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 March 31, 2014

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 Registrants (1) have 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 Registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. YES x NO o

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 April 30, 2014, Select Medical Holdings Corporation had outstanding 130,841,663 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	5

	Consolidated statements of cash flows	6

	Notes to consolidated financial statements	7

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

ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	47

ITEM 4.	CONTROLS AND PROCEDURES	47

PART II	OTHER INFORMATION	48

ITEM 1.	LEGAL PROCEEDINGS	48

ITEM 1A.	RISK FACTORS	49

ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	49

ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	50

ITEM 4.	MINE SAFETY DISCLOSURES	50

ITEM 5.	OTHER INFORMATION	50

ITEM 6.	EXHIBITS	50

SIGNATURES		51

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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,		March 31,		December 31,			March 31,
	2013		2014		2013			2014

ASSETS
Current Assets:
Cash and cash equivalents	$	4,319	$	4,692	$	4,319		$	4,692
Accounts receivable, net of allowance for doubtful accounts of $40,815 and $42,730 at 2013 and 2014, respectively	391,319		467,738		391,319			467,738
Current deferred tax asset	17,624		17,781		17,624			17,781
Other current assets	41,140		44,288		41,140			44,288
Total Current Assets	454,402		534,499		454,402			534,499

Property and equipment, net	509,102		520,194		509,102			520,194
Goodwill	1,642,633		1,642,857		1,642,633			1,642,857
Other identifiable intangibles	71,907		71,980		71,907			71,980
Other assets	139,578		146,196		139,578			146,196

Total Assets	$	2,817,622	$	2,915,726	$	2,817,622		$	2,915,726

LIABILITIES AND EQUITY
Current Liabilities:
Bank overdrafts	$	12,506	$	18,476	$	12,506		$	18,476
Current portion of long-term debt and notes payable	17,565		15,435		17,565			15,435
Accounts payable	88,285		93,022		88,285			93,022
Accrued payroll	90,011		73,081		90,011			73,081
Accrued vacation	59,730		62,180		59,730			62,180
Accrued interest	12,297		16,765		12,297			16,765
Accrued other	90,471		82,300		90,471			82,300
Income taxes payable	622		19,645		622			19,645
Due to third party payors	37		1,191		37			1,191
Total Current Liabilities	371,524		382,095		371,524			382,095

Long-term debt, net of current portion	1,427,710		1,596,765		1,427,710			1,596,765
Non-current deferred tax liability	96,287		96,502		96,287			96,502
Other non-current liabilities	91,875		95,090		91,875			95,090

Total Liabilities	1,987,396		2,170,452		1,987,396			2,170,452

Redeemable non-controlling interests	11,584		11,276		11,584			11,276

Stockholders’ Equity:
Common stock of Holdings, $0.001 par value, 700,000,000 shares authorized, 140,260,968 shares and 130,729,673 shares issued and outstanding at 2013 and 2014, respectively	140		131		—			—
Common stock of Select, $0.01 par value, 100 shares issued and outstanding	—		—		0			0
Capital in excess of par	474,729		415,875		869,576			875,264
Retained earnings (accumulated deficit)	311,365		285,397		(83,342		)	(173,861		)
Total Select Medical Holdings Corporation and Select Medical Corporation Stockholders’ Equity	786,234		701,403		786,234			701,403
Non-controlling interest	32,408		32,595		32,408			32,595
Total Equity	818,642		733,998		818,642			733,998

Total Liabilities and Equity	$	2,817,622	$	2,915,726	$	2,817,622		$	2,915,726

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 March 31,						For the Three Months Ended March 31,
	2013			2014			2013			2014

Net operating revenues	$	749,955		$	762,578		$	749,955		$	762,578

Costs and expenses:
Cost of services	624,904			638,764			624,904			638,764
General and administrative	17,398			18,123			17,398			18,123
Bad debt expense	9,321			11,018			9,321			11,018
Depreciation and amortization	15,802			16,229			15,802			16,229
Total costs and expenses	667,425			684,134			667,425			684,134

Income from operations	82,530			78,444			82,530			78,444

Other income and expense:
Loss on early retirement of debt	(1,467		)	(2,277		)	(508		)	(2,277		)
Equity in earnings of unconsolidated subsidiaries	1,058			908			1,058			908
Interest expense	(23,458		)	(20,616		)	(21,048		)	(20,616		)

