at all times,  has been) no unfair labor  practice,  complaint,  charge or
other  matter  against or  involving  employees,  former  employees or agents of
Seller  pending or threatened  before any  Governmental  Authority.  There is no
(and, at all times, has not been) labor strike, dispute, organizing effort, slow
down, stoppage or other labor difficulty pending,  involving or, to Seller's and
Shareholders' Knowledge,  threatened, against or affecting the employees, former
employees or agents of Seller.  No grievance  which might have an adverse effect
on Seller or on the  conduct  of the  Business  nor any  arbitration  proceeding
arising out of or under collective  bargaining  agreements relating to employees
of Seller is pending, and no claim therefor exists. There is (and, at all times,
has been) no collective bargaining agreement which is binding on Seller.

4.10   Litigation.
       -----------
Except as set forth on Schedule 4.10,  Seller is not (and, at all times, has not
been) (i) engaged in, a party to,  subject to or, to Seller's and  Shareholders'
Knowledge,  threatened  with any  claim,  legal or  equitable  action,  or other
proceeding  (whether as plaintiff,  defendant or otherwise and regardless of the
forum or the nature of the opposing party) which seeks damages, an injunction or
other relief against Seller,  which action,  individually  or collectively  with
such other actions,  would have a Material Adverse Effect on the Business or the
Purchased Assets; (ii) to Seller's and Shareholders'  Knowledge,  subject to any
unasserted claim, the assertion of which is likely and which, if asserted,  will
seek  damages,  an  injunction  or  other  relief  against  Seller  which  claim
individually or  collectively  with such other  unasserted  claims if made would
have a Material Adverse Effect on the Business or the Purchased Assets; or (iii)
a party to or subject to any  judgment,  order or decree  against  Seller or the
Purchased  Assets.  There has been no  reservation  of  rights by any  insurance
carrier,  and, to Seller's and Shareholders'  Knowledge,  no such reservation is
threatened,  concerning  the  coverage  of Seller  with  respect  to any  matter
described in this Section 4.10.

4.11  Compliance with Laws.
      ---------------------

(a)  Generally.  Except as set forth in Schedule 4.11(a)  attached  hereto,  and
     except  with  respect  to  compliance  with  Environmental  Laws  which  is
     addressed under Section 4.11(c) below,  Seller is in full compliance in all
     material respects with all applicable laws, rules,  regulations  including,
     without limitation,  the Health Care Laws (as defined below), ordinances or
     orders  of  any  court  or  federal,  state,  county,  municipal  or  other
     governmental   department,    commission,    board,   bureau,   agency   or
     instrumentality,  and  Seller  has not  received  any  notice,  written  or
     otherwise,  of noncompliance  with respect thereto.  All financial records,
     patient  records and other  documents  required to be  maintained by Seller
     have been  continuously  maintained by Seller for a period of at least five
     (5) years from the date of creation of such document.  For purposes of this
     Agreement,  the term "Health Care Laws" shall mean all applicable  federal,
     state or local health care laws, rules and regulations,  including  without
     limitation   those   relating   to  the   payment  or  receipt  of  illegal
     remuneration,  including 42 U.S.C. ss.  1320a-7b(b) (the  Medicare/Medicaid
     anti-kickback statute), 42 U.S.C. 1395nn (the Stark Statute), 42 U.S.C. ss.
     1320a-7a,  42 U.S.C. ss.  1320a-7b(a),  42 U.S.C.  ss.  1320a-7b(c) and any
     applicable  state laws  governing  kickbacks  and  matters  similar to such
     federal statutes.

(b)  Permits.  Without  limiting the  foregoing,  except for those failures that
     would not  reasonably be expected to have a Material  Adverse  Effect:  (i)
     Seller has all material occupancy certificates and other licenses,  permits
     and  certificates  ("Permits")  required in connection  with its ownership,
     possession,  use,  occupancy or operation  of any of the  Purchased  Assets
     owned,  leased or used by it; (ii) all of the Permits are in full force and
     effect;  (iii)  Seller is (and has been) in  material  compliance  with the
     Permits;  and (iv) none of the Permits will be  materially  affected by, or
     require  the   consent  of  any  party  by  reason  of,  the   transactions
     contemplated by this Agreement.  Schedule 4.11(b) sets forth a complete and
     accurate  listing of all  Permits  required  for the  conduct  of  Seller's
     business,  except for those Permits,  the failure of which to obtain, would
     not reasonably be expected to have a Material Adverse Effect.


                                      -15-


(c)  Environmental.  Except as set forth on Schedule  4.11(c),  to Seller's  and
     Shareholders' Knowledge, no person or party (including, but not limited to,
     any  Governmental  Authority)  has  asserted  any claim or, to Seller's and
     Shareholders' Knowledge, has any basis for any action or proceeding against
     Seller relating to any violation of  Environmental  Law (as defined below),
     relating to any  existing  or prior act,  omission,  condition  or state of
     facts.  To Seller's and  Shareholders'  Knowledge,  Seller has not received
     oral or written notice of, nor does Seller or  Shareholders  have reason to
     believe  there is, any existing or pending  violation,  citation,  claim or
     complaint  relating  to the  business  of  Seller  or any  facility  now or
     previously owned or operated by Seller arising under any Environmental Law.
     For purposes of this Agreement, the term "Environmental Law" means federal,
     state and local environmental  statutes,  laws, ordinances,  orders, rules,
     regulations,  moratoria,  judgments and consent  decrees,  or any licenses,
     authorizations,  waivers, closures, or approvals required pursuant thereto,
     relating  to  human  health  and  the   environment,   including,   without
     limitation,  the Clean Air Act, as amended;  the  Federal  Water  Pollution
     Control  Act,  as amended;  the Safe  Drinking  Water Act, as amended;  the
     Resource  Conservation and Recovery Act, as amended; the Hazardous Material
     Transportation  Act, as amended;  the Occupational Safety and Health Act of
     1970, as amended; the Comprehensive  Environmental  Response,  Compensation
     and   Liability   Act,  as  amended  by  the   Superfund   Amendments   and
     Reauthorization Act of 1986, as amended.

4.12   Transactions with Affiliates.
       -----------------------------
Except as disclosed in Schedule  4.12,  no  Shareholder,  officer or director of
Seller,  nor any  "affiliate" or  "associate"  (as such terms are defined in the
rules and  regulations  of the  Securities  and  Exchange  Commission  under the
Securities Act of 1933, as amended) of any of the foregoing:

(a)  has been a party to any lease, sublease, contract,  agreement,  commitment,
     understanding or other  arrangement of any kind  whatsoever,  involving any
     such person and Seller;

(b)  owns directly or indirectly,  in whole or in part, any property that Seller
     uses or otherwise has rights in respect of; or

(c)  has any cause of  action or other  claim  whatsoever  against,  or owes any
     amount  to,  Seller  other  than  (i) for  compensation  (including  fringe
     benefits) to officers and employees  disclosed  pursuant to Section 4.7 and
     for reimbursement of ordinary and necessary expenses incurred in connection
     with employment by Seller; and (ii) as otherwise disclosed pursuant to this
     Agreement.

4.13   Accounts Receivable. Schedule 4.13
       -------------------- -------------
attached hereto sets forth all Accounts  Receivable in existence as of March 31,
2004 for Seller and all such Accounts  Receivable,  notes  receivable and claims
arising  from such date through  Closing,  represent  or will  represent,  valid
claims  against  the  obligors  thereof  which arose in the  ordinary  course of
business and no  entitlements to or claims of offset or reduction have been made
or exist except to the extent specifically set forth in Schedule 4.13.

4.14   Commissions.
       ------------
No person,  firm or  corporation  is entitled to any  commission  or broker's or
finder's fee in connection with the transactions  contemplated by this Agreement
by reason of any act or omission of Seller or Shareholders.


                                      -16-


4.15  Generally.
      ----------

(a)  No  representation  or warranty by Seller or Shareholders in this Agreement
     or in any  Exhibit,  Schedule  or closing  certificate  furnished  or to be
     furnished to Buyer  pursuant to this  Agreement or in  connection  with the
     transactions  contemplated  by this Agreement  contains or will contain any
     untrue  statement  of a  material  fact,  or omits or will  omit to state a
     material  fact,  necessary  to make the  statements  herein or therein  not
     misleading.

