##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION  FORM 10-Q
 (Mark One)
 x
    
    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the Quarter Ended September 30, 2004 o
    
    Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For thePeriod From _________ to __________.
 Commission File Number: 000-32499 SELECT MEDICAL CORPORATION  Delaware
    
    23-2872718(State or other jurisdiction of
    
    (I.R.S. employer identificationincorporation or organization)
    
    number)
 4716 Old Gettysburg Road, P.O. Box 2034, Mechanicsburg, Pennsylvania 17055
(Address of principal executive offices and zip code) (717) 972-1100
(Registrants telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter periods as the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES x  NO o Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES x  NO o As of October 31, 2004, the number of outstanding shares of the
Registrants Common Stock was 101,907,859.




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TABLE OF CONTENTS PART I
    
    FINANCIAL INFORMATION
    
    
    3ITEM 1.
    
    CONSOLIDATED FINANCIAL STATEMENTSConsolidated balance sheets
    
    
    3Consolidated statements of operations
    
    
    4Consolidated
statement of changes in stockholders equity
    
    
    5Consolidated statements of cash flows
    
    
    6Notes to consolidated financial statements
    
    
    7ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
    
    
    23ITEM 3.
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    40ITEM 4.
    
    CONTROLS AND PROCEDURES
    
    
    40PART II
    
    OTHER INFORMATION
    
    
    40ITEM 1.
    
    LEGAL PROCEEDINGS
    
    
    40ITEM 2.
    
    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
    
    
    42ITEM 3.
    
    DEFAULTS UPON SENIOR SECURITIES
    
    
    42ITEM 4.
    
    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
    
    
    42ITEM 5.
    
    OTHER INFORMATION
    
    
    42ITEM 6.
    
    EXHIBITS
    
    
    42SIGNATURES
    
    
    
    
    43SECTION 302 CERTIFICATION OF CEOSECTION 302 CERTIFICATION OF CFOSECTION 906 CERTIFICATION OF CEOSECTION 906 CERTIFICATION OF CFO
  - 2 -




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##### Table of Contents



PART I            FINANCIAL INFORMATION 
 ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS SELECT MEDICAL CORPORATION 
 CONSOLIDATED BALANCE SHEETS
 (dollars in thousands, except share and per share amounts)
 September 30,
    
    December 31,2004
    
    2003(unaudited)AssetsCurrent Assets:Cash and cash equivalents
    
    $
    219,915
    
    
    $
    165,507Restricted cash
    
    
    7,500
    
    
    
    Accounts receivable, net of allowance for doubtful accounts of $108,256
and $111,517 in 2004 and 2003, respectively
    
    
    225,942
    
    
    
    230,171Current deferred tax asset
    
    
    62,977
    
    
    
    61,699Prepaid taxes
    
    
    
    
    
    
    958Other current assets
    
    
    21,811
    
    
    
    26,731Total Current Assets
    
    
    538,145
    
    
    
    485,066Property and equipment, net
    
    
    165,175
    
    
    
    174,902Goodwill
    
    
    302,383
    
    
    
    306,251Trademark
    
    
    58,875
    
    
    
    58,875Other intangibles
    
    
    20,286
    
    
    
    22,876Non-current deferred tax asset
    
    
    3,047
    
    
    
    6,603Other assets
    
    
    18,147
    
    
    
    24,425Total Assets
    
    $
    1,106,058
    
    
    $
    1,078,998Liabilities and Stockholders EquityCurrent Liabilities:Bank overdrafts
    
    $
    8,548
    
    
    $
    11,427Current portion of long-term debt and notes payable
    
    
    4,358
    
    
    
    10,267Accounts payable
    
    
    45,739
    
    
    
    59,569Accrued payroll
    
    
    59,289
    
    
    
    53,260Accrued vacation
    
    
    22,118
    
    
    
    21,529Accrued medical malpractice
    
    
    13,822
    
    
    
    12,777Accrued restructuring
    
    
    6,110
    
    
    
    10,375Accrued other
    
    
    71,040
    
    
    
    65,531Income taxes payable
    
    
    2,047
    
    
    
    Due to third party payors
    
    
    33,533
    
    
    
    51,951Total Current Liabilities
    
    
    266,604
    
    
    
    296,686Long-term debt, net of current portion
    
    
    351,150
    
    
    
    357,236Total Liabilities
    
    
    617,754
    
    
    
    653,922Commitments and ContingenciesMinority interest in consolidated subsidiary companies
    
    
    7,210
    
    
    
    5,901Stockholders Equity:Common stock
- $.01 par value: Authorized shares - 200,000,000 in 2004 and
2003 Issued shares - 101,856,000 and 102,219,000 in 2004 and 2003, respectively
    
    
    1,019
    
    
    
    1,022Capital in excess of par
    
    
    274,134
    
    
    
    291,519Retained earnings
    
    
    200,709
    
    
    
    121,560Accumulated other comprehensive income
    
    
    5,232
    
    
    
    5,074Total Stockholders Equity
    
    
    481,094
    
    
    
    419,175Total Liabilities and Stockholders Equity
    
    $
    1,106,058
    
    
    $
    1,078,998
 See accompanying notes. - 3 -




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##### Table of Contents



SELECT MEDICAL CORPORATION 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 (dollars in thousands,
except per share amounts)
(unaudited)
 For the Quarter
Ended
    
    For the Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net operating revenues
    
    $
    407,570
    
    
    $
    352,402
    
    
    $
    1,241,276
    
    
    $
    990,927Costs and expenses:Cost of services
    
    
    318,541
    
    
    
    282,006
    
    
    
    965,848
    
    
    
    792,493General and administrative
    
    
    10,945
    
    
    
    11,124
    
    
    
    36,490
    
    
    
    32,251Bad debt expense
    
    
    12,857
    
    
    
    13,636
    
    
    
    36,056
    
    
    
    38,156Depreciation and amortization
    
    
    10,264
    
    
    
    8,731
    
    
    
    29,533
    
    
    
    23,437Total costs and expenses
    
    
    352,607
    
    
    
    315,497
    
    
    
    1,067,927
    
    
    
    886,337Income from operations
    
    
    54,963
    
    
    
    36,905
    
    
    
    173,349
    
    
    
    104,590Other income and expense:Equity in earnings from joint ventures
    
    
    
    
    
    
    (334
    )
    
    
    
    
    
    
    (334
    )Interest income
    
    
    (634
    )
    
    
    (284
    )
    
    
    (1,485
    )
    
    
    (626
    )Interest expense
    
    
    8,632
    
    
    
    6,426
    
    
    
    25,385
    
    
    
    18,474Income from continuing operations before minority
interests and income taxes
    
    
    46,965
    
    
    
    31,097
    
    
    
    149,449
    
    
    
    87,076Minority interest in consolidated subsidiary companies
    
    
    620
    
    
    
    356
    
    
    
    2,772
    
    
    
    1,893Income from continuing operations before income taxes
    
    
    46,345
    
    
    
    30,741
    
    
    
    146,677
    
    
    
    85,183Income tax expense
    
    
    18,674
    
    
    
    12,146
    
    
    
    59,121
    
    
    
    33,503Income from continuing operations
    
    
    27,671
    
    
    
    18,595
    
    
    
    87,556
    
    
    
    51,680Income from discontinued operations, net of tax
    
    
    146
    
    
    
    18
    
    
    
    802
    
    
    
    18Net income
    
    $
    27,817
    
    
    $
    18,613
    
    
    $
    88,358
    
    
    $
    51,698Net income per common share:Basic:Income per share from continuing operations
    
    $
    0.27
    
    
    $
    0.19
    
    
    $
    0.85
    
    
    $
    0.54Income per share from discontinued operations
    
    
    
    
    
    
    
    
    