Income before income taxes	58,663			56,459			62,032			56,459

Income tax expense	21,861			22,092			23,040			22,092

Net income	36,802			34,367			38,992			34,367

Less: Net income attributable to non-controlling interests	2,384			1,323			2,384			1,323

Net income attributable to Select Medical Holdings Corporation and Select Medical Corporation	$	34,418		$	33,044		$	36,608		$	33,044

Income per common share:
Basic	$	0.25		$	0.24
Diluted	$	0.24		$	0.24

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

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Consolidated Statement 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			Accumulated Other Comprehensive Income (Loss)		Non-controlling Interests
Balance at December 31, 2013			$	818,642		140,261		$	140		$	474,729		$	311,365		$	—	$	32,408
Net income	$	34,135	34,135											33,044					1,091
Net income - attributable to redeemable non-controlling interests	232
Total comprehensive income	$	34,367
Dividends paid to common stockholders			(14,056		)									(14,056		)
Issuance and vesting of restricted stock			3,543			193		0			3,543
Repurchase of common shares			(109,500		)	(10,000	)	(10		)	(64,541		)	(44,949		)
Stock option expense			202								202
Exercise of stock options			1,943			276		1			1,942
Distributions to non-controlling interests			(904		)														(904		)
Other			(7		)									(7		)
Balance at March 31, 2014			$	733,998		130,730		$	131		$	415,875		$	285,397		$	—	$	32,595

						Select Medical Corporation Stockholders
	Comprehensive Income		Total			Common Stock Issued	Common Stock Par Value		Capital in Excess of Par		Accumulated Deficit			Accumulated Other Comprehensive Income (Loss)		Non-controlling Interests
Balance at December 31, 2013			$	818,642		0	$	0	$	869,576	$	(83,342	)	$	—	$	32,408
Net income	$	34,135	34,135								33,044					1,091
Net income - attributable to redeemable non-controlling interests	232
Total comprehensive income	$	34,367
Additional investment by Holdings			1,943						1,943
Dividends declared and paid to Holdings			(123,556		)						(123,556		)
Contribution related to restricted stock awards and stock option issuances by Holdings			3,745						3,745
Distributions to non-controlling interests			(904		)											(904		)
Other			(7		)						(7		)
Balance at March 31, 2014			$	733,998		0	$	0	$	875,264	$	(173,861	)	$	—	$	32,595

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 Three Months Ended March 31,						For the Three Months Ended March 31,
	2013			2014			2013			2014

Operating activities
Net income	$	36,802		$	34,367		$	38,992		$	34,367
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	15,802			16,229			15,802			16,229
Provision for bad debts	9,321			11,018			9,321			11,018
Equity in earnings of unconsolidated subsidiaries	(1,058		)	(908		)	(1,058		)	(908		)
Loss on early retirement of debt	1,467			2,277			508			2,277
Loss from disposal of assets	41			121			41			121
Non-cash stock compensation expense	1,749			2,155			1,749			2,155
Amortization of debt discount, premium and issuance costs	2,304			2,051			2,215			2,051
Changes in operating assets and liabilities, net of effects from acquisition of businesses:
Accounts receivable	(77,963		)	(87,437		)	(77,963		)	(87,437		)
Other current assets	(6,407		)	(3,144		)	(6,407		)	(3,144		)
Other assets	(652		)	(3,938		)	(652		)	(3,938		)
Accounts payable	4,130			4,732			4,130			4,732
Due to third-party payors	1,897			1,154			1,897			1,154
Accrued expenses	(20,700		)	(13,957		)	(17,442		)	(13,957		)
Income and deferred taxes	21,293			19,280			22,472			19,280
Net cash used in operating activities	(11,974		)	(16,000		)	(6,395		)	(16,000		)

Investing activities
Purchases of property and equipment	(13,999		)	(27,299		)	(13,999		)	(27,299		)
Investment in businesses, net of distributions	(9,977		)	(124		)	(9,977		)	(124		)
Acquisition of businesses, net of cash acquired	—			(375		)	—			(375		)
Net cash used in investing activities	(23,976		)	(27,798		)	(23,976		)	(27,798		)

