Edgar Filing: SELECT MEDICAL HOLDINGS CORP

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarterly Period Ended September 30, 2013

o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Transition Period From to .

Commission File Number: 001 – 34465 and 001 – 31441

SELECT MEDICAL HOLDINGS CORPORATION

SELECT MEDICAL CORPORATION

(Exact name of Registrant as specified in its charter)

Delaware		20-1764048
Delaware		23-2872718
(State or other jurisdiction of incorporation or organization)		(I.R.S. employer identification number)

4714 Gettysburg Road, P.O. Box 2034, Mechanicsburg, Pennsylvania 17055

(Address of principal executive offices and zip code)

(717) 972-1100

(Registrants’ telephone number, including area code)

Indicate by check mark whether the Registrant, Select Medical Holdings Corporation (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 periods as such Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o

Indicate by check mark whether the Registrant, Select Medical Corporation (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 periods as such Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES o NO x

Indicate by check mark whether the Registrants have submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrants were required to submit and post such files). YES x NO o

Indicate by check mark whether the Registrants are large accelerated filers, accelerated filers, non-accelerated filers, or smaller reporting companies. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o Accelerated filer x Non-accelerated filer o

Smaller reporting company o

Indicate by check mark whether the Registrants are shell companies (as defined in Rule 12b-2 of the Exchange Act). YES o NO x

As of October 15, 2013, Select Medical Holdings Corporation had outstanding 139,546,090 shares of common stock.

This Form 10-Q is a combined quarterly report being filed separately by two Registrants: Select Medical Holdings Corporation and Select Medical Corporation. Unless the context indicates otherwise, any reference in this report to “Holdings” refers to Select Medical Holdings Corporation and any reference to “Select” refers to Select Medical Corporation, the wholly-owned operating subsidiary of Holdings. References to the “Company,” “we,” “us,” and “our” refer collectively to Select Medical Holdings Corporation and Select Medical Corporation.

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TABLE OF CONTENTS

PART I	FINANCIAL INFORMATION	3

ITEM 1.	CONSOLIDATED FINANCIAL STATEMENTS

	Consolidated balance sheets	3

	Consolidated statements of operations	4

	Consolidated statements of changes in equity and income	6

	Consolidated statements of cash flows	7

	Notes to consolidated financial statements	8

ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	27

ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	53

ITEM 4.	CONTROLS AND PROCEDURES	54

PART II	OTHER INFORMATION	54

ITEM 1.	LEGAL PROCEEDINGS	54

ITEM 1A.	RISK FACTORS	56

ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	56

ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	56

ITEM 4.	MINE SAFETY DISCLOSURES	56

ITEM 5.	OTHER INFORMATION	56

ITEM 6.	EXHIBITS	56

SIGNATURES		57

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PART I FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

Consolidated Balance Sheets

(unaudited)

(in thousands, except share and per share amounts)

	Select Medical Holdings Corporation				Select Medical Corporation
	December 31,		September 30,		December 31,		September 30,
	2012		2013		2012		2013

ASSETS
Current Assets:
Cash and cash equivalents	$	40,144	$	9,293	$	40,144	$	9,293
Accounts receivable, net of allowance for doubtful accounts of $41,854 and $41,255 at 2012 and 2013, respectively	359,929		423,334		359,929		423,334
Current deferred tax asset	17,877		15,372		17,877		15,372
Prepaid income taxes	3,895		4,044		3,895		4,044
Other current assets	31,818		39,968		31,818		39,968
Total Current Assets	453,663		492,011		453,663		492,011

Property and equipment, net	501,552		499,531		501,552		499,531
Goodwill	1,640,534		1,641,836		1,640,534		1,641,836
Other identifiable intangibles	71,745		71,831		71,745		71,831
Other assets	93,867		137,215		92,819		137,215

Total Assets	$	2,761,361	$	2,842,424	$	2,760,313	$	2,842,424

LIABILITIES AND EQUITY
Current Liabilities:
Bank overdrafts	$	17,836	$	7,435	$	17,836	$	7,435
Current portion of long-term debt and notes payable	11,646		13,966		11,646		13,966
Accounts payable	89,547		96,360		89,547		96,360
Accrued payroll	88,586		81,303		88,586		81,303
Accrued vacation	55,714		57,328		55,714		57,328
Accrued interest	22,016		22,005		18,759		22,005
Accrued other	102,040		102,925		107,280		102,925
Due to third party payors	1,078		3,968		1,078		3,968
Total Current Liabilities	388,463		385,290		390,446		385,290

Long-term debt, net of current portion	1,458,597		1,474,915		1,291,297		1,474,915
Non-current deferred tax liability	89,510		90,859		89,510		90,859
Other non-current liabilities	68,502		80,077		68,502		80,077