    
    0.01
    
    
    
    Net income per share
    
    $
    0.27
    
    
    $
    0.19
    
    
    $
    0.86
    
    
    $
    0.54DilutedIncome per share from continuing operations
    
    $
    0.26
    
    
    $
    0.18
    
    
    $
    0.82
    
    
    $
    0.51Income per share from discontinued operations
    
    
    
    
    
    
    
    
    
    
    0.01
    
    
    
    Net income per share
    
    $
    0.26
    
    
    $
    0.18
    
    
    $
    0.83
    
    
    $
    0.51Dividends per share
    
    $
    0.03
    
    
    $
    
    
    
    $
    0.09
    
    
    $
    Weighted average shares outstanding:Basic
    
    
    101,664
    
    
    
    98,697
    
    
    
    102,248
    
    
    
    96,033Diluted
    
    
    105,179
    
    
    
    105,131
    
    
    
    106,522
    
    
    
    102,367
 See accompanying notes. - 4 -




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Select Medical Corporation 
 Consolidated Statements of Changes in Stockholders Equity and Comprehensive Income
 (dollars in
thousands)
(unaudited)
 AccumulatedCommon
    
    Capital in
    
    
    
    
    
    OtherCommon
    
    Stock Par
    
    Excess of
    
    Retained
    
    Comprehensive
    
    ComprehensiveStock
    
    Value
    
    Par
    
    Earnings
    
    Income
    
    IncomeBalance at December 31, 2003
    
    
    102,219
    
    
    $
    1,022
    
    
    $
    291,519
    
    
    $
    121,560
    
    
    $
    5,074Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    88,358
    
    
    
    
    
    
    $
    88,358Other
comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    158
    
    
    
    158Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    88,516Issuance of common stock
    
    
    3,036
    
    
    
    31
    
    
    
    17,963Cash dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,209
    )Repurchases of common stock
    
    
    (3,399
    )
    
    
    (34
    )
    
    
    (48,024
    )Valuation of non-employee options
    
    
    
    
    
    
    
    
    
    
    151Tax benefit of stock option exercises
    
    
    
    
    
    
    
    
    
    
    12,525Balance at September 30, 2004
    
    
    101,856
    
    
    $
    1,019
    
    
    $
    274,134
    
    
    $
    200,709
    
    
    $
    5,232
 See accompanying notes. - 5 -




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##### Table of Contents



SELECT MEDICAL CORPORATION 
 CONSOLIDATED STATEMENTS OF CASH FLOW
 (dollars in thousands)
(unaudited)
 For the Nine Months EndedSeptember 30,2004
    
    2003Operating activitiesNet income
    
    $
    88,358
    
    
    $
    51,698Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    29,467
    
    
    
    23,513Provision for bad debts
    
    
    36,520
    
    
    
    38,194Minority interests
    
    
    2,772
    
    
    
    1,893Changes in operating assets and liabilities, net of
effects from acquisition of businesses:Accounts receivable
    
    
    (31,814
    )
    
    
    10,927Other current assets
    
    
    5,556
    
    
    
    941Other assets
    
    
    3,241
    
    
    
    1,413Accounts payable
    
    
    (13,831
    )
    
    
    8,901Due to third-party payors
    
    
    (20,112
    )
    
    
    4,680Accrued expenses
    
    
    8,384
    
    
    
    24,010Income taxes
    
    
    20,908
    
    
    
    (1,933
    )Net cash provided by operating activities
    
    
    129,449
    
    
    
    164,237Investing activitiesPurchases of property and equipment
    
    
    (26,092
    )
    
    
    (23,725
    )Proceeds from disposal of assets
    
    
    
    
    
    
    2,400Proceeds from sale of business
    
    
    11,554
    
    
    
    Earnout payments
    
    
    (2,983
    )
    
    
    (429
    )Proceeds from sale of membership interests
    
    
    4,768
    
    
    
    Acquisition of businesses, net of cash acquired
    
    
    (325
    )
    
    
    (232,226
    )Net cash used in investing activities
    
    
    (13,078
    )
    
    
    (253,980
    )Financing activitiesIssuance of 7.5% Senior Subordinated Notes
    
    
    
    
    
    
    175,000Net repayments on credit facility debt
    

    
    (8,483
    )
    
    
    (64,415
    )Payment of deferred financing fees
    
    
    
    
    
    
    (5,578
    )Principal payments on seller and other debt
    
    
    (2,961
    )
    
    
    (2,619
    )Restricted cash
    
    
    (7,500
    )
    
    
    Proceeds from issuance of common stock
    
    
    17,994
    
    
    
    20,235Repurchase of common stock
    
    
    (48,058
    )
    
    
    Payment of dividends
    
    
    (9,209
    )
    
    
    Repayment of bank overdrafts
    
    
    (2,879
    )
    
    
    (6,810
    )Distributions to minority interests
    
    
    (996
    )
    
    
    (1,042
    )Net cash provided by (used in) financing activities
    
    
    (62,092
    )
    
    
    114,771Effect of exchange rate changes on cash
and cash equivalents
    
    
    129
    
    
    
    358Net increase in cash and cash equivalents
    
    
    54,408
    
    
    
    25,386Cash and cash equivalents at beginning of period
    
    
    165,507
    
    
    
    56,062Cash and cash equivalents at end of period
    
    $
    219,915
    
    
    $
    81,448Supplemental Cash Flow InformationCash paid for interest
    
    $
    21,837
    
    
    $
    11,493Cash paid for income taxes
    
    $
    40,832
    
    
    $
    36,149
 See accompanying notes. - 6 -




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. Basis of Presentation The unaudited condensed consolidated financial statements of Select
Medical Corporation (the Company) as of September 30, 2004 and for the three
and nine month periods ended September 30, 2004 and 2003, have been prepared in
accordance with generally accepted accounting principles. In the opinion of
management, such information contains all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation of the results
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, 2004 are not necessarily indicative of the results to be expected
for the full fiscal year ending December 31, 2004. Certain information and disclosures normally included in the notes to
consolidated financial statements have been condensed or omitted as permitted
by the rules and regulations of the Securities and Exchange Commission,
although the Company believes the disclosure is adequate to make the
information presented not misleading. The accompanying unaudited consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto for the year ended December 31, 2003
contained in the Companys Form 10-K filed with the Securities and Exchange
Commission. 2. Accounting Policies Use of Estimates The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates. Restricted Cash Restricted
cash consists of cash used to establish a trust fund, as required by
the Companys insurance program, for the
purpose of paying professional and general liability losses and expenses
incurred by the Company. Recent Accounting Pronouncements In December 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46R (FIN 46R) which replaced Interpretation No. 46,
Consolidation of Variable Interest Entities, an interpretation of Accounting
Research Bulletin No. 51, Consolidated Financial Statements, to improve
financial reporting of special purpose and other entities. In accordance with
the interpretation, business enterprises that represent the primary beneficiary
of another entity by retaining a controlling financial interest in that
entitys assets, liabilities and results of operations, must consolidate the
entity in their financial statements. Prior to the issuance of FIN 46R,
consolidation generally occurred when an enterprise controlled another entity
through voting interests. The disclosure requirements of FIN 46R are effective
for financial statements issued after December 31, 2003. The initial
recognition provisions of FIN 46R were implemented during the first reporting
period that ended March 31, 2004. The adoption of FIN 46R did not have a
material impact on the Companys financial statements for the three and nine
month periods ended September 30, 2004. - 7 -