Financing activities
Borrowings on revolving credit facility	190,000			285,000			190,000			285,000
Payments on revolving credit facility	(230,000		)	(200,000		)	(230,000		)	(200,000		)
Borrowings on credit facility term loans, net of discount	298,500			—			298,500			—
Payments on credit facility term loans	(3,563		)	(33,994		)	(3,563		)	(33,994		)
Issuance of 6.375% senior notes, includes premium	—			111,650			—			111,650
Repurchase of senior floating rate notes	(167,300		)	—			—			—
Repurchase of 7 5/8% senior subordinated notes	(70,000		)	—			(70,000		)	—
Borrowings of other debt	5,826			6,111			5,826			6,111
Principal payments on other debt	(2,291		)	(3,067		)	(2,291		)	(3,067		)
Debt issuance costs	(4,209		)	(4,434		)	(4,209		)	(4,434		)
Dividends paid to common stockholders	—			(14,056		)	—			—
Dividends paid to Holdings	—			—			(182,862		)	(123,556		)
Repurchase of common stock	(9,983		)	(109,500		)	—			—
Proceeds from issuance of common stock	—			1,943			—			—
Equity investment by Holdings	—			—			—			1,943
Proceeds from (repayments of) bank overdrafts	(5,629		)	5,970			(5,629		)	5,970
Distributions to non-controlling interests	(1,045		)	(1,452		)	(1,045		)	(1,452		)
Net cash provided by (used in) financing activities	306			44,171			(5,273		)	44,171

Net increase (decrease) in cash and cash equivalents	(35,644		)	373			(35,644		)	373

Cash and cash equivalents at beginning of period	40,144			4,319			40,144			4,319
Cash and cash equivalents at end of period	$	4,500		$	4,692		$	4,500		$	4,692

Supplemental Cash Flow Information
Cash paid for interest	$	27,206		$	14,407		$	21,626		$	14,407
Cash paid for taxes	$	1,140		$	2,812		$	1,140		$	2,812

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 March 31, 2014 and for the three month periods ended March 31, 2013 and 2014 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 months ended March 31, 2014 are not necessarily indicative of the results to be expected for the full fiscal year ending December 31, 2014. 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, 2013 contained in the Company’s Annual Report on Form 10-K filed with the SEC on February 25, 2014.

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.

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3. Intangible Assets

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

	December 31, 2013		March 31, 2014
	(in thousands)

Goodwill	$	1,642,633	$	1,642,857
Trademarks	57,709		57,709
Certificates of need	12,115		12,188
Accreditations	2,083		2,083
Total	$	1,714,540	$	1,714,837

The Company’s accreditations and trademarks have renewal terms. The costs to renew these intangibles are expensed as incurred. At March 31, 2014, the accreditations and trademarks have a weighted average time until next renewal of approximately 1.5 years and 6.2 years, respectively.

The changes in the carrying amount of goodwill for the Company’s reportable segments for the three months ended March 31, 2014 are as follows:

	Specialty Hospitals		Outpatient Rehabilitation		Total
	(in thousands)
Balance as of December 31, 2013	$	1,334,615	$	308,018	$	1,642,633
Goodwill acquired during the period	—		224		224
Balance as of March 31, 2014	$	1,334,615	$	308,242	$	1,642,857

4. Share Repurchase

On April 30, 2014, Holdings board of directors authorized an increase of $150.0 million in the capacity of its common stock repurchase program from $350.0 million to $500.0 million and extended the program until December 31, 2016. Holdings repurchased a total of 10,000,000 shares of common stock at a total cost of $109.5 million, or $10.95 per share, during the three months ended March 31, 2014. The shares were repurchased from Welsh, Carson, Anderson & Stowe IX, L.P. and WCAS Capital Partners IV, L.P. pursuant to a stock purchase agreement dated February 26, 2014.

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5. Indebtedness

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

	December 31, 2013		March 31, 2014
	(in thousands)

6.375% senior notes (1)	$	600,000	$	711,637
Senior secured credit facilities:
Revolving loan	20,000		105,000
Term loans (2)	807,815		774,995
Other	17,460		20,568
Total debt	1,445,275		1,612,200
Less: current maturities	17,565		15,435
Total long-term debt	$	1,427,710	$	1,596,765

(1) Presented net of unamortized premiums of $1.6 million at March 31, 2014.

(2) Presented net of unamortized discounts of $6.3 million and $5.2 million at December 31, 2013 and March 31, 2014, respectively.