Total Liabilities	2,005,072		2,031,141		1,839,755		2,031,141

Redeemable non-controlling interests	10,811		11,623		10,811		11,623

Stockholders’ Equity:
Common stock of Holdings, $0.001 par value, 700,000,000 shares authorized, 140,589,256 shares and 139,546,090 shares issued and outstanding at 2012 and 2013, respectively	141		140		—		—
Common stock of Select, $0.01 par value, 100 shares issued and outstanding	—		—		0		0
Capital in excess of par	473,697		472,080		859,839		866,423
Retained earnings (accumulated deficit)	243,210		296,196		21,478		(98,007		)
Total Select Medical Holdings Corporation and Select Medical Corporation Stockholders’ Equity	717,048		768,416		881,317		768,416
Non-controlling interest	28,430		31,244		28,430		31,244
Total Equity	745,478		799,660		909,747		799,660

Total Liabilities and Equity	$	2,761,361	$	2,842,424	$	2,760,313	$	2,842,424

The accompanying notes are an integral part of these consolidated financial statements.

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Consolidated Statements of Operations

(unaudited)

(in thousands, except per share amounts)

	Select Medical Holdings Corporation						Select Medical Corporation
	For the Three Months Ended September 30,						For the Three Months Ended September 30,
	2012			2013			2012			2013

Net operating revenues	$	713,669		$	722,845		$	713,669		$	722,845

Costs and expenses:
Cost of services	598,984			617,281			598,984			617,281
General and administrative	17,130			17,740			17,130			17,740
Bad debt expense	11,199			9,262			11,199			9,262
Depreciation and amortization	15,537			16,163			15,537			16,163
Total costs and expenses	642,850			660,446			642,850			660,446

Income from operations	70,819			62,399			70,819			62,399

Other income and expense:
Loss on early retirement of debt	(6,064		)	—			(6,064		)	—
Equity in earnings (losses) of unconsolidated subsidiaries	1,167			(179		)	1,167			(179		)
Interest expense	(24,575		)	(21,252		)	(21,740		)	(21,252		)

Income before income taxes	41,347			40,968			44,182			40,968

Income tax expense	16,189			15,761			17,181			15,761

Net income	25,158			25,207			27,001			25,207

Less: Net income attributable to non-controlling interests	1,048			1,935			1,048			1,935

Net income attributable to Select Medical Holdings Corporation and Select Medical Corporation	$	24,110		$	23,272		$	25,953		$	23,272

Income per common share:
Basic	$	0.17		$	0.17
Diluted	$	0.17		$	0.17

The accompanying notes are an integral part of these consolidated financial statements.

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Consolidated Statements of Operations

(unaudited)

(in thousands, except per share amounts)

	Select Medical Holdings Corporation						Select Medical Corporation
	For the Nine Months Ended September 30,						For the Nine Months Ended September 30,
	2012			2013			2012			2013

Net operating revenues	$	2,207,883		$	2,229,473		$	2,207,883		$	2,229,473

Costs and expenses:
Cost of services	1,823,272			1,867,915			1,823,272			1,867,915
General and administrative	49,908			53,065			49,908			53,065
Bad debt expense	31,603			27,429			31,603			27,429
Depreciation and amortization	47,164			47,872			47,164			47,872
Total costs and expenses	1,951,947			1,996,281			1,951,947			1,996,281

Income from operations	255,936			233,192			255,936			233,192

Other income and expense:
Loss on early retirement of debt	(6,064		)	(18,747		)	(6,064		)	(17,788		)
Equity in earnings of unconsolidated subsidiaries	6,384			1,447			6,384			1,447
Interest expense	(72,295		)	(66,614		)	(63,947		)	(64,204		)

Income before income taxes	183,961			149,278			192,309			152,647

Income tax expense	71,415			57,391			74,337			58,570

Net income	112,546			91,887			117,972			94,077

Less: Net income attributable to non-controlling interests	3,722			6,417			3,722			6,417

Net income attributable to Select Medical Holdings Corporation and Select Medical Corporation	$	108,824		$	85,470		$	114,250		$	87,660

Income per common share:
Basic	$	0.77		$	0.61
Diluted	$	0.77		$	0.61

The accompanying notes are an integral part of these consolidated financial statements.

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Consolidated Statements of Changes in Equity and Income

(unaudited)

(in thousands)

						Select Medical Holdings Corporation Stockholders
	Comprehensive Income		Total			Common Stock Issued		Common Stock Par Value			Capital in Excess of Par			Retained Earnings			Non-controlling Interests
Balance at December 31, 2012			$	745,478		140,589		$	141		$	473,697		$	243,210		$	28,430
Net income	$	89,588	89,588											85,470			4,118
Net income - attributable to redeemable non-controlling interests	2,299
Total comprehensive income	$	91,887
Dividends paid to common stockholders			(27,929		)									(27,929		)
Issuance and vesting of restricted stock			4,695			72		0			4,695
Stock option expense			708								708
Repurchase of common shares			(10,946		)	(1,115	)	(1		)	(7,020		)	(3,925		)
Acquisitions of non-controlling interests			261														261
Distributions to non-controlling interests			(1,565		)												(1,565		)
Redeemable non-controlling interests redemption value adjustment			(630		)									(630		)
Balance at September 30, 2013			$	799,660		139,546		$	140		$	472,080		$	296,196		$	31,244