(b)  As used in this Agreement,  the term "Knowledge" shall mean, in the case of
     each Shareholder,  the  Shareholder's  actual awareness without the duty to
     investigate beyond what a reasonably prudent  shareholder would be expected
     to  discover,  and in the  case of  Seller,  the  actual  awareness  of the
     officers and directors of Seller without a duty to investigate  beyond what
     a reasonably prudent individual would be expected to discover in the course
     of carrying out the duties of his or her office.


                                   ARTICLE 5
                                   ---------

               REPRESENTATIONS AND WARRANTIES OF BUYER AND PARENT
               --------------------------------------------------

            Buyer and Parent hereby jointly and severally represent and warrant
to Seller and Shareholders as of the date of this Agreement as follows:

5.1   Status of Buyer.
      ----------------

(a)  Corporate  Existence and Status.  Buyer is a corporation duly incorporated,
     organized,  entitled  to conduct  business  and  validly  existing  in good
     standing under the laws of the State of Delaware.

(b)  Corporate  Power.  Buyer  has the  corporate  power  to own and  lease  its
     properties and otherwise to conduct its business.

(c)  Qualification.  Buyer is qualified to do business as a foreign  corporation
     in each  jurisdiction  in which the nature of or the manner in which  Buyer
     conducts its business,  the character or location of the  properties  which
     Buyer owns,  leases or uses or the actions or location of Buyer's employees
     or agents either  requires  Buyer to be qualified or subjects  Buyer to any
     cost,  restriction or penalty for failing to qualify (including  assessment
     of taxes, fees or penalties for prior periods).

(d)  Authorization.

     (i)  Buyer has the right,  power and authority to enter into this Agreement
          and the related  agreements  referred to herein to which it is a party
          and to consummate the  transactions  contemplated by, and otherwise to
          comply with and perform its obligations  under, this Agreement and the
          related agreements referred to herein;

     (ii) The execution and delivery by Buyer of this  Agreement and the related
          agreements  referred  to  herein  to which  Buyer  is a party  and the
          consummation by Buyer of the  transactions  contemplated by, and other
          compliance  with  and  performance  of  its  obligations  under,  this
          Agreement and the related agreements referred to herein have been duly
          authorized by all necessary  corporate  action on the part of Buyer in
          compliance  with  governing or applicable  agreements,  instruments or
          other   documents   (including   its   Articles  or   Certificate   of
          Incorporation and Bylaws (each as amended)) and applicable law; and


                                      -17-


     (iii)Each of this Agreement and the related  agreements  referred to herein
          to which Buyer is a party  constitutes the valid and binding agreement
          of Buyer that is  enforceable  against  Buyer in  accordance  with its
          terms.

(e)  Absence of  Violations  or  Conflicts.  The  execution and delivery of this
     Agreement by Buyer and the  consummation of the  transactions  contemplated
     by, or other compliance with or performance  under,  this Agreement and the
     related agreements  referred to herein do not and will not with the passage
     of time or giving of notice or both:

     (i)  constitute a violation of, be in conflict  with,  constitute a default
          or require any payment  under,  permit a termination  of,  require any
          consent  under,  or result in the creation or  imposition of any lien,
          encumbrance  or  other  adverse  claim  or  interest  upon  any of the
          properties  of  Buyer  under  (A) any  material  contract,  agreement,
          commitment,  undertaking or understanding to which Buyer is a party or
          to which  Buyer or any of its  assets or  properties  are  subject  or
          bound, (B) any judgment, decree or order of any governmental authority
          to which Buyer or any of its properties are subject or bound,  (C) any
          applicable  law,  or  (D)  any  governing  or  applicable  agreements,
          instruments  or other  documents to which Buyer is a party  (including
          Articles  or  Certificate  of   Incorporation   and  Bylaws  (each  as
          amended)); or

     (ii) create,  or cause  the  acceleration  of the  maturity  of,  any debt,
          obligation or liability of Buyer.

(f)  No  Governmental  Consents  Required.  No  consent,   approval,   order  or
     authorization  of,  or  registration,   declaration  or  filing  with,  any
     governmental  authority on the part of Buyer is required in connection with
     the  execution  or delivery of this  Agreement or the  consummation  of the
     transactions  contemplated  by,  or other  compliance  with or  performance
     under, this Agreement by Buyer.

5.2   Commissions and Fees.
      ---------------------
Except  for A.G.  Edwards & Sons,  Inc.,  whose fee will be paid by  Parent,  no
person,  firm or  corporation  is  entitled  to any  commission  or  broker's or
finder's fee in connection with the transactions  contemplated by this Agreement
by reason of any act or omission of Buyer or Parent.

5.3   Generally.
      ----------
No  representation  or warranty by Buyer in this  Agreement  or in any  Exhibit,
Schedule or closing certificate  furnished or to be furnished to Seller pursuant
to this Agreement or in connection  with the  transactions  contemplated by this
Agreement  contains or will contain any untrue  statement of a material fact, or
omits or will omit to state a material  fact,  necessary to make the  statements
herein or therein not misleading.


                                      -18-


                                   ARTICLE 6
                                   ---------

                               COVENANTS OF SELLER
                               -------------------

6.1   Conduct of Business by Seller.
      ------------------------------
From the date hereof to the Closing Date,  except for transactions  contemplated
by this  Agreement or which are expressly  approved in writing by Buyer,  Seller
shall refrain from and Shareholders shall ensure that Seller refrains from:

(a)  subjecting  any of the Purchased  Assets to any lien,  encumbrance or other
     claim of any kind;

(b)  modifying,  amending,  altering or terminating  (whether by written or oral
     agreement, or any manner of action or inaction) any of the Client Contracts
     or Assumed Contracts; and

(c)  taking  or  permitting  any  other  action  that,  if  taken  or  permitted
     immediately  prior to the execution of this Agreement,  would  constitute a
     breach of or an exception to the  representations and warranties in ARTICLE
     4 hereof or the covenants in ARTICLE 6 and ARTICLE 7 hereof.

6.2   Affirmative Covenants Relating to Seller and Shareholders.
      ----------------------------------------------------------
From the date  hereof to the Closing  Date,  Seller and  Shareholders  shall use
their reasonable best efforts to ensure that Seller shall:

(a)  maintain Seller's  property and professional  insurance in amounts and with
     coverage  at least as great as the  amounts  and  coverage in effect on the
     date of this Agreement;

(b)  keep in Seller's employ the present  officers and key employees,  including
     the professional  staff, of Seller to preserve the goodwill of those having
     business relations with Seller;

(c)  maintain the books,  accounts and records of Seller in a manner  consistent
     with past practice;

(d)  allow,  upon the  prior  consent  of  Seller,  which  consent  shall not be
     unreasonably withheld,  Buyer and Buyer's employees,  attorneys,  auditors,
     accountants  and other  authorized  representatives,  free and full  access
     during  Seller's   normal   business  hours  to  the  facilities,   plants,
     properties,   books,  records,  documents  and  correspondence  of  Seller,
     including,  but not  limited  to,  historical  financial  information  with
     respect  to the Client  Contracts  and  Assumed  Contracts  and  employment
     records  with respect to the  Retained  Employees,  in order that Buyer may
     have full opportunity to make such investigation as Buyer may desire of the
     Business;  provided,  however,  that such  access  shall  not  unreasonably
     interfere   with   the   operations   of   Seller,   and  any   contractual
     confidentiality  requirements  between  Buyer and  Seller  or  Shareholders
     existing prior to this Agreement shall remain in full force and effect,  as
     supplemented  hereby,  except as otherwise  required by law  (including any
     required disclosure of the execution of this Agreement);

(e)  (i) comply with all applicable law relating to Seller, or to the conduct of
     the  Business,  and (ii) conduct such  Business in such a manner so that on
     the Closing  Date the  representations  and  warranties  contained  in this
     Agreement  shall be  materially  true as though  such  representations  and
     warranties were made on and as of such date,  except for changes  permitted
     or contemplated by the terms of this Agreement;


                                      -19-


(f)  provide  Buyer with  prompt  written  notice of any  change in the  assets,
     operations,  liabilities,  earnings,  business or condition  (financial  or
     otherwise) of Seller which would have a Material Adverse Effect; and

(g)  operate the  Business  only in the  ordinary  course with the  objective of
     preserving Seller's business organizations intact, including using its best
     efforts to retain the services of Seller's  present  officers and employees
     and the goodwill of its customers and others having business relations with
     Seller.