Senior Secured Credit Facilities

On June 1, 2011, Select entered into its existing senior secured credit agreement that provides for $1.15 billion in senior secured credit facilities. Set forth below is a summary of the terms of the senior secured credit facilities.

On August 13, 2012, Select entered into an additional credit extension amendment to its senior secured credit facilities providing for a $275.0 million series A term loan at the same interest rate and with the same term as the original term loan.

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, referred to as the series B term loan. 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. On May 28, 2013, Select issued and sold $600.0 million aggregate principal amount of 6.375% senior notes due June 1, 2021. Select used the proceeds of the 6.375% 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.

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

· 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 new term loan tranche, referred to as the 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%;

· lower the interest rate payable on the series B term loan from Adjusted LIBO plus 3.75%, or Alternate Base Rate plus 2.75%, to Adjusted LIBO plus 3.25%, or Alternate Base Rate plus 2.25%;

· 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 the senior secured credit facilities) is less than or equal to 2.75 to 1.00; and

· amend the definition of ‘‘Available Amount’’ in a manner the effect of which was to increase the amount available for investments, restricted payments and payment of specified indebtedness.

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On March 4, 2014, Select made a principal prepayment of $34.0 million associated with its term loans in accordance with the provision in its senior secured credit facilities agreement that requires mandatory prepayments of term loans resulting from excess cash flow as defined in the senior secured credit facilities.

On March 4, 2014, Select amended its senior secured credit facilities in order to, among other things:

· convert the remaining series B term loan to a new term loan tranche, referred to as the series D term loan, and lower the interest rate payable on the series D term loan from Adjusted LIBO plus 3.25%, or Alternate Base Rate plus 2.25%, to Adjusted LIBO plus 2.75%, or Alternate Base Rate plus 1.75%;

· set the maturity date of the series D term loan at December 20, 2016;

· convert the remaining series C term loan to a new term loan tranche, referred to as the series E term loan, and lower the interest rate payable on the series E term loan from Adjusted LIBO plus 3.00% (subject to an Adjusted LIBO rate floor of 1.00%), or Alternate Base Rate plus 2.00%, to Adjusted LIBO plus 2.75% (subject to an Adjusted LIBO rate floor of 1.00%), or Alternate Base Rate plus 1.75%;

· set the maturity date of the series E term loan at June 1, 2018;

· beginning with the quarter ending March 31, 2014, increase the quarterly compliance threshold set forth in the leverage ratio financial maintenance covenant to a level of 5.00 to 1.00 from 4.50 to 1.00;

· provide for a prepayment premium of 1.00% if the senior secured credit facilities are amended at any time prior to September 4, 2014 in the case of the series D term loans and March 4, 2015 in the case of the series E term loans and such amendment reduces the yield applicable to such loans; and

· amend the definition of “Available Amount” in a manner the effect of which was to increase the amount available for investments, restricted payments and the payment of specified indebtedness.

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Select’s senior secured credit facilities now provides for senior secured financing consisting of:

· a $300.0 million, revolving credit facility, $293.3 million of which matures on March 1, 2018 and the remaining $6.7 million maturing on June 1, 2016, including a $75.0 million sublimit for the issuance of standby letters of credit and a $25.0 million sublimit for swingline loans;

· a $284.6 million series D term loan, maturing on December 20, 2016; and

· a $495.6 million series E term loan, maturing on June 1, 2018.

All borrowings under Select’s senior secured credit facilities are subject to the satisfaction of required conditions, including the absence of a default at the time of and after giving effect to such borrowing and the accuracy of the representations and warranties of the borrowers.

The interest rates per annum applicable to borrowings under Select’s senior secured credit facilities are, at its option, equal to either an Alternate Base Rate or an Adjusted LIBO rate for a one, two, three or six month interest period, or a nine or twelve month period if available, in each case, plus an applicable margin percentage. The Alternate Base Rate is the greatest of (1) JPMorgan Chase Bank, N.A.’s prime rate, (2) one-half of 1% over the weighted average of rates on overnight Federal funds as published by the Federal Reserve Bank of New York and (3) the Adjusted LIBO rate from time to time for an interest period of one month, plus 1.00%. The Adjusted LIBO rate is, with respect to any interest period, the London interbank offered rate for such interest period, adjusted for any applicable statutory reserve requirements.