						Select Medical Corporation Stockholders
	Comprehensive Income		Total			Common Stock Issued	Common Stock Par Value		Capital in Excess of Par		Retained Earnings (accumulated deficit)			Non-controlling Interests
Balance at December 31, 2012			$	909,747		0	$	0	$	859,839	$	21,478		$	28,430
Net income	$	91,778	91,778								87,660			4,118
Net income - attributable to redeemable non-controlling interests	2,299
Total comprehensive income	$	94,077
Federal tax benefit of losses contributed by Holdings			1,181						1,181
Net change in dividends payable to Holdings			5,239								5,239
Dividends declared and paid to Holdings			(211,754		)						(211,754		)
Contribution related to restricted stock awards and stock option issuances by Holdings			5,403						5,403
Acquisitions of non-controlling interests			261											261
Distributions to non-controlling intersts			(1,565		)									(1,565		)
Redeemable non-controlling interests redemption value adjustment			(630		)						(630		)
Balance at September 30, 2013			$	799,660		0	$	0	$	866,423	$	(98,007	)	$	31,244

The accompanying notes are an integral part of these consolidated financial statements.

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Consolidated Statements of Cash Flows

(unaudited)

(in thousands)

	Select Medical Holdings Corporation						Select Medical Corporation
	For the Nine Months Ended September 30,						For the Nine Months Ended September 30,
	2012			2013			2012			2013

Operating activities
Net income	$	112,546		$	91,887		$	117,972		$	94,077
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	47,164			47,872			47,164			47,872
Provision for bad debts	31,603			27,429			31,603			27,429
Equity in earnings of unconsolidated subsidiaries	(6,384		)	(1,447		)	(6,384		)	(1,447		)
Loss on early retirement of debt	6,064			18,747			6,064			17,788
Gain from disposal or sale of assets	(3,484		)	(93		)	(3,484		)	(93		)
Non-cash stock compensation expense	3,990			5,403			3,990			5,403
Amortization of debt discount and issuance costs	5,494			6,507			5,215			6,418
Changes in operating assets and liabilities, net of effects from acquisition of businesses:
Accounts receivable	(10,507		)	(89,237		)	(10,507		)	(89,237		)
Other current assets	(1,849		)	(7,642		)	(1,849		)	(7,642		)
Other assets	1,270			(3,211		)	1,270			(3,211		)
Accounts payable	(4,098		)	6,798			(4,098		)	6,798
Due to third-party payors	360			2,890			360			2,890
Accrued expenses	348			4,788			2,956			8,046
Income and deferred taxes	11,559			4,414			14,481			5,593
Net cash provided by operating activities	194,076			115,105			204,753			120,684

Investing activities
Purchases of property and equipment	(45,188		)	(45,331		)	(45,188		)	(45,331		)
Proceeds from sale of assets	16,511			518			16,511			518
Investment in businesses, net of distributions	(9,899		)	(32,430		)	(9,899		)	(32,430		)
Acquisition of businesses, net of cash acquired	(1,547		)	(848		)	(1,547		)	(848		)
Net cash used in investing activities	(40,123		)	(78,091		)	(40,123		)	(78,091		)

Financing activities
Borrowings on revolving credit facility	365,000			580,000			365,000			580,000
Payments on revolving credit facility	(405,000		)	(645,000		)	(405,000		)	(645,000		)
Borrowings on credit facility term loans, net of discount	266,750			298,500			266,750			298,500
Payments on credit facility term loans	(7,063		)	(594,668		)	(7,063		)	(594,668		)
Issuance of 6.375% senior notes	—			600,000			—			600,000
Repurchase of senior floating rate notes	—			(167,300		)	—			—
Repurchase of 7 5/8% senior subordinated notes	(278,495		)	(70,000		)	(278,495		)	(70,000		)
Borrowings of other debt	5,835			9,238			5,835			9,238
Principal payments on other debt	(7,417		)	(7,467		)	(7,417		)	(7,467		)
Debt issuance costs	(4,236		)	(18,820		)	(4,236		)	(18,820		)
Dividends paid to common stockholders	—			(27,929		)	—			—
Dividends paid to Holdings	—			—			(57,467		)	(211,754		)
Repurchase of common stock	(46,790		)	(10,946		)	—			—
Proceeds from issuance of common stock	1,104			—			—			—
Equity investment by Holdings	—			—			1,104			—
Repayment of bank overdrafts	(3,011		)	(10,401		)	(3,011		)	(10,401		)
Distributions to non-controlling interests	(2,997		)	(3,072		)	(2,997		)	(3,072		)
Net cash used in financing activities	(116,320		)	(67,865		)	(126,997		)	(73,444		)

Net increase (decrease) in cash and cash equivalents	37,633			(30,851		)	37,633			(30,851		)

Cash and cash equivalents at beginning of period	12,043			40,144			12,043			40,144
Cash and cash equivalents at end of period	$	49,676		$	9,293		$	49,676		$	9,293

Supplemental Cash Flow Information
Cash paid for interest	$	68,122		$	60,439		$	57,448		$	54,860
Cash paid for taxes	$	59,850		$	52,977		$	59,850		$	52,977

The accompanying notes are an integral part of these consolidated financial statements.