6.3   Consents and Closing Conditions.
      --------------------------------
Seller and  Shareholders  shall use their  reasonable best efforts (a) to obtain
such third party and governmental consents, authorizations,  approvals, releases
and terminations as may be required hereunder, and to take such other actions as
may be  appropriate  in order to fulfill the  closing  conditions  contained  in
Section 8.1  hereof,  and (b) to cause the  representations  and  warranties  of
Seller in ARTICLE 4 to be true and correct on and as of the Closing Date.

6.4   Obligations Concerning Employees.
      ---------------------------------

(a)  From the date hereof  through the Closing Date,  Buyer shall have the right
     upon  reasonable  notice to Seller during normal business hours and without
     undue  disruption  of the  operation  of the  Business,  to  interview  the
     employees of Seller,  perform drug tests on said  employees  and  otherwise
     conduct  hiring  procedures  with  regard  to its  possible  hiring  of the
     employees  of Seller.  Subject to the  satisfactory  completion  of Buyer's
     employment  screening  process,  Buyer shall offer employment at Closing to
     the  employees  of  Seller  listed  on  Schedule   6.4(a)  (the   "Retained
     Employees").

(b)  On or prior  to the  Closing  Date,  at such  time as  shall be  reasonably
     acceptable  to Buyer,  Seller shall  notify all of the  employees of Seller
     that the  assets of  Seller  are being  sold to  Buyer,  that the  Retained
     Employees  will be offered  employment by Buyer,  and that any decisions by
     Buyer regarding its hiring  procedures or the hiring of Seller's  employees
     will be communicated to the employees by Buyer.

(c)  As soon as  practicable  after the Closing Date,  Seller shall issue to all
     employees of Seller as of the Closing Date payroll  checks,  for all earned
     salary, wages,  incentive bonuses,  accrued sick pay, vacation or paid time
     off and other compensation and benefits (net of usual withholdings) owed or
     accruing to such employees for their services  rendered  through 11:59 p.m.
     on the Closing Date.

(d)  Seller shall comply with all  provisions  of federal and state law relating
     to the continuation of health insurance benefits for terminated  employees.
     Seller shall be responsible for providing Worker  Adjustment and Retraining
     Notification Act, 29 U.S.C. ss. 2101 et. seq. ("WARN Act") notices,  if and
     to the extent  required,  in connection  with any  terminations of Seller's
     employees  effected  pursuant  to  this  Agreement,  and  shall  be  solely
     responsible for, and will, hold Buyer harmless from, any WARN Act liability
     arising as a result of any  employee  termination(s)  occurring on or after
     the Closing Date.

6.5   Negotiations with Others.
      -------------------------
During the period from the date of this  Agreement to the Closing Date, or until
such date as this  Agreement may be  terminated  in  accordance  with its terms,
neither  Seller  nor  any of  Seller's  members,  managers,  officers,  counsel,
accountants, auditors or other agents retained by or acting on behalf of Seller,
will (i) seek, solicit,  initiate,  encourage or otherwise facilitate (including
by way of furnishing  information)  the  submission  of inquiries,  proposals or
offers from any corporation, partnership, person or other entity or group (other


                                      -20-


than Buyer) relating to the possible acquisition of stock or equity interests of
Seller or the possible  purchase of all or  substantially  all of the  Purchased
Assets, or any tender or exchange offer, merger, reverse merger,  consolidation,
business combination,  recapitalization,  spin-off, liquidation, dissolution, or
similar  transaction  involving,   directly  or  indirectly,   Seller  (each  an
"Acquisition  Proposal"),  (ii)  enter  into,  participate  or  cooperate  in or
consider or pursue any discussions or negotiations  regarding or that reasonably
may be expected to lead to an  Acquisition  Proposal or furnish to any person or
entity   information   concerning   Seller  for  purposes  of  facilitating  any
Acquisition  Proposal,  or (iii) otherwise solicit or cooperate in any way with,
or assist,  participate in, facilitate or encourage any effort or attempt by any
person to make or enter into an Acquisition Proposal.  Seller shall notify Buyer
in writing  within 24 hours  following  receipt of any  unsolicited  Acquisition
Proposal  or  request  for  information  from  any  third  party.  Such  written
notification  shall  describe  in  reasonable  detail  any such  occurrence  and
identify the person or persons involved.

6.6   Employment Agreements.
      ----------------------
John H. Short, Ph.D. shall enter into a Termination  Compensation Agreement with
Parent on or before the Closing Date, such agreement to be in substantially  the
form set forth as Exhibit C hereto and  incorporated  herein by  reference  (the
"Short Employment Agreement"). Each other Shareholder and each associate partner
of Seller  shall enter into an  Employment  Agreement  with Buyer on the Closing
Date in  substantially  the form set forth as Exhibit D hereto and  incorporated
herein by reference (the "Phase 2 Employment Agreements").

6.7   Disposition of Performance Bonus Pursuant to Consulting Agreement.
      ------------------------------------------------------------------
Seller and  Shareholders,  on the one hand, and Parent and Buyer,  on the other,
agree that after the Closing Date, the  performance  bonus due Seller under that
certain letter agreement for consulting services effective as of June 3, 2003 by
and between  Seller and Parent (the  "Consulting  Letter") for the first quarter
2004, if any,  shall be computed and paid to  Shareholders  by Parent as soon as
practicable  after  such  computation.  No  performance  bonuses  for any period
subsequent  to the first  quarter of 2004 shall be computed or paid to Seller or
Shareholders.


                                   ARTICLE 7
                                   ---------

                         COVENANTS REGARDING TAX MATTERS
                         -------------------------------

7.1   Returns and Payment of Taxes.
      -----------------------------
Each party shall be  responsible  for filing  Forms W-2 with respect to the 2004
taxable year in accordance with the "Standard Procedure" described in Rev. Proc.
96-60,  1996-2.C.B.  399. The responsibility  for all other information  Returns
shall be allocated  similarly.  Seller shall be  responsible  for payment of any
sales  or use tax  liability  or  other  Taxes  resulting  from  the sale of the
Purchased Assets as contemplated by this Agreement.

7.2   Cooperation and Records Retention.
      ----------------------------------
Seller shall cause its accountants and other representatives to provide to Buyer
on a timely basis the information  (including but not limited to all work papers
and  records  relating  to  Seller)  that  Seller  or its  accountants  or other
representatives  have within their control and that may be reasonably  necessary
in connection with the  preparation of any and all Returns  required to be filed
by Buyer or any other  examination  by any taxing  authority  or  administrative
proceeding  relating to Taxes.  Seller agrees that it will cooperate with Buyer,
its accountants and its other representatives, in a prompt and timely manner, in
connection with the preparation and filing of any and all Returns required to be
filed  by  Buyer  or  any  other   examination   by  any  taxing   authority  or
administrative  proceeding  relating to Taxes.  Seller and Buyer shall retain or
cause to be retained,  until the applicable  statutes of limitations  (including
any extensions and carryovers)  have expired,  copies of all Returns for all tax
periods  beginning  before the  Closing  Date,  together  with  supporting  work
schedules and other records or information that may be relevant to such Returns.


                                      -21-


7.3   Employee Benefit Plans.
      -----------------------

(a)  401(k) Plan.  The parties agree as follows with respect to the 401(k) Plan:
     (i) Buyer shall (A) assume  sponsorship  of the 401(k) Plan effective as of
     the Closing  Date,  (B)  continue  the 401(k)  Plan for the maximum  period
     permitted under Code section 410(b)(6)(C),  and (C) fund the 401(k) Plan on
     substantially  the same terms as past practice;  provided,  however,  in no
     event  shall the 401(k)  Plan be  operated in a manner that would cause the
     401(k) Plan to lose its tax-qualified status; (ii) the 401(k) Plan shall be
     amended to provide that (A) Seller shall make a contribution  to the 401(k)
     Plan for all eligible  employees of Seller who are employed by Seller as of
     the day  immediately  preceding  the  Closing  Date based on such  eligible
     employee's  compensation  paid  during  the  current  plan  year  up to and
     including the day  immediately  prior to the Closing Date,  (B) Buyer shall
     make a contribution to the 401(k) Plan for all eligible employees of Seller
     who are employed by Buyer as of December 31, 2004 based on the compensation
     of such  eligible  employees  from  the  Closing  Date up to and  including
     December 31, 2004; provided,  however, that the aggregate  contribution for
     any participant for the plan years commencing on January 1, 2004 and ending
     on December 31, 2005 shall be substantially the same as past practice,  (C)
     this transaction does not constitute a severance of employment and will not
     permit participants to receive a distribution from the 401(k) Plan, and (D)
     any other modifications deemed necessary by Buyer or required by the IRS to
     maintain the 401(k) Plan's tax-qualified status.