Borrowings under the series D term loan bear interest at a rate equal to Adjusted LIBO plus 2.75%, or Alternate Base Rate plus 1.75%. Borrowings under the series E term loan bear interest at a rate equal to Adjusted LIBO plus 2.75%, or Alternate Base Rate plus 1.75%. The Adjusted LIBO for the series E term loan will at no time be less than 1.00%.

Borrowings under the revolving credit facility bear interest at a rate equal to Adjusted LIBO plus a percentage ranging from 2.75% to 3.75%, or Alternate Base Rate plus a percentage ranging from 1.75% to 2.75%, in each case based on Select’s ratio of total indebtedness to Consolidated EBITDA (as defined in the senior secured credit facilities).

On the last day of each calendar quarter Select is required to pay each lender a commitment fee in respect of any unused commitments under the revolving credit facility, which is currently 0.50% per annum subject to adjustment based upon the ratio of Select’s total indebtedness to Consolidated EBITDA (as defined in the senior secured credit facilities).

Subject to exceptions, Select’s senior secured credit facilities require mandatory prepayments of term loans in amounts equal to:

· 50% (as may be reduced based on Select’s ratio of total indebtedness to Consolidated EBITDA (as defined in the senior secured credit facilities)) of Select’s annual excess cash flow;

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· 100% of the net cash proceeds from non-ordinary course asset sales or other dispositions, or as a result of a casualty or condemnation event, subject to reinvestment rights and certain other exceptions; and

· 100% of the net cash proceeds from certain incurrences of debt.

Beginning on March 31, 2015 and following application of the 2013 excess cash flow payment, discussed above, under the senior secured credit facilities the aggregate principal amount will amortize as follows:

· the series D term loan has aggregate quarterly repayment requirements of $0.7 million until maturity, at which time the remaining balance of $279.5 million is due on December 20, 2016; and

· the series E term loan has aggregate quarterly repayment requirements of $1.3 million until maturity, at which time the remaining balance of $479.2 million is due on June 1, 2018.

Select’s senior secured credit facilities are guaranteed by Holdings, Select and substantially all of its current subsidiaries, and will be guaranteed by substantially all of Select’s future subsidiaries and secured by substantially all of Select’s existing and future property and assets and by a pledge of its capital stock and the capital stock of its subsidiaries.

Select’s senior secured credit facilities require that it comply on a quarterly basis with certain financial covenants, including a maximum leverage ratio test.

In addition, Select’s senior secured credit facilities include negative covenants, subject to significant exceptions, restricting or limiting its ability and the ability of Holdings and Select’s restricted subsidiaries, to, among other things:

· incur, assume, permit to exist or guarantee additional debt and issue or sell or permit any subsidiary to issue or sell preferred stock;

· amend, modify or waiver any rights under the certificate of indebtedness, credit agreements, certificate of incorporation, bylaws or other organizational documents which would be materially adverse to the creditors;

· pay dividends or other distributions on, redeem, repurchase, retire or cancel capital stock;

· purchase or acquire any debt or equity securities of, make any loans or advances to, guarantee any obligation of, or make any other investment in, any other company;

· incur or permit to exist certain liens on property or assets owned or accrued or assign or sell any income or revenues with respect to such property or assets;

· sell or otherwise transfer property or assets to, purchase or otherwise receive property or assets from, or otherwise enter into transactions with affiliates;

· merge, consolidate or amalgamate with another company or permit any subsidiary to merge, consolidate or amalgamate with another company;

· sell, transfer, lease or otherwise dispose of assets, including any equity interests;

· repay, redeem, repurchase, retire or cancel any subordinated debt;

· incur capital expenditures;

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· engage to any material extent in any business other than business of the type currently conducted by Select or reasonably related businesses; and

· incur obligations that restrict the ability of its subsidiaries to incur or permit to exist any liens on Select’s property or assets or to make dividends or other payments to Select.

Select’s senior secured credit facilities also contain certain representations and warranties, affirmative covenants and events of default. The events of default include payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults to certain indebtedness, certain events of bankruptcy, certain events under ERISA, material judgments, actual or asserted failure of any guaranty or security document supporting Select’s senior secured credit facilities to be in full force and effect and any change of control. If such an event of default occurs, the lenders under Select’s senior secured credit facilities will be entitled to take various actions, including the acceleration of amounts due under the senior secured credit facilities and all actions permitted to be taken by a secured creditor.