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SELECT MEDICAL HOLDINGS CORPORATION AND SELECT MEDICAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. Basis of Presentation

The unaudited consolidated financial statements of Select Medical Holdings Corporation (“Holdings”) and Select Medical Corporation (“Select”) as of September 30, 2013 and for the three and nine month periods ended September 30, 2012 and 2013 have been prepared in accordance with generally accepted accounting principles (“GAAP”). In the opinion of management, such information contains all adjustments, which are normal and recurring in nature, necessary for a fair statement of the financial position, results of operations and cash flow for such periods. All significant intercompany transactions and balances have been eliminated. The results of operations for the three and nine months ended September 30, 2013 are not necessarily indicative of the results to be expected for the full fiscal year ending December 31, 2013. Holdings and Select and their subsidiaries are collectively referred to as the “Company.” The consolidated financial statements of Holdings include the accounts of its wholly-owned subsidiary Select. Holdings conducts substantially all of its business through Select and its subsidiaries.

Certain information and disclosures normally included in the notes to consolidated financial statements have been condensed or omitted consistent with the rules and regulations of the Securities and Exchange Commission (the “SEC”), although the Company believes the disclosure is adequate to make the information presented not misleading. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2012 contained in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 26, 2013.

2. Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.

3. Intangible Assets

The gross carrying amounts of the Company’s indefinite-lived intangible assets consist of the following:

	December 31, 2012		September 30, 2013
	(in thousands)

Goodwill	$	1,640,534	$	1,641,836
Trademarks	57,709		57,709
Certificates of need	11,914		12,039
Accreditations	2,122		2,083
Total	$	1,712,279	$	1,713,667

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The Company’s accreditations and trademarks have renewal terms. The costs to renew these intangibles are expensed as incurred. At September 30, 2013, the accreditations and trademarks have a weighted average time until next renewal of approximately 1.5 years and 6.7 years, respectively.

The changes in the carrying amount of goodwill for the Company’s reportable segments for the nine months ended September 30, 2013 are as follows:

	Specialty Hospitals		Outpatient Rehabilitation			Total
	(in thousands)
Balance as of December 31, 2012	$	1,333,220	$	307,314		$	1,640,534
Goodwill acquired during the period	1,395		40			1,435
Purchase price adjustment	—		(133		)	(133		)
Balance as of September 30, 2013	$	1,334,615	$	307,221		$	1,641,836

4. Indebtedness

The components of long-term debt and notes payable are as follows:

	Select Medical Holdings Corporation
	December 31, 2012		September 30, 2013
	(in thousands)

7 5/8% senior subordinated notes	$	70,000	$	—
6.375% senior notes	—		600,000
Senior secured credit facilities:
Revolving loan	130,000		65,000
Term loans (1)	1,096,641		809,438
Senior floating rate notes	167,300		—
Other	6,302		14,443
Total debt	1,470,243		1,488,881
Less: current maturities	11,646		13,966
Total long-term debt	$	1,458,597	$	1,474,915

	Select Medical Corporation
	December 31, 2012		September 30, 2013
	(in thousands)

7 5/8% senior subordinated notes	$	70,000	$	—
6.375% senior notes	—		600,000
Senior secured credit facilities:
Revolving loan	130,000		65,000
Term loans (1)	1,096,641		809,438
Other	6,302		14,443
Total debt	1,302,943		1,488,881
Less: current maturities	11,646		13,966
Total long-term debt	$	1,291,297	$	1,474,915

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(1) Presented net of unamortized discounts of $14.2 million and $6.8 million at December 31, 2012 and September 30, 2013, respectively.

On February 20, 2013, Select entered into a credit extension amendment to its senior secured credit facilities providing for a $300.0 million additional term loan tranche, (the “series B term loan”) to Select. Select used the borrowings under the series B term loan to redeem all of its outstanding 7 5/8% senior subordinated notes due 2015 on March 22, 2013, to finance Holdings’ redemption of all of its senior floating rate notes due 2015 on March 22, 2013 and to repay a portion of the balance outstanding under Select’s revolving credit facility. The Company recognized a loss on early retirement of debt of $1.5 million during the three months ended March 31, 2013 for unamortized debt issuance costs, of which approximately $0.5 million was associated with Select’s 7 5/8% senior subordinated notes due 2015 and approximately $1.0 million was associated with Holdings’ senior floating rate notes due 2015.

Borrowings under the series B term loan bear interest at a rate equal to Adjusted LIBO plus 3.25%, or Alternate Base Rate plus 2.25%. The series B term loan amortizes in equal quarterly installments on the last day of each March, June, September and December in aggregate annual amounts equal to $3.0 million. The balance of the series B term loan is payable on February 20, 2016.