(b)  Health  Plan.  Subject to the consent of the  insurance  company  providing
     benefits under the Health Plan,  Buyer agrees to assume  sponsorship of the
     Health  Plan and to  continue  its  coverage  for the plan  year  after the
     current plan year, provided that the costs to Parent increase at no greater
     rate than the costs associated with Parent's other health care plans.


                                   ARTICLE 8
                                   ---------

                             CONDITIONS TO CLOSING
                             ---------------------

8.1   Buyer's Conditions to Closing.
      ------------------------------

The  obligations of Buyer to consummate the  transactions  contemplated  by this
Agreement shall be subject to the fulfillment to Buyer's reasonable satisfaction
of each of the following conditions on or prior to the Closing Date:

(a)  Continued Truth of Warranties.  The  representations and warranties of each
     of Seller and  Shareholders  contained herein shall be true in all respects
     on and as of the Closing Date with the same force and effect as though made
     as of such date, except for any variations permitted by this Agreement.

(b)  Performance  of  Covenants.  Each of Seller  and  Shareholders  shall  have
     performed in all respects all covenants and obligations and complied in all
     respects with all conditions  required by this Agreement to be performed or
     complied with by it and them on or prior to the Closing Date.

(c)  No Material Adverse Effect.  There shall have been no change in the assets,
     operations,  liabilities,  earnings,  business or condition  (financial  or
     otherwise)  of Seller  having a Material  Adverse  Effect on the  Purchased
     Assets or the Business since the date of the Reference Balance Sheet.


                                      -22-


(d)  Permits and Consents. The parties hereto shall have secured all appropriate
     orders,  consents,   approvals  and  clearances,   in  form  and  substance
     satisfactory to Buyer, by and from all third parties  reasonably  requested
     by Buyer,  including  but not limited to  governmental  authorities,  whose
     order,  consent  and  approval  or  clearance  is  required  by contract or
     applicable   law  for  the   consummation   of  the   transactions   herein
     contemplated.

(e)  Action or Proceeding.  No action or proceeding  before a court of any other
     governmental  agency or body shall have been instituted or threatened which
     would restrain or prohibit the transactions contemplated by this Agreement.

(f)  Fairness  Opinion.  The  disinterested  members  of the  Parent's  Board of
     Directors  shall have  received  a written  opinion  from  their  financial
     advisor for the asset purchase transaction  contemplated in this Agreement,
     A.G.  Edwards & Sons,  Inc., to the effect that the  consideration  paid in
     such transaction is fair to Parent from a financial point of view.

(g)  Closing Documents. Each of Seller and Shareholders shall have delivered all
     documents  required to be delivered  by it or them at the Closing,  as more
     specifically  set forth in  ARTICLE  9, in each case in form and  substance
     satisfactory to Buyer.

8.2   Seller's and Shareholders' Conditions to Closing.
      -------------------------------------------------
The  obligations  of Seller and  Shareholders  to  consummate  the  transactions
contemplated  by this Agreement  shall be subject to the fulfillment to Seller's
and  Shareholders'  reasonable  satisfaction  of the following  conditions on or
prior to the Closing Date:

(a)  Continued Truth of Warranties.  The representations and warranties of Buyer
     herein  contained  shall be true in all material  respects on and as of the
     Closing Date with the same force and effect as though made as of such date,
     except for any variations permitted by this Agreement.

(b)  Performance  of  Covenants.  Buyer  shall have  performed  in all  material
     respects  all  covenants  and  obligations  and  complied  in all  material
     respects with all conditions  required by this Agreement to be performed or
     complied with by it on or prior to the Closing Date.

(c)  Permits and Consents. The parties hereto shall have secured all appropriate
     orders,  consents,   approvals  and  clearances,   in  form  and  substance
     reasonably  satisfactory to Seller and Shareholders,  by and from all third
     parties,  including  but not  limited to  governmental  authorities,  whose
     order, consent, approval or clearance is required by contract or applicable
     law for the consummation of the transactions herein contemplated.

(d)  Action  or  Proceeding.  No  action  or  proceeding  before  a court of any
     governmental  agency or body shall have been instituted or threatened which
     would restrain or prohibit the transactions contemplated by this Agreement.

(e)  Closing  Documents.  Buyer shall have  delivered the Purchase Price and all
     documents  required  to  be  delivered  by  it  at  the  Closing,  as  more
     specifically  set  forth in  ARTICLE  9, in form and  substance  reasonably
     satisfactory to each of Seller and Shareholders.


                                      -23-


                                   ARTICLE 9
                                   ---------

                      DOCUMENTS TO BE DELIVERED AT CLOSING
                      ------------------------------------

9.1   Documents to be Delivered by Seller.  At the Closing, Seller shall:
      ------------------------------------
(a)  Execute and deliver to Buyer any and all  instruments  of sale,  assignment
     and transfer and other documents  reasonably requested by Buyer in order to
     effect  the  transfer  of the  Purchased  Assets  to Buyer,  to effect  the
     assumption of the Assumed  Liabilities  by Buyer or otherwise to facilitate
     the transactions contemplated hereby;

(b)  Deliver to Buyer a certificate of incumbency and copies of the  resolutions
     adopted by the board of directors of Seller and  Shareholders,  authorizing
     the execution and delivery of this  Agreement and the  consummation  of the
     transactions  contemplated hereby, duly certified as of the Closing Date by
     the Secretary of Seller;

(c)  Deliver to Buyer a certificate of Seller,  dated as of the Closing Date, to
     the  effect  that  the   representations   and  warranties  of  Seller  and
     Shareholders  as  contained  in  ARTICLE 4 of this  Agreement  are true and
     correct  as of such  Closing  Date,  and that the  covenants  of  Seller as
     contained  in  ARTICLE 6 and  ARTICLE 7 of this  Agreement  required  to be
     performed  or complied  with on or prior to the  Closing  Date have been so
     performed or complied with;

(d)  Deliver to Buyer a certificate  of good standing or its  equivalent,  dated
     not more than ten (10) days prior to the  Closing  Date,  attesting  to the
     good  standing  of Seller as a  corporation  under the laws of the State of
     Utah;

(e)  To the extent any assignments,  consents or approvals shall be necessary to
     any of the transactions herein  contemplated,  including but not limited to
     the transfer of the Contracts from Seller to Buyer, deliver to Buyer copies
     of all such assignments, consents or approvals; and

(f)  Deliver to Buyer the definitive Short Employment  Agreement and the Phase 2
     Employment Agreements duly executed by all parties thereto.

9.2   Documents to be Delivered by Buyer.  At the Closing, Buyer shall:
      ----------------------------------
(a)  Execute and deliver to Seller any and all  documents  identified in Section
     9.1(a),  to the  extent  appropriate  in order to effect  the  transactions
     contemplated hereby;

(b)  Deliver to Seller a certificate of Buyer,  dated as of the Closing Date, to
     the effect that the representations and warranties of Buyer as contained in
     ARTICLE 5 of this Agreement are true and correct as of such Closing Date;

(c)  To the extent any  consents or  approvals  shall be necessary to any of the
     transactions  herein  contemplated,  Buyer  shall  deliver  to Seller  upon
     request copies of all such consents or approvals as obtained by Buyer;

(d)  Deliver to Seller the Purchase Price;

(e)  Deliver to Seller the definitive Short Employment Agreement and the Phase 2
     Employment Agreements duly executed by all parties thereto.