At March 31, 2014, Select had outstanding borrowings of $780.2 million (excluding unamortized original issue discounts of $5.2 million) under the term loans and borrowings of $105.0 million (excluding letters of credit) under the revolving loan portion of the senior secured credit facilities. Select had $152.7 million of availability under its revolving credit facility (after giving effect to $42.3 million of outstanding letters of credit) at March 31, 2014.

The applicable margin percentage for borrowings under Select’s revolving loan is subject to change based upon the ratio of Select’s leverage ratio (as defined in the senior secured credit facility). The applicable interest rate for revolving loans as of March 31, 2014 was (1) Alternate Base plus 2.75% for alternate base rate loans and (2) LIBO plus 3.75% for adjusted LIBO rate loans.

Select’s senior secured credit facility requires it to maintain certain leverage ratios (as defined in the senior secured credit facility). For the four consecutive fiscal quarters ended March 31, 2014, Select was required to maintain its leverage ratio (its ratio of total indebtedness to consolidated EBITDA) at less than 5.00 to 1.00. Select’s leverage ratio was 4.40 to 1.00 as of March 31, 2014.

Senior Notes

On March 11, 2014, Select issued and sold $110.0 million aggregate principal amount of additional 6.375% senior notes due June 1, 2021 (the “Additional Notes”), at 101.50% of the aggregate principal amount resulting in gross proceeds of $111.7 million. The notes were issued as additional notes under the indenture pursuant to which it previously issued $600.0 million of 6.375% senior notes due June 1, 2021 (the “Existing Notes” and, together with the Additional notes, the “Notes”).

The Additional Notes are expected to be treated as a single series with the Existing Notes and will have the same terms as those of the Existing Notes, except that (i) the Additional Notes will be subject to a separate registration rights agreement and (ii) the Additional Notes will be issued initially under CUSIP numbers different from the Existing Notes. The Additional Notes

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and the Existing Notes will vote as one class under the indenture governing the Notes. Holders who exchange their Additional Notes in the contemplated registered exchange offer will receive registered notes that are expected to share a single CUSIP number with the Existing Notes, and we expect that such registered notes and the Existing Notes will thereafter be fungible.

Interest on the 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 for the Existing Notes and on June 1, 2014 for the Additional Notes. The 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 Notes are fully and unconditionally guaranteed by all of Select’s wholly owned subsidiaries. The 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 Notes prior to June 1, 2016 by paying a “make-whole” premium. Select may redeem some or all of the 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 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 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.

The indenture relating to the 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 Notes or file such reports electronically with the SEC. These covenants are subject to a number of exceptions, limitations and qualifications set forth in the Indenture.

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Maturities of Long-Term Debt and Notes Payable

Maturities of the Company’s long-term debt for the period from April 1, 2014 through December 31, 2014 and the years after 2014 are approximately as follows and are presented net of the discounts on the senior secured credit facility term loans and premium on the senior notes (in thousands):

April 1, 2014 — December 31, 2014	$	13,337
2015	10,516
2016	391,916
2017	4,265
2018	480,216
2019 and beyond	711,950

Loss on Early Retirement of Debt

On March 4, 2014, Select amended its term loans under its senior secured credit facility. During the three months ended March 31, 2014, the Company recognized a loss of $2.3 million for unamortized debt issuance costs, unamortized original issue discount, and certain fees incurred related to term loan modifications.

On March 22, 2013, the Company redeemed Select’s 7 5/8% senior subordinated notes due 2015 and redeemed Holdings’ senior floating rate notes due 2015. During the three months ended March 31, 2013, the Company recognized a loss on early retirement of debt of $1.5 million for unamortized debt issuance costs of which approximately $0.5 million was associated with Select’s redemption of its 7 5/8% senior subordinated notes due 2015 and approximately $1.0 million was associated with Holdings’ redemption of its senior floating rate notes due 2015.

6. 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 $827.8 million and $880.0 million at December 31, 2013 and March 31, 2014, respectively. The fair value of Select’s senior secured credit facility was $828.3 million and $876.4 million at December 31, 2013 and March 31, 2014, 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.

The carrying value of Select’s 6.375% senior notes was $600.0 million and $711.6 million at December 31, 2013 and March 31, 2014, respectively. The fair value of Select’s 6.375% senior notes was $586.5 million

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and $721.4 million at December 31, 2013 and March 31, 2014, respectively. 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.