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##### Table of Contents



Stock Option Plans During the nine months ended September 30, 2004, the Company granted stock
options under its Second Amended and Restated 1997 Stock Option Plan totaling
3,704,000 shares of Common Stock at exercise prices ranging from $13.86 to
$15.50 per share. In addition, the Company granted stock options under its
2002 Non-Employee Directors Plan totaling 110,800 shares of Common Stock at
the exercise price of $15.50 per share. As permitted by Statement of Financial Accounting Standards No. 123,
Accounting for Stock Based Compensation (SFAS No. 123), the Company has
chosen to apply APB Opinion No. 25, Accounting for Stock Issued to Employees
(APB 25) and related interpretations in accounting for its Plans. Accordingly,
no compensation cost has been recognized for options granted under the Plans. For purposes of pro forma disclosures, the estimated fair value of the
options is expensed over the options vesting period. The Companys pro forma
net earnings and earnings per share assuming compensation costs had been
recognized consistent with the fair value method under SFAS No. 123 were as
follows: For the Three Months Ended
    
    For the Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(dollars in thousands, except per share amounts)Net income  as reported
    
    $
    27,817
    
    
    $
    18,613
    
    
    $
    88,358
    
    
    $
    51,698Deduct: Total stock based employee
compensation expense determined
under fair value based method for
all awards, net of related tax
effects
    
    
    5,292
    
    
    
    8,461
    
    
    
    15,336
    
    
    
    10,369Net income  pro forma
    
    $
    22,525
    
    
    $
    10,152
    
    
    $
    73,022
    
    
    $
    41,329Weighted average grant-date fair value
    
    $
    6.16
    
    
    $
    6.51
    
    
    $
    6.42
    
    
    $
    6.41Basic earnings per share  as reported
    
    
    0.27
    
    
    
    0.19
    
    
    
    0.86
    
    
    
    0.54Basic earnings per share  pro forma
    
    
    0.22
    
    
    
    0.10
    
    
    
    0.71
    
    
    
    0.43Diluted earnings per share  as
reported
    
    
    0.26
    
    
    
    0.18
    
    
    
    0.83
    
    
    
    0.51Diluted earnings per share  pro forma
    
    
    0.21
    
    
    
    0.10
    
    
    
    0.69
    
    
    
    0.40
 - 8 -




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Accumulated Other Comprehensive Income Accumulated other comprehensive income consists of cumulative translation
adjustment gains associated with the Companys Canadian operations of
$5,232,000 and $5,123,000 at September 30, 2004 and December 31, 2003,
respectively. Also, included in accumulated other comprehensive income at
December 31, 2003 were unrealized losses on available-for-sale securities of
$49,000, net of tax. Following is a reconciliation of net income to
comprehensive income: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(dollars in thousands)Net income
    
    $
    27,817
    
    
    $
    18,613
    
    
    $
    88,358
    
    
    $
    51,698Unrealized gains (losses) on available for sale
securities
    
    
    
    
    
    
    11
    
    
    
    (4
    )
    
    
    (100
    )Realized losses on available for sale securities
    
    
    
    
    
    
    
    
    
    
    53
    
    
    
    Realized loss on interest rate swap
    
    
    
    
    
    
    

    
    
    
    
    
    
    
    313Changes in foreign currency translation
    
    
    2,706
    
    
    
    (28
    )
    
    
    109
    
    
    
    4,290Total comprehensive income
    
    $
    30,523
    
    
    $
    18,596
    
    
    $
    88,516
    
    
    $
    56,201
 3. Intangible Assets Amortization expense for intangible assets for the three months ended
September 30, 2004 and 2003 was $857,000 and $760,000, respectively.
Amortization expense for intangible assets for the nine months ended September
30, 2004 and 2003 was $2,571,000 and $774,000, respectively. Estimated
amortization expense for intangible assets for each of the five years
commencing January 1, 2004 will be approximately $3,429,000 and primarily
relates to the amortization of the non-compete agreement associated with the
acquisition of Kessler Rehabilitation Corporation that occurred in September
2003. Intangible assets consist of the following: As of September 30, 2004Gross Carrying
    
    AccumulatedAmount
    
    Amortization(dollars in thousands)Amortized intangible assetsNon-Compete agreements
    
    $
    24,000
    
    
    $
    (3,714
    )Unamortized intangible assetsGoodwill
    
    $
    302,383Trademarks
    
    
    58,875Total
    
    $
    361,258
 - 9 -




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The changes in the carrying amount of goodwill for the Companys
reportable segments for the nine months ended September 30, 2004 are as
follows: Specialty
    
    OutpatientHospitals
    
    Rehabilitation
    
    All Other
    
    Total(dollars in thousands)Balance as of December 31, 2003
    
    $
    180,011
    
    
    $
    125,656
    
    
    $
    584
    
    
    $
    306,251Sale of business
    
    
    (2,693
    )
    
    
    
    
    
    
    
    
    
    
    (2,693
    )Assignment of membership interests
    
    
    (1,351
    )
    
    
    
    
    
    
    
    
    
    
    (1,351
    )Income tax benefits recognized
    
    
    
    
    
    
    (2,897
    )
    
    
    
    
    
    
    (2,897
    )Earn-out payments
    
    
    
    
    
    
    2,983
    
    
    
    
    
    
    
    2,983Translation adjustment
    
    
    
    
    
    
    517
    
    
    
    
    
    
    
    517Other
    
    
    
    
    
    
    (427
    )
    
    
    
    
    
    
    (427
    )Balance as of September 30, 2004
    
    $
    175,967
    
    
    $
    125,832
    
    
    $
    584
    
    
    $
    302,383
 4. Restructuring Charges The following summarizes the Companys restructuring activity: LeaseTerminationCosts
    
    Severance
    
    Total(dollars in thousands)January 1, 2004
    
    $
    5,805
    
    
    $
    4,570
    
    
    $
    10,375Amounts paid in 2004
    
    
    (2,051
    )
    
    
    (2,214
    )
    
    
    (4,265
    )September 30, 2004
    
    $
    3,754
    
    
    $
    2,356
    
    
    $
    6,110
 The Company expects to pay out the remaining lease termination costs through
2007 and severance related to workforce reductions of 36 employees through
2005. 5. Segment Information The Companys segments consist of (i) specialty hospitals and (ii)
outpatient rehabilitation. 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 (loss) before interest, income taxes,
depreciation and amortization, special charges, loss on early retirement of
debt, equity in earnings from joint ventures and minority interest. For the
periods presented there were no special charges or loss on early retirement of
debt that effect Adjusted EBITDA. - 10 -




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##### Table of Contents



The following table summarizes selected financial data for the Companys
reportable segments: Three Months Ended September 30, 2004Specialty
    
    OutpatientHospitals
    
    Rehabilitation
    
    All Other
    
    Total(dollars in thousands)Net revenue
    
    $
    270,647
    
    
    $
    133,522
    
    
    $
    3,401
    
    
    $
    407,570Adjusted EBITDA
    
    
    58,945
    
    
    
    17,349
    
    
    
    (11,067
    )
    
    
    65,227Total assets
    
    
    509,050
    
    
    
    367,578
    
    
    
    229,430
    
    
    
    1,106,058Capital expenditures
    
    
    5,397
    
    
    
    1,219
    
    
    
    344
    
    
    
    6,960
 Three Months Ended September 30, 2003Specialty
    
    OutpatientHospitals
    
    Rehabilitation
    
    All Other
    
    Total(dollars in thousands)Net revenue
    
    $
    220,967
    
    
    $
    129,108
    
    
    $
    2,327
    
    
    $
    352,402Adjusted EBITDA
    
    
    38,376
    
    
    
    16,862
    
    
    
    (9,602
    )
    
    
    45,636Total assets
    
    
    427,773
    
    
    
    370,031
    
    
    
    193,138
    
    
    
    990,942Capital expenditures
    
    
    5,970
    
    
    
    1,685
    
    
    
    864
    
    
    