                                      -24-


                                   ARTICLE 10
                                   ----------

                                 INDEMNIFICATION
                                 ---------------

10.1   Indemnification of Buyer.
       -------------------------
Subject to the  provisions  of this Article 10, by execution of this  Agreement,
Shareholders   hereby  acknowledge  that  each  Shareholder  shall  jointly  and
severally  indemnify  Buyer  and its  officers,  directors,  employees,  agents,
representatives,  affiliates,  successors and assigns (collectively,  the "Buyer
Parties")  and hold each of them  harmless from and against and pay on behalf of
or reimburse such Buyer Parties in respect of the following:

(a)  any and all loss,  liability or damage (including  judgments and settlement
     payments) (a "Loss"),  incurred by Buyer incident to, arising in connection
     with or resulting from any  misrepresentation,  breach,  nonperformance  or
     inaccuracy  of any  representation,  warranty  or  covenant  of  Seller  or
     Shareholders  made  or  contained  in  this  Agreement  or in any  Exhibit,
     Schedule,  certificate or other document executed and delivered to Buyer by
     Shareholders  or by or on  behalf  of  Seller  under  or  pursuant  to this
     Agreement or the transactions contemplated herein;

(b)  any Excluded Liability;

(c)  any and all reasonable  costs and expenses and all other Losses incurred in
     claiming,   contesting   or   remedying   any  breach,   misrepresentation,
     nonperformance  or  inaccuracy  described  in  this  Section  10.1,  or  in
     enforcing  the  Buyer  Parties'   rights  to   indemnification   hereunder,
     including, by way of illustration and not limitation,  all reasonable legal
     and accounting fees, other reasonable  professional expenses and all filing
     fees  and  reasonable  collection  costs  incident  thereto  and  all  such
     reasonable fees, costs and expenses  incurred in defending claims which, if
     successfully prosecuted, would have resulted in a Loss.

Buyer's remedy for any  indemnification  of Losses hereunder may be satisfied by
proceeding  against one or more of the Shareholders  individually for all or any
portion of such Loss.  Notwithstanding the preceding  sentence,  Buyer agrees to
use commercially  reasonably  efforts to pursue its remedies against each of the
Shareholders individually in a manner consistent with the amount of the Purchase
Price distributed to each Shareholder by Seller hereunder.

10.2   Indemnification of Shareholders.
       --------------------------------
Subject to the  provisions  of this Article 10, by execution of this  Agreement,
Buyer hereby  acknowledges  that Buyer shall indemnify each Shareholder and each
of their respective agents, representatives,  affiliates, successors and assigns
(collectively,  the "Seller  Parties")  and hold each of them  harmless from and
against and pay on behalf of or reimburse  such Seller Parties in respect of the
following

(a)  any and all  Losses  incurred  by  Shareholders  incident  to,  arising  in
     connection   with  or  resulting   from  any   misrepresentation,   breach,
     nonperformance or inaccuracy of any representation, warranty or covenant by
     Buyer made or  contained in this  Agreement  or in any  Exhibit,  Schedule,
     certificate or other  document  executed and delivered to  Shareholders  by
     Buyer;

(b)  the Assumed Liabilities;

(c)  any  liability or obligation  relating to the Business or Purchased  Assets
     arising out of any event or occurrence arising after the Closing Date; and


                                      -25-


(d)  any and all  reasonable  costs and  expenses  and all  Losses  incurred  in
     claiming,   contesting   or   remedying   any  breach,   misrepresentation,
     nonperformance  or  inaccuracy  described  in  this  Section  10.2,  or  in
     enforcing  the  Seller  Parties'  rights  to   indemnification   hereunder,
     including, by way of illustration and not limitation,  all reasonable legal
     and accounting fees, other reasonable  professional expenses and all filing
     fees  and  reasonable  collection  costs  incident  thereto  and  all  such
     reasonable fees, costs and expenses  incurred in defending claims which, if
     successfully prosecuted, would have resulted in a Loss.

10.3  Notice of and Procedures for Collecting Indemnification.
      -------------------------------------------------------

(a)  Initial Claim Notice.  When either Buyer, on the one hand, or Shareholders,
     on the other hand, becomes aware of a situation which may result in damages
     for which it or they would be entitled to be indemnified hereunder,  Buyer,
     on the one hand, or  Shareholders,  on the other (the  "Indemnitee")  shall
     submit  promptly a written notice (the "Initial Claim Notice") to the other
     party from which  indemnification  may be  forthcoming  pursuant to Section
     10.1 or 10.2 (the  "Indemnitor")  to such effect after first becoming aware
     of such matter and shall furnish the Indemnitor with such information as is
     available  demonstrating a right or possible right to receive indemnity. If
     the potential  claim is predicated on, or later results in, the filing by a
     third party of any action at law or in equity (a "Third Party Claim"),  the
     Indemnitee shall provide promptly to the Indemnitor a supplemental  Initial
     Claim Notice not later than twenty (20)  calendar days prior to the date on
     which a responsive pleading must be filed, and shall also furnish a copy of
     such claim (if made in  writing)  and of all  documents  received  from the
     third party in support of such  claim.  In  addition,  each  Initial  Claim
     Notice shall name, when known,  the person or persons making the assertions
     which are the basis for such claim. Failure by the Indemnitee to deliver an
     Initial  Claim  Notice or an update  thereof in a timely  manner  shall not
     relieve  the  Indemnitor  of any of its  obligations  under this  Agreement
     except to the extent of actual and material prejudice to the Indemnitor.

(b)  Rights of Indemnitor.  If, prior to the expiration of 30 calendar days from
     the mailing of an Initial  Claim Notice (the "Claim  Answer  Period"),  the
     Indemnitor  shall request in writing that such claim not be paid,  the same
     shall not be paid, and the Indemnitor shall settle,  compromise or litigate
     in good faith such  claim,  and  employ  attorneys  of its choice to do so;
     provided,  however,  that Indemnitee  shall not be required to refrain from
     paying any claim  which has  matured by court  judgment  or decree,  unless
     appeal is taken  therefrom and proper appeal bond posted by the Indemnitor,
     nor shall it be required to refrain from paying any claim where such action
     would  result  in the  foreclosure  of a lien  upon any of its  assets or a
     default in a lease or other contract except a lease or other contract which
     is the subject of the dispute. The Indemnitee shall cooperate fully to make
     available to the Indemnitor and its attorneys,  representatives and agents,
     all pertinent  information under its control. The Indemnitee shall have the
     right to elect to settle or  compromise  all other  contested  claims  with
     respect to which the  Indemnitor  has not,  within the Claim Answer Period,
     acknowledged  in writing (i) liability  therefor,  and (ii) its election to
     assume full responsibility for the settlement,  compromise,  litigation and
     payment of such claim.

(c)  Final Claims Statement. At such time as damages for which the Indemnitor is
     liable hereunder are incurred by Indemnitee by actual payment thereof or by
     entry of a final  judgment,  the  Indemnitee  shall  forward a Final Claims
     Statement  to the  Indemnitor  setting  forth the amount of such damages in
     reasonable detail on an itemized basis. The Indemnitee shall supplement the
     Final Claims Statement with such supporting  proof of loss (e.g.  vouchers,
     canceled checks,  accounting  summaries,  judgments,  settlement agreement,
     etc.) as the  Indemnitor  may  reasonably  request in writing within thirty
     (30) calendar days after receipt by Indemnitor of a Final Claims Statement.
     All amounts  reflected on Final Claims Statements shall be paid promptly by
     the Indemnitor to the Indemnitee and the Indemnitee shall have the right to
     immediate payment of proceeds from insurance policies paid to Indemnitor in
     connection with the claim for which the indemnification right arose.


                                      -26-


10.4   Payment of Claims for Indemnification.
       --------------------------------------
Any amounts payable to Buyer Parties  pursuant to the provisions of Section 10.1
shall be the  responsibility  of Shareholders.  Any additional  amounts shall be
paid promptly upon notice of Buyer to  Shareholders  of incurrence of such loss,
liability,  cost, expense or damage and an explanation of the losses for Buyer's
demand for  indemnification  under  Article 10 of this  Agreement.  Any  amounts
payable to Seller  Parties  pursuant to the  provisions  of Section 10.2 of this
Agreement shall be the  responsibility  of Buyer and shall be paid promptly upon
notice of  Shareholders  to Buyer of incurrence of such loss,  liability,  cost,
expense or damage and an explanation of the losses for Shareholders'  demand for
indemnification under Section 10.2 of this Agreement.