7. 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 March 31, 2013
	Specialty Hospitals		Outpatient Rehabilitation		Other			Total
	(in thousands)

Net operating revenues	$	557,751	$	192,101	$	103		$	749,955
Adjusted EBITDA	93,347		22,833		(16,099		)	100,081
Total assets	2,202,236		504,541		102,059			2,808,836
Capital expenditures	10,897		2,845		257			13,999

	Three Months Ended March 31, 2014
	Specialty Hospitals		Outpatient Rehabilitation		Other			Total
	(in thousands)

Net operating revenues	$	564,625	$	197,850	$	103		$	762,578
Adjusted EBITDA	92,150		20,989		(16,311		)	96,828
Total assets	2,290,655		525,040		100,031			2,915,726
Capital expenditures	21,498		3,630		2,171			27,299

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

	Three Months Ended March 31, 2013
	Specialty Hospitals			Outpatient Rehabilitation			Other
	(in thousands)
Adjusted EBITDA	$	93,347		$	22,833		$	(16,099	)
Depreciation and amortization	(11,862		)	(2,969		)	(971		)
Stock compensation expense	—			—			(1,749		)

										Select Medical Holdings Corporation			Select Medical Corporation
Income (loss) from operations	$	81,485		$	19,864		$	(18,819	)	$	82,530		$	82,530
Loss on early retirement of debt										(1,467		)	(508		)
Equity in earnings of unconsolidated subsidiaries										1,058			1,058
Interest expense										(23,458		)	(21,048		)
Income before income taxes										$	58,663		$	62,032

	Three Months March 31, 2014
	Specialty Hospitals			Outpatient Rehabilitation			Other
	(in thousands)
Adjusted EBITDA	$	92,150		$	20,989		$	(16,311	)
Depreciation and amortization	(12,095		)	(3,212		)	(922		)
Stock compensation expense	—			—			(2,155		)

										Select Medical Holdings Corporation			Select Medical Corporation
Income (loss) from operations	$	80,055		$	17,777		$	(19,388	)	$	78,444		$	78,444
Loss on early retirement of debt										(2,277		)	(2,277		)
Equity in losses of unconsolidated subsidiaries										908			908
Interest expense										(20,616		)	(20,616		)
Income before income taxes										$	56,459		$	56,459

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8. 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 March 31,
	2013		2014
	(in thousands, except per share amounts)
Numerator:
Net income attributable to Select Medical Holdings Corporation	$	34,418	$	33,044
Less: Earnings allocated to unvested restricted stockholders	708		770
Net income available to common stockholders	$	33,710	$	32,274

Denominator:
Weighted average shares — basic	137,389		135,540
Effect of dilutive securities:
Stock options	209		413
Weighted average shares — diluted	137,598		135,953

Basic income per common share	$	0.25	$	0.24
Diluted income per common share	$	0.24	$	0.24

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 March 31,
	2013	2014
	(in thousands)
Stock options	1,554	12

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9. 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 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. The court has subsequently granted additional motions filed by the United States to continue the stay, and the current stay extends through May 16, 2014.

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In January 2014, representatives of the United States Attorney’s Office for the Southern District of Indiana and the Office of Attorney General for the State of Indiana informed the Company that, while they have not yet decided whether to intervene in the case, their investigation is continuing concerning allegations that SSH-Evansville admitted patients for whom long-term acute care was not medically necessary, up-coded diagnoses at admission, discharged patients too early or held patients too long, readmitted patients discharged to short-stay acute care hospitals only after nine days to enable billing for two admissions, and allowed unnecessary bronchoscopies to be performed. The Company is involved in ongoing discussions with the government regarding this matter.

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 March 31, 2014, 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 $19.7 million.

10. Subsequent Event

On April 30, 2014, Holdings’ board of directors declared a cash dividend of $0.10 per share. The dividend will be payable on or about May 28, 2014 to stockholders of record as of the close of business on May 16, 2014.

11. 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, 2013 and March 31, 2014 and for the three months ended March 31, 2013 and 2014.