    8,519
 Nine Months Ended September 30, 2004Specialty
    
    OutpatientHospitals
    
    Rehabilitation
    
    All Other
    
    Total(dollars in thousands)Net revenue
    
    $
    807,944
    
    
    $
    423,465
    
    
    $
    9,867
    
    
    $
    1,241,276Adjusted EBITDA
    
    
    174,966
    
    
    
    64,427
    
    
    
    (36,511
    )
    
    
    202,882Total assets
    
    
    509,050
    
    
    
    367,578
    
    
    
    229,430
    
    
    
    1,106,058Capital expenditures
    
    
    18,422
    
    
    
    4,370
    
    
    
    3,300
    
    
    
    26,092
 Nine Months Ended September 30, 2003Specialty
    
    OutpatientHospitals
    
    Rehabilitation
    
    All Other
    
    Total(dollars in thousands)Net revenue
    
    $
    596,158
    
    
    $
    386,730
    
    
    $
    8,039
    
    
    $
    990,927Adjusted EBITDA
    
    
    94,570
    
    
    
    59,756
    
    
    
    (26,299
    )
    
    
    128,027Total assets
    
    
    427,773
    
    
    
    370,031
    
    
    
    193,138
    
    
    
    990,942Capital expenditures
    
    
    13,386
    
    
    
    6,215
    
    
    
    4,124
    
    
    
    23,725
 - 11 -




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A reconciliation of net income to Adjusted EBITDA is as follows: For the Three Months
    
    For the Nine Months EndedEnded September 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(dollars in thousands)Net income
    
    $
    27,817
    
    
    $
    18,613
    
    
    $
    88,358
    
    
    $
    51,698Income from
discontinued
operations, net of
tax
    
    
    (146
    )
    
    
    (18
    )
    
    
    (802
    )
    
    
    (18
    )Income tax expense
    
    
    18,674
    
    
    
    12,146
    
    
    
    59,121
    
    
    
    33,503Minority interest
    
    
    620
    
    
    
    356
    
    
    
    2,772
    
    
    
    1,893Interest expense, net
    
    
    7,998
    
    
    
    6,142
    
    
    
    23,900
    
    
    
    17,848Equity in earnings
from joint ventures
    
    
    
    
    
    
    (334
    )
    
    
    
    
    
    
    (334
    )Depreciation and
amortization
    
    
    10,264
    
    
    
    8,731
    
    
    
    29,533
    
    
    
    23,437Adjusted EBITDA
    
    $
    65,227
    
    
    $
    45,636
    
    
    $
    202,882
    
    
    $
    128,027
 6. Net Income per Share The following table sets forth for the periods indicated the calculation of net
income per 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 diluted earnings per share: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(dollars in thousands, except per share data)Numerator:Income from continuing operations
    
    $
    27,671
    
    
    $
    18,595
    
    
    $
    87,556
    
    
    $
    51,680Income from discontinued operations, net of
tax
    
    
    146
    
    
    
    18
    
    
    
    802
    
    
    
    18Net income
    
    $
    27,817
    
    
    $
    18,613
    
    
    $
    88,358
    
    
    $
    51,698Denominator:Denominator for basic earnings per share -
weighted average shares
    
    
    101,664
    
    
    
    98,697
    
    
    
    102,248
    
    
    
    96,033Effect of dilutive securities:a) Stock options
    
    
    3,515
    
    
    
    6,434
    
    
    
    4,274
    
    
    
    5,466b) Warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    868Denominator for diluted earnings per
share-adjusted weighted average shares and
assumed exercises
    
    
    105,179
    
    
    
    105,131
    
    
    
    106,522
    
    
    
    102,367
 - 12 -




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##### Table of Contents



Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(dollars in thousands, except per share data)Basic income per common share:Income from continuing operations
    
    $
    0.27
    
    
    $
    0.19
    
    
    $
    0.85
    
    
    $
    0.54Income from discontinued operations
    
    
    
    
    
    
    
    
    
    
    0.01
    
    
    
    Net income per common share
    
    $
    0.27
    
    
    $
    0.19
    
    
    $
    0.86
    
    
    $
    0.54Diluted net income per common share:Income from continuing operations
    
    $
    0.26
    
    
    $
    0.18
    
    
    $
    0.82
    
    
    $
    0.51Income from discontinued operations
    
    
    
    
    
    
    
    
    
    
    0.01
    
    
    
    Diluted net income per common share
    
    $
    0.26
    
    
    $
    0.18
    
    
    $
    0.83
    
    
    $
    0.51Anti-dilutive shares excluded in the
computation of diluted income per
common share
    
    
    10,925
    
    
    
    2,718
    
    
    
    4,444
    
    
    
    916
 7. Supplemental Disclosures of Cash Flow Information Non-cash investing and financing activities are comprised of the
following: For the Nine Months EndedSeptember 30,2004
    
    2003(dollars in thousands)Tax benefit of stock option exercises
    
    $
    12,525
    
    
    $
    18,641Notes issued with acquisitions
    
    
    
    
    
    
    316Liabilities assumed with acquisitions
    
    
    
    
    
    
    39,217
 8. Stock Repurchase Program On February 23, 2004, the Companys Board of Directors authorized a
program to repurchase up to $80.0 million of its common stock. The program
will remain in effect until August 31, 2005, unless extended or cancelled by
the Board of Directors. The extent to which the Company repurchases its shares
and the timing of any purchases will depend on prevailing market conditions and
other corporate considerations. The Company anticipates funding for this
program to come from available corporate funds, including cash on hand and
future cash flow. The repurchased shares will be immediately retired. During
the nine months ended September 30, 2004, the Company repurchased and retired a
total of 3,399,400 shares at a cost, including fees and commissions, of $48.1
million. The Company did not repurchase any of its stock during the third
quarter ended September 30, 2004. The Company will not purchase any of its
stock under its share repurchase program during the pendency of the proposed
merger, which is described in footnote 10. - 13 -




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##### Table of Contents



9. Discontinued Operations On September 27, 2004, the Company sold the land, building and certain
other assets and liabilities associated with its only skilled nursing facility
for approximately $11.6 million. The skilled nursing facility was acquired as
part of the Kessler acquisition in September 2003. The operating results of
the skilled nursing facility have been reclassified and reported as
discontinued operations. Previously, the operating results of this facility
were included in the Companys Specialty Hospitals segment. Summarized income
statement information relating to discontinued operations is as follows: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(dollars in thousands, except per share data)Net revenue
    
    $
    3,467
    
    
    $
    1,073
    
    
    $
    10,426
    
    
    $
    1,073Income from discontinued operations before
income tax expense
    
    $
    249
    
    
    $
    30
    
    
    $
    1,343
    
    
    $
    30Income tax expense
    
    
    103
    
    
    
    12
    
    
    
    541
    
    
    
    12Income from discontinued operations, net of tax
    
    $
    146
    
    
    $
    18
    
    
    $
    802
    
    
    $
    18
 10. Subsequent Event  Proposed Merger On October 18, 2004 the Company announced that it has signed an agreement
to merge with a subsidiary of EGL Holding Company. EGL Holding Company is a
new private company formed by an investment group led by Welsh, Carson, Anderson &
Stowe, a private equity firm focused on investments in the healthcare sector,
and including Thoma Cressey Equity Partners, a private equity firm and an
existing stockholder of the Company, and certain members of the Companys
management, including Rocco Ortenzio and Robert Ortenzio. Under the terms of
the merger agreement, each share of the Companys common stock, other than
certain shares held by the stockholders participating in the buying group, will
be converted into the right to receive $18.00 per share in cash. The closing of the transaction is subject to various conditions contained
in the merger agreement, including the approval by the holders of a majority of
the Companys shares (other than the stockholders continuing in EGL Holding
Company), the closing of financing arrangements as set forth in bank commitment
letters that have been received by EGL Holding Company, the closing of tender
offers for and consent solicitations with respect to the Companys public debt
securities, the expiration of the applicable waiting period under the
Hart-Scott-Rodino Act and other customary conditions. The transaction is
expected to be completed in the first quarter of 2005. 11. Commitments and Contingencies Other In February 2002, PHICO Insurance Company (PHICO), at the request of the
Pennsylvania Insurance Department, was placed in liquidation by an order of the
Commonwealth Court of Pennsylvania (Liquidation Order). The Company had
placed its primary malpractice insurance coverage through PHICO from June 1998 - 14 -