10.5   Exclusive Remedy.
       -----------------
The sole and  exclusive  remedy  of the Buyer  Parties  and the  Seller  Parties
hereunder,  under the Agreement or otherwise in connection with the transactions
contemplated hereby will be restricted to the  indemnification  rights set forth
in this Article 10.

10.6   Certain Limitations.
       --------------------

(a)  The representations and warranties  contained in Sections 4.3 (Taxes),  4.8
     (Employee And Fringe Benefits),  and 4.11(a) and (c) (Compliance with Laws)
     shall survive until ninety (90) days after the expiration of the statute of
     limitations period applicable  thereto.  The representations and warranties
     contained  in  Sections  4.1 (Status of Seller),  4.14  (Commissions),  5.1
     (Status  of  Buyer)  and  5.2   (Commissions   and  Fees)   shall   survive
     indefinitely.  There shall be no time  limitations  on claims for indemnity
     based upon the payment by the party seeking indemnification of any Excluded
     Liability or Assumed  Liability  that is the  obligation of the other party
     under this Agreement.  All other representations and warranties,  covenants
     and agreements  contained in this  Agreement  shall survive until the first
     anniversary of the Closing Date provided that any representation, warranty,
     covenant or agreement  with respect to which  indemnity may be sought under
     this Article 10 shall survive the time that it would otherwise terminate if
     notice of the breach  thereof  giving rise to the right to indemnity  shall
     have been given to the party  against  which  indemnity  is sought prior to
     such date.

(b)  No damages  shall be  recoverable  by the Seller  Parties or Buyer  Parties
     pursuant to the  provisions of this Article 10, and no claim  therefor will
     be asserted for any purpose whatsoever hereunder,  unless the amount of the
     Seller  Parties' or Buyer  Parties',  as the case may be, damages equals at
     least Fifty Thousand and 00/100 Dollars  ($50,000.00)  in the aggregate but
     upon  exceeding  Fifty  Thousand  and 00/100  Dollars  ($50,000.00)  in the
     aggregate,  the  party  seeking  indemnification  shall be  entitled  to be
     indemnified from the first dollar.

(c)  The aggregate amount of damages recoverable pursuant to this Article 10 for
     breaches of  representations  and warranties will be limited to One Million
     Five Hundred Thousand and 00/100 Dollars  ($1,500,000.00).  Such limitation
     shall not apply to claims for indemnity based upon the payment by the party
     seeking indemnification of any Excluded Liability or Assumed Liability that
     is the  obligation of the other party under this  Agreement or to any claim
     in which the party seeking  indemnification  has  established  fraud and/or
     intentional misrepresentation.


                                      -27-


(d)  The amount which any Indemnitor is or may be required to pay any Indemnitee
     pursuant to this Article 10 shall be reduced by any  insurance  proceeds or
     other  amounts  actually  recovered by or on behalf of such  Indemnitee  in
     reduction of the related  Loss.  If an  Indemnitee  shall have received the
     payment  required by this Agreement from an Indemnitor in respect of a Loss
     and shall subsequently actually receive insurance proceeds or other amounts
     in respect of such Loss, then such Indemnitee  shall pay to such Indemnitor
     a sum  equal to the  amount of such  insurance  proceeds  or other  amounts
     actually received (net of any expenses in obtaining the same).

                                   ARTICLE 11
                                   ----------

                                  MISCELLANEOUS
                                  -------------

11.1   Notices.
       --------
Any notices or other communications required or permitted hereunder to any party
hereto shall be  sufficiently  given if delivered in person or sent by certified
or registered mail, postage prepaid, addressed as follows:

                  In the case of Buyer:

                        RehabCare Group, Inc.
                        7733 Forsyth Boulevard, Suite 2300
                        St. Louis, Missouri  63105
                        Attn: H. Edwin Trusheim, Chairman of the Board

                  With a copy to:

                        Thompson Coburn LLP
                        One US Bank Plaza
                        St. Louis, Missouri  63101
                        Attn: Robert M. LaRose, Esq.

                  In the case of Seller and Shareholders:

                        Phase 2 Consulting, Inc.
                        2120 South 2100 East, 3rd Floor
                        Salt Lake City, Utah 84101
                  Attn: John H. Short, Ph.D., Managing Director

                  With a copy to:

                        Jones, Waldo, Holbrook & McDonough
                        170 South Main Street, Suite 1500
                        Salt Lake City, Utah 84101
                        Attn: Bruce E. Babcock, Esq.

or such substituted address as any party shall have given notice to the others
in writing in the manner set forth in this Section 11.1.


                                      -28-


11.2   Amendment.
       ----------
This  Agreement  may be  amended  or  modified  in whole  or in part  only by an
agreement  in  writing  executed  by all  parties  hereto  and  making  specific
reference to this Agreement.

11.3   Waiver; Investigation.
       ----------------------
The  parties  hereto  may,  by  written  agreement:  (a) extend the time for the
performance of any of the obligations or other acts of the parties  hereto;  (b)
waive any inaccuracies in the representations  contained in this Agreement;  (c)
waive compliance with, or modify,  any of the covenants or conditions  contained
in this Agreement; and (d) waive or modify performance of any of the obligations
of any of the parties hereto; provided,  however, that no such waiver or failure
to insist upon strict  compliance with such obligation,  covenant,  agreement or
condition  shall  operate as a waiver of, or an  estoppel  with  respect to, any
subsequent insistence upon such strict compliance other than with respect to the
matter so waived or modified.  Buyer  acknowledges that its officers,  employees
and  authorized  representatives  and agents have been given an  opportunity  to
examine the agreements, instruments, documents and other information relating to
Seller that they have  requested to examine.  Any  inspection,  preparation,  or
compilation of information or Schedules, or audit of the receivables,  payables,
properties,  financial condition,  or other matters relating to Seller conducted
by or on behalf  of Buyer  pursuant  to this  Agreement  shall in no way  limit,
affect,  or  impair  the  ability  of  Buyer to rely  upon the  representations,
warranties,  covenants,  and  agreements  of  Seller  set  forth  herein or seek
indemnification for any matter as set forth in ARTICLE 10 hereof.

11.4   Termination.
       ------------
This Agreement may be terminated by the parties hereto prior
to Closing as follows:

(a)  by mutual written consent of Buyer, Seller and Shareholders;

(b)  upon  written  notice from Buyer to Seller and  Shareholders  if any of the
     conditions  precedent to Buyer's  obligations  hereunder  shall have become
     incapable of fulfillment through no fault of Buyer;

(c)  upon written  notice from  Shareholders  to Buyer if any of the  conditions
     precedent to Seller's or  Shareholders'  obligations  hereunder  shall have
     become incapable of fulfillment through no fault of Seller or Shareholders,
     as the case may be;

(d)  by Buyer, on the one hand, or Seller and  Shareholders,  on the other hand,
     in the  event of a breach  by the  other  party  to this  Agreement  of any
     representation, warranty or agreement contained herein, which breach is not
     cured to the  reasonable  satisfaction  of the  non-breaching  party within
     fifteen (15)  business days after  written  notice  thereof is given to the
     breaching  party  by  the  non-breaching  party  or is  not  waived  by the
     non-breaching party during such period; or

(e)  at the election of Buyer or Seller and  Shareholders if the Closing has not
     occurred on or prior to June 30 2004.

In the  event of such  termination  as  provided  above,  this  Agreement  shall
forthwith  terminate  and  there  shall  be no  liability  on the part of any of
Shareholders, Seller or Buyer or their respective officers and directors, except
for  liabilities  arising  from  a  breach  of  this  Agreement  prior  to  such
termination;  provided,  however,  that the  provisions  of the  confidentiality
agreement between the parties shall continue in full force and effect.


                                      -29-


11.5   Counterparts.
       -------------
This Agreement may be executed in one or more  counterparts,  all of which taken
together shall constitute one instrument.