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
	Consolidating Balance Sheet
	March 31, 2014
	(unaudited)
	Select Medical Corporation (Parent Company Only)			Subsidiary Guarantors		Non-Guarantor Subsidiaries		Eliminations			Consolidated
	(in thousands)
Assets
Current Assets:
Cash and cash equivalents	$	70		$	3,160	$	1,462	$	—		$	4,692
Accounts receivable, net	—			405,944		61,794		—			467,738
Current deferred tax asset	7,288			6,025		4,468		—			17,781
Intercompany receivables	—			1,040,402		97,006		(1,137,408		)(a)	—
Other current assets	11,788			27,702		4,798		—			44,288
Total Current Assets	19,146			1,483,233		169,528		(1,137,408		)	534,499

Property and equipment, net	16,571			444,841		58,782		—			520,194
Investment in affiliates	3,091,734			76,777		—		(3,168,511		)(b)(c)	—
Goodwill	—			1,642,857		—		—			1,642,857
Non-current deferred tax asset	8,878			—		—		(8,878		)(d)	—
Other identifiable intangibles	—			71,980		—		—			71,980
Other assets	38,598			106,982		616		—			146,196

Total Assets	$	3,174,927		$	3,826,670	$	228,926	$	(4,314,797	)	$	2,915,726

Liabilities and Equity
Current Liabilities:
Bank overdrafts	$	18,476		$	—	$	—	$	—		$	18,476
Current portion of long-term debt and notes payable	7,144			7,379		912		—			15,435
Accounts payable	8,023			71,790		13,209		—			93,022
Intercompany payables	1,137,408			—		—		(1,137,408		)(a)	—
Accrued payroll	913			71,878		290		—			73,081
Accrued vacation	4,781			49,620		7,779		—			62,180
Accrued interest	15,406			1,359		—		—			16,765
Accrued other	42,894			32,550		6,856		—			82,300
Income taxes payable	19,645			—		—		—			19,645
Due to third party payors	—			404		787		—			1,191
Total Current Liabilities	1,254,690			234,980		29,833		(1,137,408		)	382,095

Long-term debt, net of current portion	1,163,004			370,919		62,842		—			1,596,765
Non-current deferred tax liability	—			97,656		7,724		(8,878		)(d)	96,502
Other non-current liabilities	55,830			34,140		5,120		—			95,090

Total Liabilities	2,473,524			737,695		105,519		(1,146,286		)	2,170,452

Redeemable non-controlling interests	—			—		11,276		—			11,276

Stockholder’s Equity:
Common stock	0			—		—		—			0
Capital in excess of par	875,264			—		—		—			875,264
Retained earnings	(173,861		)	952,332		15,346		(967,678		)(c)	(173,861		)
Subsidiary investment	—			2,136,643		64,190		(2,200,833		)(b)	—
Total Select Medical Corporation Stockholder’s Equity	701,403			3,088,975		79,536		(3,168,511		)	701,403

Non-controlling interests	—			—		32,595		—			32,595
Total Equity	701,403			3,088,975		112,131		(3,168,511		)	733,998

Total Liabilities and Equity	$	3,174,927		$	3,826,670	$	228,926	$	(4,314,797	)	$	2,915,726

(a) Elimination of intercompany.

(b) Elimination of investments in consolidated subsidiaries.

(d) Reclass of non-current deferred tax assset to report net non-current deferred tax liability in consolidation.

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	Select Medical Corporation Consolidating Statement of Operations For the Three Months Ended March 31, 2014 (unaudited)
	Select Medical Corporation (Parent Company Only)			Subsidiary Guarantors			Non- Guarantor Subsidiaries			Eliminations		Consolidated
	(in thousands)

Net operating revenues	$	103		$	655,233		$	107,242		$	—	$	762,578

Costs and expenses:
Cost of services	445			545,809			92,510			—		638,764
General and administrative	19,312			(1,189		)	—			—		18,123
Bad debt expense	—			9,164			1,854			—		11,018
Depreciation and amortization	923			12,829			2,477			—		16,229
Total costs and expenses	20,680			566,613			96,841			—		684,134

Income (loss) from operations	(20,577		)	88,620			10,401			—		78,444

Other income and expense:
Intercompany interest and royalty fees	(282		)	285			(3		)	—		—
Intercompany management fees	38,868			(33,818		)	(5,050		)	—		—
Equity in earnings of unconsolidated subsidiaries	—			887			21			—		908
Loss on early retirement of debt	(2,277		)	—			—			—		(2,277		)
Interest expense	(13,796		)	(5,797		)	(1,023		)