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##### Table of Contents



through December 2000. In January 2001, these policies were replaced by
policies issued with other insurers. Currently, the Company has approximately
six unsettled cases in six states from the policy years covered by PHICO issued
policies. The Liquidation Order refers these claims to the various state
guaranty associations. These state guaranty association statutes generally
provide for coverage between $100,000-$300,000 per insured claim, depending
upon the state. Some states also have catastrophic loss funds to cover
settlements in excess of the available state guaranty funds. Most state
insurance guaranty statutes provide for net worth and residency limitations
that, if applicable, may limit or prevent the Company from recovering from
these state guaranty association funds. At this time, the Company believes
that it will meet the requirements for coverage under most of the applicable
state guarantee association statutes, and that the resolution of these claims
will not have a material adverse effect on the Companys financial position,
cash flow or results of operations. However, because the rules related to
state guaranty association funds are subject to interpretation, and because
these claims are still in the process of resolution, the Companys conclusions
may change as this process progresses. Litigation On August 24, 2004, Clifford C. Marsden and Ming Xu filed a purported
class action complaint in the United States District Court for the Eastern
District of Pennsylvania on behalf of the public stockholders of the Company
against Martin Jackson, Robert A. Ortenzio, Rocco A. Ortenzio, Patricia Rice
and the Company. The complaint alleges, among other things, failure to
disclose adverse information regarding a potential regulatory change affecting
reimbursement for the Companys services applicable to long-term acute care
hospitals operated as hospitals within hospitals or as satellites, and the
issuance of false and misleading statements about the financial outlook of the
Company. The complaint seeks, among other things, damages in an unspecified
amount, interest and attorneys fees. The Company believes that the
allegations in the complaint are without merit and intends to vigorously defend
against this action. On October 18, 2004, Garco Investments, LLP filed a purported class action
complaint in the Court of Chancery of the State of Delaware, New Castle County,
on behalf of the unaffiliated stockholders of the Company against Russell L.
Carson, David S. Chernow, Bryan C. Cressey, James E. Dalton, Jr., Meyer
Feldberg, Robert A. Ortenzio, Rocco A. Ortenzio, Thomas A. Scully, Leopold
Swergold and LeRoy S. Zimmerman, who are all of the Companys directors, the
Company and Welsh Carson Anderson & Stowe. The complaint alleges, among other
things, that the Companys directors violated their fiduciary duties by
approving the merger agreement before engaging in a full and fair sale process
or an active market check, and that Welsh Carson knowingly aided and abetted
the alleged breaches of fiduciary duty committed by the director defendants.
The complaint seeks, among other things, to enjoin the defendants from
consummating the merger or, alternatively, to rescind the proposed merger in
the event it has been consummated or award rescissory damages. The Company
believes that the allegations in the complaint are without merit and
intends to
vigorously defend against this action. On November 3, 2004, Terrence C. Davey filed a purported class action
complaint in the Court of Chancery of the State of Delaware, New Castle County,
on behalf of the unaffiliated stockholders of the Company against Russell L.
Carson, David S. Chernow, Bryan C. Cressey, James E. Dalton, Jr., Meyer
Feldberg, Robert A. Ortenzio, Rocco A. Ortenzio, Thomas A. Scully, Leopold
Swergold and LeRoy S. Zimmerman, who are all of the Companys directors, the
Company and Welsh Carson Anderson & Stowe. The complaint alleges, among other
things, that the defendants have breached their fiduciary duties owed to the
plaintiff and the stockholders of the Company and that the proposed merger
consideration is not fair or adequate. The complaint seeks, among other
things, to enjoin the defendants from consummating the merger or,
alternatively, to rescind the proposed merger in the event it has been
consummated or award rescissory - 15 -




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##### Table of Contents



damages. The Company believes that the allegations in the complaint are
without merit and intends to vigorously defend against this action. The Company carries director and officer insurance; however, because of
the uncertain nature of the litigation, the Company cannot predict the outcome
of these matters. The Company is subject to legal proceedings and claims that have arisen in
the ordinary course of its business and have not been finally adjudicated,
which include malpractice claims covered (subject to the above discussion
regarding PHICO Insurance Company) under the Companys insurance policy. In the
opinion of management, the outcome of these actions will not have a material
adverse effect on the financial position or results of operations of the
Company. 12. Regulatory Changes On August 2, 2004, the Centers for Medicare & Medicaid Services (CMS)
announced final regulatory changes applicable to long-term acute care hospitals
operated as hospitals within hospitals or as satellites (HIHs).
Effective for hospital cost reporting periods beginning on or after October 1,
2004, the final rule, subject to certain exceptions, provides long-term acute
care HIHs with lower rates of reimbursement for Medicare admissions from their
hosts that are in excess of specified percentages. For new long-term acute
care HIHs, the Medicare admissions limitation will be 25%. For existing
long-term acute care HIHs as of October 1, 2004 that meet specified criteria,
which includes all of Selects long-term acute care HIHs, the Medicare
admissions limitations will be phased-in over a four-year period starting with
hospital cost reporting periods beginning on or after October 1, 2004, as
follows: (i) for discharges during the cost reporting period beginning on or
after October 1, 2004 and before October 1, 2005, the Medicare
admissions limitation is the percentage of patients admitted from the host during Medicare fiscal
year 2004; (ii) for discharges during the cost reporting period beginning on or
after October 1, 2005 and before October 1, 2006, the Medicare admissions
limitation is the lesser of the percentage of patients admitted from the host
during Medicare fiscal year 2004 or 75%; (iii) for discharges during the cost
reporting period beginning on or after October 1, 2006 and before October 1,
2007, the Medicare admissions limitation is the lesser of the percentage of
patients admitted from the host during Medicare fiscal year 2004 or 50%; and
(iv) for discharges during the cost reporting period beginning on or after
October 1, 2007, the Medicare admissions limitation is 25%. - 16 -




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13. Financial Information for Subsidiary Guarantors and Non-Guarantor Subsidiaries The
7 1/2% and the 9 1/2% Senior Subordinated Notes are fully and
unconditionally guaranteed on a senior subordinated basis by all of
the Companys wholly owned domestic subsidiaries (the
Subsidiary Guarantors). Certain of the Companys
subsidiaries did not guarantee the 7 1/2% and the 9 1/2% Senior
Subordinated Notes (the Non-Guarantor Subsidiaries). The
Subsidiary Guarantors are the same for both the 7 1/2% and the 9 1/2%
Senior Subordinated Notes. The Company conducts a significant portion of its business through its
subsidiaries. Following is condensed consolidating financial information for
the Company, the Subsidiary Guarantors and the Non-Guarantor Subsidiaries at
September 30, 2004 and for the nine months ended September 30, 2004 and 2003. The equity method has been used by the Company 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. The following table
sets forth the Non-Guarantor Subsidiaries at September 30, 2004
and for the nine months ended September 30, 2004 and 2003: Caritas Rehab Services, LLCCanadian Back Institute LimitedCupertino Medical Center, P.C.Elizabethtown Physical TherapyJeff Ayres, PT Therapy Center, Inc.Jeffersontown Physical Therapy, LLCKentucky Orthopedic Rehabilitation, LLC.Kessler Core PT, OT and Speech Therapy at New York, LLCLanghorne, P.CLester OSM, P.CLouisville Physical Therapy, P.S.C.Medical Information Management Systems, LLC.Metropolitan West Physical Therapy and Sports Medicine Services Inc.Metro Therapy, Inc.MKJ Physical Therapy, Inc.New York Physician Services, P.C.North Andover Physical Therapy, Inc.OccuMed East, P.C.Ohio Occupational Health, P.C., Inc.Partners in Physical Therapy, PLLCPhiladelphia Occupational Health, P.C.Rehabilitation Physician Services, P.CRobinson & Associates, P.C.Select Specialty Hospital  Central Pennsylvania, L.P.Select Specialty Hospital  Houston, L.P.Select Specialty Hospital  Mississippi Gulf Coast, Inc.South Philadelphia, P.C.Spring Physical Therapy, P.C.Therex, P.C.TJ Corporation I, LLC.U.S. Regional Occupational Health II, P.C.Waltham Physical Therapy Associates, Inc.
 - 17 -