11.6   Binding on Successors and Assigns.
       ----------------------------------
This Agreement shall be binding upon, inure to the benefit of and be enforceable
by and against the parties hereto and their respective successors and assigns in
accordance with the terms hereof.  No party hereto may assign its interest under
this Agreement  without the prior written  consent of the other parties  hereto;
provided, however, that Buyer may assign its interest herein to any affiliate or
subsidiary  of  Buyer   without   obtaining  the  prior  consent  of  Seller  or
Shareholders.

11.7   Severability.
       -------------
In the event that any one or more of the provisions  contained in this Agreement
or any application  thereof shall be invalid,  illegal or  unenforceable  in any
respect, the validity, legality or enforceability of the remaining provisions of
this  Agreement  and  any  other  application  thereof  shall  not in any way be
affected or impaired thereby; provided, however, that to the extent permitted by
applicable  law,  any  invalid,  illegal,  or  unenforceable  provision  may  be
considered  for  the  purpose  of  determining  the  intent  of the  parties  in
connection with the other provisions of this Agreement.

11.8   Headings.
       ---------
The  headings in the  sections  and  subsections  of this  Agreement  and in the
Schedules are inserted for convenience only and in no way alter, amend,  modify,
limit or restrict the contractual obligations of the parties.

11.9   Expenses of Litigation.
       -----------------------
In the event of any litigation  arising from the breach of this  Agreement,  the
prevailing  party in such  litigation  shall be entitled  to recover  reasonable
attorneys' fees and costs, including appeals.

11.10   List of Exhibits and Schedules.
        -------------------------------
As mentioned in this Agreement, there are attached hereto or delivered herewith,
the following Exhibits and Schedules:

                                    EXHIBITS
                                    --------
                                                         Section
  Exhibit            Document                           Reference
  -------            --------                           ---------

     A               Articles of Incorporation            4.1(b)
     B               Bylaws                               4.1(b)
     C               Short Employment Agreement           6.6 and 9.1(f)
     D               Phase 2 Employment Agreements        6.6 and 9.1(f)

                                    SCHEDULES
                                    ---------
  Schedule
     No.             Schedule Caption
  --------           ----------------

   1.1(a)(i)         Client Accounts and Contracts
   1.1(a)(ii)        Leases
   1.1(a)(iii)       Personal Property
   1.1(a)(iv)        Assumed Contracts
   1.1(a)(vi)        Intellectual Property
   1.3               Balance Sheet
   4.1(e)            Foreign Qualifications
   4.1(g)            Violations or Conflicts
   4.2               Seller Financial Statements


                                      -30-


   4.3(b)            Tax Matters
   4.4(a)            Title to Purchased Assets
   4.4(b)            Leases
   4.4(c)            Adequacy
   4.5               Exceptions to Intellectual Property
   4.6(a)            Indebtedness
   4.6(b)            Client Account Notices
   4.6(c)            Insurance
   4.6(d)            Status
   4.7               Officers and Directors
   4.8               Employee and Fringe Benefit Plans
   4.10              Litigation
   4.11(a)           Compliance with Laws
   4.11(b)           Permits
   4.11(c)           Environmental
   4.12              Transactions With Affiliates
   4.13              Accounts Receivable
   6.4(a)            Retained Employees

Each of the  foregoing  Exhibits and  Schedules is  incorporated  herein by this
reference and expressly made a part hereof.

11.11   Expenses.
        ---------
Each of the parties  hereto shall bear its own expenses  incurred in  connection
with this Agreement and the transactions herein contemplated, including, but not
limited to, legal and accounting fees and expenses.

11.12   Further Assurances and Cooperation.
        -----------------------------------
Seller and Shareholders shall execute,  acknowledge and deliver to Buyer any and
all other assignments,  consents, approvals, conveyances,  assurances, documents
and instruments reasonably requested by Buyer at any time and shall take any and
all other actions  reasonably  requested by Buyer at any time for the purpose of
more effectively assigning, transferring,  granting, conveying and confirming to
Buyer, the Purchased Assets. After consummation of the transactions contemplated
herein,  the parties agree to cooperate with each other in regard to all matters
arising from the purchase by Buyer of the Purchased Assets.

11.13   Confidentiality and Publicity.
        ------------------------------
The parties  hereto shall hold in confidence the  information  contained in this
Agreement and all information related to this Agreement,  which is not otherwise
known to the  public,  shall be held by each party  hereto as  confidential  and
proprietary  information  and shall not be disclosed  without the prior  written
consent of the other  parties.  Accordingly,  Buyer and  Shareholders  shall not
discuss with, or provide  nonpublic  information to, any third party (except for
such  party's  attorneys,  accountants,  directors  of an affiliate of any party
hereto,  and  other  consultants  and  professional  advisors)  concerning  this
transaction  prior to the  Closing,  except:  (i) as  required  in  governmental
filings,   securities   filing  or  judicial,   administrative   or  arbitration
proceedings;  or (ii)  pursuant  to  public  announcements  made  with the prior
written approval of Shareholders and Buyer.

11.14   Fair Meaning.
        -------------
This  Agreement  shall be  construed  according  to its fair  meaning  and as if
prepared by all parties hereto.

11.15   Gender and Number and Construction.
        -----------------------------------
All  references  to the neuter  gender  shall  include the feminine or masculine
gender and vice versa,  where  applicable,  and all  references  to the singular
shall  include the plural and vice versa,  where  applicable.  Unless  otherwise
expressly  provided,  the word "including"  followed by a listing does not limit
the preceding words or terms and shall mean "including, without limitation."


                                      -31-


11.16   Tax Effect.
        -----------
Neither of the parties (nor such party's counsel or accountants)  has made or is
making  any  representations  to any other  party (nor such  party's  counsel or
accountant)  concerning any of the tax effects of the transactions  provided for
in this Agreement and each party hereto represents that it has obtained,  or may
obtain,  independent  tax advice with  respect  thereto and upon which it, if so
obtained, has solely relied.

11.17   Time is of the Essence.
        -----------------------
Time is of the  essence  for all  dates  and  time  periods  set  forth  in this
Agreement and each performance called for in this Agreement.

11.18   Entire Agreement.
        -----------------
All prior negotiations and agreements among the parties hereto are superseded by
this Agreement, and there are no representations,  warranties, understandings or
agreements  other  than  those  expressly  set forth  herein or in an Exhibit or
Schedule delivered pursuant hereto,  except as modified in writing  concurrently
herewith or subsequent hereto.

11.19   Governing Law.
        --------------
This Agreement shall be governed by and construed and  interpreted  according to
the laws of the State of Missouri,  determined without reference to conflicts of
law  principles.  To the extent  permitted  by law,  each of the parties  hereto
hereby  irrevocably  submits to the  jurisdiction of any Missouri state court or
United States federal  court,  in either case sitting in Missouri over any suit,
action or other  proceeding  brought by any party  arising out of or relating to
this  Agreement,  and each of the  parties  hereto  irrevocably  agrees that all
claims with respect to any such suit,  action or other proceeding shall be heard
and determined in such courts.


                  [Remainder of page intentionally left blank.]


                                      -32-



            IN WITNESS WHEREOF, the parties hereto have caused this Agreement to
be executed by their duly authorized representatives on the day and year first
above written.

Buyer:                                   Seller:

PHASE 2 CONSULTING, INC.                 PHASE 2 CONSULTING, INC.



By /s/ Vincent L. Germanese              By /s/ John H. Short, Ph.D.
  ----------------------------------       ------------------------------------
    Vincent L. Germanese                      John H. Short, Ph.D.
                                              President

Parent:                                  Shareholders:

                                         /s/ John H. Short, Ph.D.
REHABCARE GROUP, INC.                    --------------------------------------
                                         John H. Short, Ph.D.