At the time of issuing the series B term loan, Select had additional term loan tranches outstanding including an $850.0 million term loan tranche issued on June 1, 2011 (the “original term loan”) and a $275.0 million incremental term loan tranche issued August 13, 2012 (the “series A term loan”). Both the original term loan and series A term loan tranches were issued at a discount and amortized in equal quarterly installments on the last day of each March, June, September and December. The balance of both the original term loan and series A term loan was payable on June 1, 2018.

On May 28, 2013, Select issued and sold $600.0 million aggregate principal amount of its 6.375% senior notes due 2021. On May 28, 2013, Select used the proceeds of the senior notes to pay a portion of the amounts then outstanding on the original term loan and the series A term loan, and to pay related fees and expenses. Select recognized a loss on early retirement of debt of $17.3 million in the three months ended June 30, 2013 in connection with the repayment of a portion of its term loans and amendment of the existing senior secured credit facility, which included the write-off of unamortized debt issuance costs.

Interest on the senior notes accrues at the rate of 6.375% per annum and is payable semi-annually in cash in arrears on June 1 and December 1 of each year, commencing on December 1, 2013. The senior notes are Select’s senior unsecured obligations and rank equally in right of payment with all of its other existing and future senior unsecured indebtedness and senior in right of payment to all of its existing and future subordinated indebtedness. The senior notes are unconditionally guaranteed by all of Select’s wholly-owned subsidiaries. The senior notes are guaranteed, jointly and severally, by Select’s direct or indirect existing and future domestic restricted subsidiaries other than certain non-guarantor subsidiaries.

Select may redeem some or all of the senior notes prior to June 1, 2016 by paying a “make-whole” premium. Select may redeem some or all of the senior notes on or after June 1, 2016 at specified redemption prices. In addition, prior to June 1, 2016, Select may redeem up to 35% of the senior notes with the net proceeds of certain equity offerings at a price of 106.375% plus accrued and unpaid interest, if any. Select is obligated to offer to repurchase the senior notes at a price of 101% of their principal amount plus accrued and unpaid interest, if any, as a result of certain change of control events. These restrictions and prohibitions are subject to certain qualifications and exceptions.

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The Indenture relating to the senior notes contains covenants that, among other things, limit Select’s ability and the ability of certain of its subsidiaries to (i) grant liens on its assets, (ii) make dividend payments, other distributions or other restricted payments, (iii) incur restrictions on the ability of Select’s restricted subsidiaries to pay dividends or make other payments, (iv) enter into sale and leaseback transactions, (v) merge, consolidate, transfer or dispose of substantially all of their assets, (vi) incur additional indebtedness, (vii) make investments, (viii) sell assets, including capital stock of subsidiaries, (ix) use the proceeds from sales of assets, including capital stock of restricted subsidiaries, and (x) enter into transactions with affiliates. In addition, the Indenture requires, among other things, Select to provide financial and current reports to holders of the senior notes or file such reports electronically with the U.S. Securities and Exchange Commission (the “SEC”). These covenants are subject to a number of exceptions, limitations and qualifications set forth in the Indenture.

On June 3, 2013, Select amended its existing senior secured credit facilities in order to:

· extend the maturity date on $293.3 million of its $300.0 million revolving credit facility from June 1, 2016 to March 1, 2018;

· convert the remaining original term loan and series A term loan to a series C term loan and lower the interest rate payable on the series C term loan from Adjusted LIBO plus 3.75%, or Alternate Base Rate plus 2.75%, to Adjusted LIBO plus 3.00%, or Alternate Base Rate plus 2.00%, and amend the provision of the series C term loan from providing that Adjusted LIBO will at no time be less than 1.75% to providing that Adjusted LIBO will at no time be less than 1.00%; and

· amend the restrictive covenants governing the senior secured credit facilities in order to allow for unlimited restricted payments so long as there is no event of default under the senior secured credit facilities and the total pro forma ratio of total indebtedness to Consolidated EBITDA (as defined in our senior secured credit facilities) is less than or equal to 2.75 to 1.00.

Maturities of Long-Term Debt and Notes Payable

Maturities of the Company’s long-term debt for the period from October 1, 2013 through December 31, 2013 and the years after 2013 are approximately as follows and are presented net of the discounts on the senior secured credit facility term loans (in thousands):

October 1, 2013 – December 31, 2013	$	4,869
2014	11,497
2015	10,086
2016	296,134
2017	4,075
2018 and beyond	1,162,220

5. Fair Value

Financial instruments include cash and cash equivalents, notes payable and long-term debt. The carrying amount of cash and cash equivalents approximates fair value because of the short-term maturity of these instruments.

The carrying value of Select’s senior secured credit facility was $1,226.6 million and $874.4 million at December 31, 2012 and September 30, 2013, respectively. The fair value of Select’s senior secured credit facility was $1,216.2 million and $867.9 million at December 31, 2012 and September 30, 2013, respectively. The fair value of Select’s senior secured credit facility was based on quoted market prices for this debt in the syndicated loan market.