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##### Table of Contents



Select Medical CorporationCondensed Consolidating Balance SheetSeptember 30, 2004Select MedicalCorporation(Parent Company
    
    Subsidiary
    
    Non-GuarantorOnly)
    
    Guarantors
    
    Subsidiaries
    
    Eliminations
    
    Consolidated(dollars in thousands)AssetsCurrent Assets:Cash and cash equivalents
    
    $
    111,153
    
    
    $
    99,202
    
    
    $
    9,560
    
    
    $
    
    
    
    $
    219,915Restricted cash
    
    
    7,500
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,500Accounts receivable, net
    
    
    178
    
    
    
    213,473
    
    
    
    12,291
    
    
    
    
    
    
    
    225,942Current deferred tax asset
    
    
    13,466
    
    
    
    47,651
    
    
    
    1,860
    
    
    
    
    
    
    
    62,977Other current assets
    
    
    3,832
    
    
    
    12,714
    
    
    
    5,265
    
    
    
    
    
    
    
    21,811Total Current Assets
    
    
    136,129
    
    
    
    373,040
    
    
    
    28,976
    
    
    
    
    
    
    
    538,145Property and equipment, net
    
    
    8,764
    
    
    
    139,383
    
    
    
    17,028
    
    
    
    
    
    
    
    165,175Investment in affiliates
    
    
    564,136
    
    
    
    59,403
    
    
    
    
    
    
    
    (623,539
    ) (a)
    
    
    Goodwill
    
    
    5,853
    
    
    
    247,429
    
    
    
    49,101
    
    
    
    
    
    
    
    302,383Trademark
    
    
    
    
    
    
    58,875
    
    
    
    
    
    
    
    
    
    
    
    58,875Other intangibles
    
    
    
    
    
    
    20,286
    
    
    
    
    
    
    
    
    
    
    
    20,286Non-current deferred tax asset
    
    
    1,666
    
    
    
    2,809
    
    
    
    (1,428
    )
    
    
    
    
    
    
    3,047Other assets
    
    
    11,747
    
    
    
    5,265
    
    
    
    1,135
    
    
    
    
    
    
    
    18,147Total Assets
    
    $
    728,295
    
    
    $
    906,490
    
    
    $
    94,812
    
    
    $
    (623,539
    )
    
    $
    1,106,058Liabilities and Stockholders EquityCurrent Liabilities:Bank overdrafts
    
    $
    8,548
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    8,548Current portion of long-term debt and notes payable
    
    
    1,380
    
    
    
    2,493
    
    
    
    485
    
    
    
    
    
    
    
    4,358Accounts payable
    
    
    1,200
    
    
    
    36,820
    
    
    
    7,719
    
    
    
    
    
    
    
    45,739Intercompany accounts
    
    
    129,767
    
    
    
    (126,997
    )
    
    
    (2,770
    )
    
    
    
    
    
    
    Accrued payroll
    
    
    900
    
    
    
    58,244
    
    
    
    145
    
    
    
    
    
    
    
    59,289Accrued vacation
    
    
    2,448
    
    
    
    17,923
    
    
    
    1,747
    
    
    
    
    
    
    
    22,118Accrued medical malpractice
    
    
    13,822
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13,822Accrued restructuring
    
    
    
    
    
    
    6,110
    
    
    
    
    
    
    
    
    
    
    
    6,110Accrued other
    
    
    14,846
    
    
    
    52,682
    
    
    
    3,512
    
    
    
    
    
    
    
    71,040Income taxes payable
    
    
    (25,326
    )
    
    
    35,768
    
    
    
    (8,395
    )
    
    
    
    
    
    
    2,047Due to third party payors
    
    
    6,053
    
    
    
    31,843
    
    
    
    (4,363
    )
    
    
    
    
    
    
    33,533Total Current Liabilities
    
    
    153,638
    
    
    
    114,886
    
    
    
    (1,920
    )
    
    
    
    
    
    
    266,604Long-term debt, net of current portion
    
    
    93,563
    
    
    
    238,814
    
    
    
    18,773
    
    
    
    
    
    
    
    351,150Total liabilities
    
    
    247,201
    
    
    
    353,700
    
    
    
    16,853
    
    
    
    
    
    
    
    617,754Commitments and ContingenciesMinority interest in consolidated subsidiary companies
    
    
    
    
    
    
    212
    
    
    
    6,998
    
    
    
    
    
    
    
    7,210Stockholders Equity:Common stock
    
    
    1,019
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,019Capital in excess of par
    
    
    274,134
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    274,134Retained earnings
    
    
    200,709
    
    
    
    187,989
    
    
    
    41,793
    
    
    
    (229,782
    ) (b)
    
    
    200,709Subsidiary investment
    
    
    
    
    
    
    364,589
    
    
    
    29,168
    
    
    
    (393,757
    ) (a)
    
    
    Accumulated other comprehensive loss
    
    
    5,232
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,232Total Stockholders Equity
    
    
    481,094
    
    
    
    552,578
    
    
    
    70,961
    
    
    
    (623,539
    )
    
    
    481,094Total Liabilities and Stockholders Equity
    
    $
    728,295
    
    
    $
    906,490
    
    
    $
    94,812
    
    
    $
    (623,539
    )
    
    $
    1,106,058
  (a)
    
    Elimination of investments in subsidiaries.(b)
    
    Elimination of investments in subsidiaries earnings. - 18 -




---



##### Table of Contents



Select Medical CorporationCondensed Consolidating Statement of OperationsFor the Nine Months Ended September 30, 2004Select Medical
    
    
    
    
    
    Non-Corporation (Parent
    
    Subsidiary
    
    GuarantorCompany Only)
    
    Guarantors
    
    Subsidiaries
    
    Eliminations
    
    Consolidated(dollars in thousands)Net operating revenues
    
    $
    25
    
    
    $
    1,063,780
    
    
    $
    177,471
    
    
    $
    
    
    
    $
    1,241,276Costs and expenses:Cost of services
    
    
    
    
    
    
    820,305
    
    
    
    145,543
    
    
    
    
    
    
    
    965,848General and administrative
    
    
    35,280
    
    
    
    1,210
    
    
    
    
    
    
    
    
    
    
    
    36,490Bad debt expense
    
    
    
    
    
    
    34,154
    
    
    
    1,902
    
    
    
    
    
    
    
    36,056Depreciation and amortization
    
    
    1,813
    
    
    
    24,135
    
    
    
    3,585
    
    
    
    
    
    
    
    29,533Total costs and expenses
    
    
    37,093
    
    
    
    879,804
    
    
    
    151,030
    
    
    
    
    
    
    
    1,067,927Income (loss) from operations
    
    
    (37,068
    )
    