By /s/ H. Edwin Trusheim                 /s/ Peter F. Singer
  ----------------------------------     --------------------------------------
    H. Edwin Trusheim                    Peter F. Singer
    Chairman of the Board
                                         /s/ Howard W. Salmon
                                         --------------------------------------
                                         Howard W. Salmon










                                      -33-



                                    Exhibit A

                            Articles of Incorporation






                                    Exhibit B

                                     Bylaws






                                    Exhibit C

                           Short Employment Agreement




                                    Exhibit D

                         Phase 2 Employment Agreements

EX-13.1

EXHIBIT 13.1

SIX-YEAR FINANCIAL SUMMARY
Dollars in thousands, except per share data
(Year ended December 31,)	2004			2003			2002			2001			2000			1999
Consolidated statement of earnings data:
Operating revenues	$	383,846		$	539,322		$	562,565		$	542,265		$	452,374		$	309,425
Operating earnings (loss) (1) (2) (8)		41,804			(14,396	)		39,697			36,967			44,189			29,922
Net earnings (loss) (1) (2) (3) (8)		23,181			(13,699	)		24,395			21,035			23,534			15,098
Net earnings (loss) per share (EPS): (1) (2) (3) (4) (8)
Basic	$	1.42		$	(0.86	)	$	1.45		$	1.25		$	1.62		$	1.15
Diluted	$	1.38		$	(0.86	)	$	1.38		$	1.16		$	1.45		$	1.03
Weighted average shares outstanding (000s):(4)
Basic		16,292			16,000			16,833			16,775			14,563			13,144
Diluted		16,835			16,000			17,642			18,077			16,268			14,814
Consolidated balance sheet data:
Working capital	$	76,451		$	76,952		$	67,846		$	77,524		$	64,186		$	27,069
Total assets		277,666			233,626			235,530			250,661			229,093			187,264
Total liabilities		70,638			55,671			46,916			51,625			111,133			109,481
Stockholders’ equity		207,028			177,955			188,614			199,036			117,960			77,783
Financial statistics:
Operating margin (2) (8)		10.9	%		(2.7	)%		7.1	%		6.8	%		9.8	%		9.7	%
Net margin (1) (2) (3) (8)		6.0	%		(2.5	)%		4.3	%		3.9	%		5.2	%		4.9	%
Current ratio		2.3:1			2.9:1			2.8:1			2.7:1			2.6:1			1.6:1
Diluted EPS growth rate (1) (2) (3) (5) (8)		260.5	%		(162.3	)%		19.0	%		(20.0	)%		40.8	%		19.8	%
Return on equity (1) (2) (3) (5) (8)		12.0	%		(7.5	)%		12.6	%		13.3	%		24.0	%		21.9	%
Operating statistics:
Healthcare staffing:
Average number of branch offices (6)		N/A			73			108			108			89			55
Number of weeks worked (6) (7)		N/A			141,114			182,552			233,898			223,951			131,110
Program management:
Inpatient units (acute rehabilitation and skilled
nursing):
Average number of programs		142			133			135			137			136			132
Average admissions per program		383			422			411			394			373			369
Average length of stay (days/discharge) (9)		16.0			12.9			13.3			13.8			14.3			14.5
Patient days		871,185			721,570			737,017			746,583			725,497			706,822
Outpatient programs:
Average number of locations		42			48			55			61			53			40
Patient visits		1,133,462			1,247,534			1,366,439			1,439,169			1,173,324			785,943
Contract therapy:
Average number of locations		588			460			378			250			156			91

(1)	The results for 2002 reflect the adoption of Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets” on January 1, 2002.
(2)	The results for 2001 include $9.0 million in non-recurring charges related to our supplemental staffing division.
(3)	The results for 2001 include a pretax loss of $0.5 million ($0.3 million after tax or $0.02 per share) on write-down of an investment. The results for 1999 include a pretax loss of $1.0 million ($0.6 million after tax or $0.05 per share) on write-down of investments.
(4)	Share data adjusted for 2-for-1 stock split in June 2000.
(5)	Average of beginning and ending equity.
(6)	We exited the healthcare staffing business in February 2004 with the sale of StarMed Staffing, Inc. to InteliStaf Holdings, Inc.
(7)	Includes both supplemental and travel weeks worked.
(8)	The results for 2003 include a pretax restructuring charge of $1.3 million ($0.8 million after tax or $0.05 per diluted share) and a pretax loss on net assets held for sale of $43.6 million ($30.6 million after tax or $1.90 per diluted share).
(9)	Average length of stay for inpatient units increased from 2003 to 2004 primarily as a result of the acquisition of the VitalCare units in March 2004. Excluding the impact of the VitalCare units, average length of stay in 2004 was 12.5 days.

EXHIBIT 13.1

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 closing sale prices per share of our common stock, as reported on the New York Stock Exchange, for the periods indicated.

CALENDAR QUARTER		1st		2nd		3rd		4th
2004	High	$	25.04	$	26.68	$	26.10	$	28.81
	Low		18.82		19.48		21.65		22.26
2003	High		20.70		18.45		18.56		23.01
	Low		16.55		13.53		14.25		14.88

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 7, 2005, was approximately 14,220, including 542 shareholders of record and an estimated 13,680 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: http://www.rehabcare.com

EX-21.1

EXHIBIT 21.1

Subsidiaries of Registrant

Subsidiary	Jurisdiction of Organization
American VitalCare, Inc.	State of California
Managed Alternative Care, Inc.	State of California
StarMed Management, Inc.	State of Delaware
RehabCare Group East, Inc.	State of Delaware
RehabCare Group Management Services, Inc.	State of Delaware
RehabCare Group of California, Inc.	State of Delaware
RehabCare Texas Holdings, Inc.	State of Delaware
RehabCare Group of Texas, L.P.	State of Texas
Salt Lake Physical Therapy Associates, Inc.	State of Utah
Phase 2 Consulting, Inc.	State of Delaware
RehabCare Group of Virginia, LLC	State of Virginia

EX-23.1

EXHIBIT 23.1

Consent of Independent Registered Public Accounting Firm

The Board of Directors
RehabCare Group, Inc.:

We consent to the incorporation by reference in the registration statement No. 33-43236 on Form S-8, registration statement No. 33-67944 on Form S-8, registration statement No. 33-82106 on Form S-8, registration statement No. 33-82048 on Form S-8, registration statement No. 333-11311 on Form S-8, and registration statement No. 333-120005 on Form S-8 of RehabCare Group, Inc. of our reports dated March 16, 2005, with respect to the consolidated balance sheets of RehabCare Group, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of earnings, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004, management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2004 and the effectiveness of internal control over finanical reporting as of December 31, 2004 which reports appear in the December 31, 2004 annual report on Form 10-K of RehabCare Group, Inc.

Our report refers to the adoption of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangibles.”

/s/ KPMG LLP

St. Louis, Missouri
March 16, 2005

EX-31.1

EXHIBIT 31.1

CERTIFICATION

I, John H. Short, certify that:

1.	I have reviewed this annual report on Form 10-K of RehabCare Group, Inc. (the “Registrant”):
2.	Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3.	Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this annual report;
4.	The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f)) for the Registrant and we have:

a)	designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b)	designed such internal control over financial reporting or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
c)	evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this annual report based on such evaluation; and
d)	disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

5. The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of Registrant’s board of directors (or persons performing the equivalent function):

a)	all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and report financial information; and
b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

Date:  March 16, 2005	By:	/s/                   John H. Short
	John H. Short, President and Chief Executive Officer

EX-31.2

EXHIBIT 31.2

CERTIFICATION

I, Vincent L. Germanese, certify that:

1.	I have reviewed this annual report on Form 10-K of RehabCare Group, Inc. (the “Registrant”):
2.	Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3.	Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this annual report;
4.	The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f)) for the Registrant and we have:

a)	designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b)	designed such internal control over financial reporting or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
c)	evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this annual report based on such evaluation; and
d)	disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

5. The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of Registrant’s board of directors (or persons performing the equivalent function):

a)	all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and report financial information; and
b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

Date:  March 16, 2005	By:	/s/ Vincent L. Germanese
		Vincent L. Germanese Senior Vice President, Chief Financial Officer and Secretary

EX-32.1

EXHIBIT 32.1

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of RehabCare Group, Inc. (the “Company”) on Form 10-K for the period ending December 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I John H. Short, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that:

(1)	The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

By:	/s/      John H. Short
	John H. Short President and Chief Executive Officer RehabCare Group, Inc. March 16, 2005

EX-32.2

EXHIBIT 32.2

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of RehabCare Group, Inc. (the “Company”) on Form 10-K for the period ending December 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I Vincent L. Germanese, Senior Vice President, Chief Financial Officer and Secretary of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that:

(1)	The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

By:	/s/      Vincent L. Germanese
	Vincent L. Germanese Senior Vice President, Chief Financial Officer and Secretary RehabCare Group, Inc. March 16, 2005