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The carrying value of Select’s 6.375% senior notes was $600.0 million at September 30, 2013. The fair value of Select’s 6.375% senior notes was $570.0 million at September 30, 2013. The fair value of this debt was based on quoted market prices.

The Company considers the inputs in the valuation process of its senior secured credit facility and 6.375% senior notes to be Level 2 in the fair value hierarchy. Level 2 in the fair value hierarchy is defined as inputs that are observable for the asset or liability, either directly or indirectly which includes quoted prices for identical assets or liabilities in markets that are not active.

6. Segment Information

The Company’s reportable segments consist of (i) specialty hospitals and (ii) outpatient rehabilitation. Other activities include the Company’s corporate services and certain other non-consolidating joint ventures and minority investments in other healthcare related businesses. The outpatient rehabilitation reportable segment has two operating segments: outpatient rehabilitation clinics and contract therapy. These operating segments are aggregated for reporting purposes as they have common economic characteristics and provide a similar service to a similar patient base. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance of the segments based on Adjusted EBITDA. Adjusted EBITDA is defined as net income before interest, income taxes, depreciation and amortization, gain (loss) on early retirement of debt, stock compensation expense, equity in earnings (losses) of unconsolidated subsidiaries and other income (expense).

The following tables summarize selected financial data for the Company’s reportable segments. The segment results of Holdings are identical to those of Select with the exception of total assets:

	Three Months Ended September 30, 2012
	Specialty Hospitals		Outpatient Rehabilitation		Other			Total
	(in thousands)

Net operating revenues	$	531,409	$	182,246	$	14		$	713,669
Adjusted EBITDA	83,659		20,354		(16,266		)	87,747
Total assets:
Select Medical Corporation	2,165,248		431,310		184,120			2,780,678
Select Medical Holdings Corporation	2,165,248		431,310		185,250			2,781,808
Capital expenditures	12,281		3,073		1,900			17,254

	Three Months Ended September 30, 2013
	Specialty Hospitals		Outpatient Rehabilitation		Other			Total
	(in thousands)

Net operating revenues	$	532,610	$	190,223	$	12		$	722,845
Adjusted EBITDA	75,280		21,619		(16,471		)	80,428
Total assets:
Select Medical Corporation	2,232,756		445,729		163,939			2,842,424
Select Medical Holdings Corporation	2,232,756		445,729		163,939			2,842,424
Capital expenditures	14,157		2,802		410			17,369

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	Nine Months Ended September 30, 2012
	Specialty Hospitals		Outpatient Rehabilitation		Other			Total
	(in thousands)

Net operating revenues	$	1,641,577	$	566,195	$	111		$	2,207,883
Adjusted EBITDA	285,779		68,669		(47,358		)	307,090
Total assets:
Select Medical Corporation	2,165,248		431,310		184,120			2,780,678
Select Medical Holdings Corporation	2,165,248		431,310		185,250			2,781,808
Capital expenditures	31,963		9,786		3,439			45,188

	Nine Months Ended September 30, 2013
	Specialty Hospitals		Outpatient Rehabilitation		Other			Total
	(in thousands)

Net operating revenues	$	1,649,747	$	579,404	$	322		$	2,229,473
Adjusted EBITDA	265,020		70,506		(49,059		)	286,467
Total assets:
Select Medical Corporation	2,232,756		445,729		163,939			2,842,424
Select Medical Holdings Corporation	2,232,756		445,729		163,939			2,842,424
Capital expenditures	35,257		8,646		1,428			45,331

A reconciliation of Adjusted EBITDA to income before income taxes is as follows:

	Three Months Ended September 30, 2012
	Specialty Hospitals				Outpatient Rehabilitation			Other			Select Medical Holdings Corporation			Select Medical Corporation
	(in thousands)
Adjusted EBITDA	$		83,659		$	20,354		$	(16,266	)
Depreciation and amortization	(11,553			)	(3,152		)	(832		)
Stock compensation expense	—				—			(1,391		)

Income (loss) from operations	$	72,106			$	17,202		$	(18,489	)	$	70,819		$	70,819
Loss on early retirement of debt											(6,064		)	(6,064		)
Equity in earnings of unconsolidated subsidiaries											1,167			1,167
Interest expense											(24,575		)	(21,740		)
Income before income taxes											$	41,347		$	44,182

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	Three Months Ended September 30, 2013
	Specialty Hospitals			Outpatient Rehabilitation			Other			Select Medical Holdings Corporation			Select Medical Corporation
	(in thousands)
Adjusted EBITDA	$	75,280		$	21,619		$	(16,471	)
Depreciation and amortization	(12,267		)	(2,979		)	(917		)
Stock compensation expense	—			—			(1,866		)

Income (loss) from operations	$	63,013		$	18,640		$	(19,254	)	$	62,399		$	62,399
Equity in losses of unconsolidated subsidiaries										(179		)	(179		)
Interest expense										(21,252		)	(21,252		)
Income before income taxes										$	40,968		$	40,968