    
    183,976
    
    
    
    26,441
    
    
    
    
    
    
    
    173,349Other income and expense:Intercompany interest and royalty fees
    
    
    22,060
    
    
    
    (22,015
    )
    
    
    (45
    )
    
    
    
    
    
    
    Intercompany management fees
    
    
    (79,073
    )
    
    
    76,173
    
    
    
    2,900
    
    
    
    
    
    
    
    Interest income
    
    
    (967
    )
    
    
    (513
    )
    
    
    (5
    )
    
    
    
    
    
    
    (1,485
    )Interest expense
    
    
    7,870
    
    
    
    15,662
    
    
    
    1,853
    
    
    
    
    
    
    
    25,385Income from continuing operations before minority
interests and income taxes
    
    
    13,042
    
    
    
    114,669
    
    
    
    21,738
    
    
    
    
    
    
    
    149,449Minority interest in consolidated subsidiary companies
    
    
    
    
    
    
    212
    
    
    
    2,560
    
    
    
    
    
    
    
    2,772Income from continuing operations before income taxes
    
    
    13,042
    
    
    
    114,457
    
    
    
    19,178
    
    
    
    
    
    
    
    146,677Income tax expense
    
    
    8,151
    
    
    
    47,001
    
    
    
    3,969
    
    
    
    
    
    
    
    59,121Income from continuing operations
    
    
    4,891
    
    
    
    67,456
    
    
    
    15,209
    
    
    
    
    
    
    
    87,556Income from discontinued operations, net of tax
    
    
    
    
    
    
    802
    
    
    
    
    
    
    
    
    
    
    
    802Equity in earnings of subsidiaries
    
    
    83,467
    
    
    
    9,409
    
    
    
    
    
    
    
    (92,876
    ) (a)
    
    
    Net income
    
    $
    88,358
    
    
    $
    77,667
    
    
    $
    15,209
    
    
    $
    (92,876
    )
    
    $
    88,358
  (a)
    
    Elimination of equity in net income (loss) from consolidated subsidiaries. - 19 -




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##### Table of Contents



Select Medical CorporationCondensed Consolidating Statement of Cash FlowsFor the Nine Months Ended September 30, 2004Select MedicalCorporation
    
    
    
    
    
    Non-(Parent Company
    
    Subsidiary
    
    GuarantorOnly)
    
    Guarantors
    
    Subsidiaries
    
    Eliminations
    
    Consolidated(dollars in thousands)Operating activitiesNet income
    
    $
    88,358
    
    
    $
    77,667
    
    
    $
    15,209
    
    
    $
    (92,876
    )(a)
    
    $
    88,358Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    1,813
    
    
    
    24,069
    
    
    
    3,585
    
    
    
    
    
    
    
    29,467Provision for bad debts
    
    
    
    
    
    
    34,618
    
    
    
    1,902
    
    
    
    
    
    
    
    36,520Minority interests
    
    
    
    
    
    
    212
    
    
    
    2,560
    
    
    
    
    
    
    
    2,772Changes in operating assets and liabilities, net of
effects from acquisition of businesses:Equity in earnings of subsidiaries
    
    
    (83,467
    )
    
    
    (9,409
    )
    
    
    
    
    
    
    92,876
    (a)
    
    
    Intercompany
    
    
    26,856
    
    
    
    (14,920
    )
    
    
    (11,936
    )
    
    
    
    
    
    
    Accounts receivable
    
    
    (146
    )
    
    
    (44,176
    )
    
    
    12,508
    
    
    
    
    
    
    
    (31,814
    )Other current assets
    
    
    341
    
    
    
    1,270
    
    
    
    3,945
    
    
    
    
    
    
    
    5,556Other assets
    
    
    1,978
    
    
    
    1,454
    
    
    
    (191
    )
    
    
    
    
    
    
    3,241Accounts payable
    
    
    (7,259
    )
    
    
    (7,366
    )
    
    
    794
    
    
    
    
    
    
    
    (13,831
    )Due to third-party payors
    
    
    
    
    
    
    (18,102
    )
    
    
    (2,010
    )
    
    
    
    
    
    
    (20,112
    )Accrued expenses
    
    
    1,321
    
    
    
    6,525
    
    
    
    538
    
    
    
    
    
    
    
    8,384Income taxes
    
    
    22,098
    
    
    
    
    
    
    
    (1,190
    )
    
    
    
    
    
    
    20,908Net cash provided by operating activities
    
    
    51,893
    
    
    
    51,842
    
    
    
    25,714
    
    
    
    
    
    
    
    129,449Investing activitiesPurchases of property and equipment, net
    
    
    (3,126
    )
    
    
    (21,153
    )
    
    
    (1,813
    )
    
    
    
    
    
    
    (26,092
    )Proceeds from sale of business
    
    
    
    
    
    
    11,554
    
    
    
    
    
    
    
    
    
    
    
    11,554Earnout payments
    
    
    
    
    
    
    (2,983
    )
    
    
    
    
    
    
    
    
    
    
    (2,983
    )Proceeds from sale of membership interests
    
    
    
    
    
    
    4,768
    
    
    
    
    
    
    
    
    
    
    
    4,768Acquisition of businesses, net of cash acquired
    
    
    
    
    
    
    
    
    
    
    (325
    )
    
    
    
    
    
    
    (325
    )Net cash used in investing activities
    
    
    (3,126
    )
    
    
    (7,814
    )
    
    
    (2,138
    )
    
    
    
    
    
    
    (13,078
    )Financing activitiesIntercompany debt reallocation
    
    
    9,920
    
    
    
    (2,983
    )
    
    
    (6,937
    )
    
    
    
    
    
    
    Net repayments on credit facility debt
    
    
    
    
    
    
    
    
    
    
    (8,483
    )
    
    
    
    
    
    
    (8,483
    )Principal payments on seller and other debt
    
    
    
    
    
    
    (2,721
    )
    
    
    (240
    )
    
    
    
    
    
    
    (2,961
    )Restricted cash
    
    
    (7,500
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,500
    )Repurchases of common stock
    
    
    (48,058
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (48,058
    )Proceeds from issuance of common stock
    
    
    17,994
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17,994Payment of common stock dividends
    
    
    (9,209
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,209
    )Repayment of bank overdrafts
    
    
    (2,879
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,879
    )Distributions to minority interests
    
    
    
    
    
    
    
    
    
    
    (996
    )
    
    
    
    
    
    
    (996
    )Net cash used in financing activities
    
    
    (39,732
    )
    
    
    (5,704
    )
    
    
    (16,656
    )
    
    
    
    
    
    
    (62,092
    )Effect of exchange rate changes on cash
and cash equivalents
    
    
    129
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    129Net increase in cash and cash equivalents
    
    
    9,164
    
    
    
    38,324
    
    
    
    6,920
    
    
    
    
    
    
    
    54,408Cash and cash equivalents at beginning of period
    
    
    101,989
    
    
    
    60,878
    
    
    
    2,640
    
    
    
    
    
    
    
    165,507Cash and cash equivalents at end of period
    
    $
    111,153
    
    
    $
    99,202
    
    
    $
    9,560
    
    
    $
    
    
    
    $
    219,915
  (a)
    
    Elimination of equity in earnings of subsidiary. - 20 -




---



##### Table of Contents



Select Medical CorporationCondensed Consolidating
Statement of OperationsFor the Nine Months Ended September 30, 2004Select Medical
    
    
    
    
    
    Non-Corporation Company
    
    Subsidiary
    
    GuarantorCompany Only)
    
    Guarantors
    
    Subsidiaries
    
    Eliminations
    
    Consolidated(dollars in thousands)Net operating revenues
    
    $
    6,145
    
    
    $
    829,493
    
    
    $
    155,289
    
    
    $
    
    
    