		Nine Months Ended September 30, 2012
		Specialty Hospitals			Outpatient Rehabilitation			Other			Select Medical Holdings Corporation			Select Medical Corporation
		(in thousands)
Adjusted EBITDA		$	285,779		$	68,669		$	(47,358	)
Depreciation and amortization			(34,875	)		(10,034	)		(2,255	)
Stock compensation expense		—			—			(3,990		)

Income (loss) from operations	$		250,904		$	58,635		$	(53,603	)	$	255,936		$	255,936
Loss on early retirement of debt											(6,064		)	(6,064		)
Equity in earnings of unconsolidated subsidiaries											6,384			6,384
Interest expense											(72,295		)	(63,947		)
Income before income taxes											$	183,961		$	192,309

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	Nine Months Ended September 30, 2013
	Specialty Hospitals			Outpatient Rehabilitation			Other			Select Medical Holdings Corporation			Select Medical Corporation
	(in thousands)
Adjusted EBITDA	$	265,020		$	70,506		$	(49,059	)
Depreciation and amortization	(36,061		)	(8,949		)	(2,862		)
Stock compensation expense	—			—			(5,403		)

Income (loss) from operations	$	228,959		$	61,557		$	(57,324	)	$	233,192		$	233,192
Equity in earnings of unconsolidated subsidiaries										1,447			1,447
Loss on early retirement of debt										(18,747		)	(17,788		)
Interest expense										(66,614		)	(64,204		)
Income before income taxes										$	149,278		$	152,647

7. Income per Common Share

The Company applies the two-class method for calculating and presenting income per common share. The two-class method is an earnings allocation formula that determines earnings per share for each class of stock participation rights in undistributed earnings. The following table sets forth for the periods indicated the calculation of income per common share in the Company’s consolidated statement of operations and the differences between basic weighted average shares outstanding and diluted weighted average shares outstanding used to compute basic and diluted income per common share, respectively:

	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2012		2013		2012		2013
	(in thousands, except per share amounts)
Numerator:
Net income attributable to Select Medical Holdings Corporation	$	24,110	$	23,272	$	108,824	$	85,470
Less: Earnings allocated to unvested restricted stockholders	407		497		1,759		1,802
Net income available to common stockholders	$	23,703	$	22,775	$	107,065	$	83,668

Denominator:
Weighted average shares — basic	137,551		136,646		139,138		136,879
Effect of dilutive securities:
Stock options	337		147		266		161
Weighted average shares — diluted	137,888		136,793		139,404		137,040

Basic income per common share	$	0.17	$	0.17	$	0.77	$	0.61
Diluted income per common share	$	0.17	$	0.17	$	0.77	$	0.61

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The following share amounts are shown here for informational and comparative purposes only since their inclusion would be anti-dilutive:

	For the Three Months Ended September 30,		For the Nine Months Ended September 30,
	2012	2013	2012	2013
	(in thousands)
Stock options	78	1,477	1,683	1,528

8. Commitments and Contingencies

Litigation

The Company is a party to various legal actions, proceedings and claims (some of which are not insured), and regulatory and other governmental audits and investigations in the ordinary course of its business. The Company cannot predict the ultimate outcome of pending litigation, proceedings and regulatory and other governmental audits and investigations. These matters could potentially subject the Company to sanctions, damages, recoupments, fines and other penalties. The Department of Justice, Centers for Medicare & Medicaid Services (“CMS”) or other federal and state enforcement and regulatory agencies may conduct additional investigations related to the Company’s businesses in the future that may, either individually or in the aggregate, have a material adverse effect on the Company’s business, financial position, results of operations and liquidity.

To address claims arising out of the operations of the Company’s specialty hospitals and outpatient rehabilitation facilities, the Company maintains professional malpractice liability insurance and general liability insurance, subject to self-insured retention of $2.0 million per medical incident for professional liability claims and $2.0 million per occurrence for general liability claims. The Company also maintains umbrella liability insurance covering claims which, due to their nature or amount, are not covered by or not fully covered by the Company’s other insurance policies. These insurance policies also do not generally cover punitive damages and are subject to various deductibles and policy limits. Significant legal actions, as well as the cost and possible lack of available insurance, could subject the Company to substantial uninsured liabilities. In the Company’s opinion, the outcome of these actions, individually or in the aggregate, will not have a material adverse effect on its financial position, results of operations, or cash flows.

Healthcare providers are subject to lawsuits under the qui tam provisions of the federal False Claims Act. Qui tam lawsuits typically remain under seal (hence, usually unknown to the defendant) for some time while the government decides whether or not to intervene on behalf of a private qui tam plaintiff (known as a relator) and take the lead in the litigation. These lawsuits can involve significant monetary damages and penalties and award bounties to private plaintiffs who successfully bring the suits. The Company has been a defendant in these cases in the past, and may be named as a defendant in similar cases from time to time in the future.

On January 8, 2013, a federal magistrate judge unsealed an Amended Complaint in United States of America and the State of Indiana, ex rel. Doe I, Doe II and Doe III v. Select Medical Corporation, Select Specialty Hospital-Evansville, Evansville Physician Investment Corporation, Dr. Richard Sloan and Dr. Jeffrey Selby. The Amended Complaint, which was served on the Company on February 15, 2013, is a civil action filed under seal on September 28, 2012 in the United States District Court for the Southern District of Indiana by private plaintiff-relators on behalf of the United States and the state of Indiana under the federal False Claims Act and Indiana False Claims and Whistleblower Protection Act. Although the Amended Complaint identifies

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the relators by fictitious pseudonyms, on March 28, 2013, the relators filed a Notice identifying themselves as the former CEO at the Company’s long term acute care hospital in Evansville, Indiana (“SSH-Evansville”) and two former case managers at SSH-Evansville. The named defendants include the Company, SSH-Evansville, and two physicians who have practiced at SSH-Evansville. On March 26, 2013, the defendants, relators and the United States filed a joint motion seeking a stay of the proceedings, in which the United States notified the court that its investigation has not been completed and therefore it is not yet able to decide whether or not to intervene, and on March 29, 2013, the magistrate judge granted the motion and stayed all deadlines in the case for 90 days. On June 26, 2013, the United States filed a motion seeking to extend such stay of the proceedings for an additional 90 days, and, on August 12, 2013, the court granted the motion and stayed all deadlines in the case until October 1, 2013. On September 25, 2013, the United States filed a motion seeking to extend such stay for an additional 90 days.

The Amended Complaint alleges that the defendants manipulated the length of stay of patients at SSH-Evansville in order to maximize reimbursement under the Medicare prospective payment system applicable to long term acute care hospitals. It also alleges that the defendants manipulated the discharge of patients to other facilities and the timing of readmissions from those facilities in order to enable SSH-Evansville to receive two separate Medicare payments and causing the other facility to submit claims for unnecessary services. The Amended Complaint discusses the federal Stark Law and Anti-Kickback Statute and implies that the behavior of physicians referring to or providing services at SSH-Evansville was based on their financial interests. The Amended Complaint further alleges that Dr. Selby, a pulmonologist formerly on the medical staff of SSH-Evansville, performed unnecessary bronchoscopies at the hospital with the knowledge of the Company, and that Dr. Sloan, the Chief Medical Officer and an attending physician at SSH-Evansville, falsely coded the diagnoses of Medicare patients in order to increase SSH-Evansville’s reimbursement. Moreover, the Amended Complaint alleges that the practices at SSH-Evansville involved corporate policies of the Company used to maximize profit at all Select long term acute care hospitals. The Amended Complaint alleges that, through these acts, the defendants have violated the federal False Claims Act and Indiana False Claims and Whistleblower Protection Act and are liable for unspecified treble damages and penalties.

As previously disclosed, beginning in April 2012, the Company and SSH-Evansville have received various subpoenas and demands for documents relating to SSH-Evansville, including a request for information and subpoenas from the Office of Inspector General of the U.S. Department of Health and Human Services and subpoenas from the Office of Attorney General for the State of Indiana, and the Evansville (Indiana) Police Department has executed a search warrant at SSH-Evansville. The Company has produced and will continue to produce documents in response to, and intends to fully cooperate with, these governmental investigations. At this time, the Company is unable to predict the timing and outcome of this matter.

Construction Commitments

At September 30, 2013, the Company had outstanding commitments under construction contracts related to new construction, improvements and renovations at the Company’s long term acute care properties and inpatient rehabilitation facilities totaling approximately $15.3 million.

9. Subsequent Event

On October 30, 2013, Holdings’ board of directors declared a quarterly cash dividend of $0.10 per share. The dividend will be payable on or about November 22, 2013 to stockholders of record as of the close of business on November 12, 2013.

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10. Financial Information for Subsidiary Guarantors and Non-Guarantor Subsidiaries under Select’s 6.375% Senior Notes

Select’s 6.375% senior notes are fully and unconditionally guaranteed, except for customary limitations, on a senior basis by all of Select’s wholly-owned subsidiaries (the “Subsidiary Guarantors”) which is defined as a subsidiary where Select or a subsidiary of Select holds all of the outstanding ownership interests. Certain of Select’s subsidiaries did not guarantee the 6.375% senior notes (the “Non-Guarantor Subsidiaries”).

Select conducts a significant portion of its business through its subsidiaries. Presented below is condensed consolidating financial information for Select, the Subsidiary Guarantors and the Non-Guarantor Subsidiaries at December 31, 2012 and September 30, 2013 and for the three and nine months ended September 30, 2012 and 2013.

The equity method has been used by Select with respect to investments in subsidiaries. The equity method has been used by Subsidiary Guarantors with respect to investments in Non-Guarantor Subsidiaries. Separate financial statements for Subsidiary Guarantors are not presented.

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Select Medical Corporation

Condensed Consolidating Balance Sheet

September 30, 2013

(unaudited)

Select Medical
Corporation (Parent
Company Only)

Subsidiary
Guarantors

Non-Guarantor
Subsidiaries

Eliminations

Consolidated

(in thousands)

Assets