    $
    990,927Costs and expenses:Cost of services
    
    
    
    
    
    
    659,510
    
    
    
    132,983
    
    
    
    
    
    
    
    792,493General and administrative
    
    
    31,258
    
    
    
    993
    
    
    
    
    
    
    
    
    
    
    
    32,251Bad debt expense
    
    
    
    
    
    
    31,386
    
    
    
    6,770
    
    
    
    
    
    
    
    38,156Depreciation and amortization
    
    
    1,848
    
    
    
    18,539
    
    
    
    3,050
    
    
    
    
    
    
    
    23,437Total costs and expenses
    
    
    33,106
    
    
    
    710,428
    
    
    
    142,803
    
    
    
    
    
    
    
    886,337Income (loss) from operations
    
    
    (26,961
    )
    
    
    119,065
    
    
    
    12,486
    
    
    
    
    
    
    
    104,590Other income and expense:Intercompany interest and royalty fees
    
    
    18,236
    
    
    
    (18,250
    )
    
    
    14
    
    
    
    
    
    
    
    Intercompany management fees
    
    
    (45,661
    )
    
    
    43,703
    
    
    
    1,958
    
    
    
    
    
    
    
    Equity in earnings from joint ventures
    
    
    
    
    
    
    (334
    )
    
    
    
    
    
    
    
    
    
    
    (334
    )Interest income
    
    
    (402
    )
    
    
    (224
    )
    
    
    
    
    
    
    
    
    
    
    (626
    )Interest expense
    
    
    6,107
    
    
    
    8,930
    
    
    
    3,437
    
    
    
    
    
    
    
    18,474Income (loss) from continuing operations before minority interests
and income taxes
    
    
    (5,241
    )
    
    
    85,240
    
    
    
    7,077
    
    
    
    
    
    
    
    87,076Minority interest in consolidated subsidiary companies
    
    
    
    
    
    
    79
    
    
    
    1,814
    
    
    
    
    
    
    
    1,893Income (loss) from continuing operations before income taxes
    
    
    (5,241
    )
    
    
    85,161
    
    
    
    5,263
    
    
    
    
    
    
    
    85,183Income tax expense (benefit)
    
    
    (1,304
    )
    
    
    32,140
    
    
    
    2,667
    
    
    
    
    
    
    
    33,503Income from discontinued operations, net of tax
    
    
    
    
    
    
    18
    
    
    
    
    
    
    
    
    
    
    
    18Equity in earnings of subsidiaries
    
    
    55,635
    
    
    
    128
    
    
    
    
    
    
    
    (55,763
    )(a)
    
    
    Net income
    
    $
    51,698
    
    
    $
    53,167
    
    
    $
    2,596
    
    
    $
    (55,763
    )
    
    $
    51,698
  (a)
    
    Elimination of equity in net income (loss) from consolidated subsidiaries. - 21 -




---



##### Table of Contents



Select Medical CorporationCondensed Consolidating Statement of Cash FlowsFor the Nine Months Ended September 30, 2004Select MedicalCorporation
    
    
    
    
    
    Non-(Parent Company
    
    Subsidiary
    
    GuarantorOnly)
    
    Guarantors
    
    Subsidiaries
    
    Eliminations
    
    Consolidated(dollars in thousands)Operating activitiesNet income
    
    $
    51,698
    
    
    $
    53,167
    
    
    $
    2,596
    
    
    $
    (55,763
    )(a)
    
    $
    51,698Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    1,848
    
    
    
    18,615
    
    
    
    3,050
    
    
    
    
    
    
    
    23,513Provision for bad debts
    
    
    
    
    
    
    31,424
    
    
    
    6,770
    
    
    
    
    
    
    
    38,194Minority interests
    
    
    
    
    
    
    79
    
    
    
    1,814
    
    
    
    
    
    
    
    1,893Changes in operating assets and liabilities, net of
effects from acquisition of businesses:Equity in earnings of subsidiaries
    
    
    (55,635
    )
    
    
    (128
    )
    
    
    
    
    
    
    55,763
    (a)
    
    
    Intercompany
    
    
    (11,819
    )
    
    
    17,271
    
    
    
    (5,452
    )
    
    
    
    
    
    
    Accounts receivable
    
    
    (430
    )
    
    
    10,300
    
    
    
    1,057
    
    
    
    
    
    
    
    10,927Other current assets
    
    
    540
    
    
    
    (441
    )
    
    
    842
    
    
    
    
    
    
    
    941Other assets
    
    
    778
    
    
    
    297
    
    
    
    338
    
    
    
    
    
    
    
    1,413Accounts payable
    
    
    (22
    )
    
    
    9,024
    
    
    
    (101
    )
    
    
    
    
    
    
    8,901Due to third-party payors
    
    
    9,480
    
    
    
    (8,820
    )
    
    
    4,020
    
    
    
    
    
    
    
    4,680Accrued expenses
    
    
    10,286
    
    
    
    11,002
    
    
    
    2,722
    
    
    
    
    
    
    
    24,010Income taxes
    
    
    413
    
    
    
    
    
    
    
    (2,346
    )
    
    
    
    
    
    
    (1,933
    )Net cash provided by operating activities
    
    
    7,137
    
    
    
    141,790
    
    
    
    15,310
    
    
    
    
    
    
    
    164,237Investing activitiesPurchases of property and equipment, net
    
    
    (4,074
    )
    
    
    (16,718
    )
    
    
    (2,933
    )
    
    
    
    
    
    
    (23,725
    )Proceeds from disposal of assets
    
    
    2,400
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,400Earnout payments
    
    
    
    
    
    
    (429
    )
    
    
    
    
    
    
    
    
    
    
    (429
    )Acquisition of businesses, net of cash acquired
    
    
    
    
    
    
    (232,036
    )
    
    
    (190
    )
    
    
    
    
    
    
    (232,226
    )Net cash used in investing activities
    
    
    (1,674
    )
    
    
    (249,183
    )
    
    
    (3,123
    )
    
    
    
    
    
    
    (253,980
    )Financing activitiesIntercompany debt reallocation
    
    
    (115,862
    )
    
    
    123,497
    
    
    
    (7,635
    )
    
    
    
    
    
    
    Issuance of 7.5% Senior Subordinated Notes
    
    
    175,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    175,000Payment of deferred financing costs
    
    
    (5,578
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,578
    )Net repayments on credit facility debt
    
    
    (61,657
    )
    
    
    
    
    
    
    (2,758
    )
    
    
    
    
    
    
    (64,415
    )Principal payments on seller and other debt
    
    
    
    
    
    
    (2,551
    )
    
    
    (68
    )
    
    
    
    
    
    
    (2,619
    )Proceeds from issuance of common stock
    
    
    20,235
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20,235Repayment of bank overdrafts
    
    
    (6,810
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,810
    )Distributions to minority interests
    
    
    
    
    
    
    
    
    
    
    (1,042
    )
    
    
    
    
    
    
    (1,042
    )Net cash provided by (used in) financing activities
    
    
    5,328
    
    
    
    120,946
    
    
    
    (11,503
    )
    
    
    
    
    
    
    114,771Effect of exchange rate changes on cash
and cash equivalents
    
    
    358
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    358Net increase in cash and cash equivalents
    
    
    11,149
    
    
    
    13,553
    
    
    
    684
    
    
    
    
    
    
    
    25,386Cash and cash equivalents at beginning of period
    
    
    25,378
    
    
    
    28,022
    
    
    
    2,662
    
    
    
    
    
    
    
    56,062Cash and cash equivalents at end of period
    
    $
    36,527
    
    
    $
    41,575
    
    
    $
    3,346
    
    
    $
    
    
    
    $
    81,448
  (a)
    
    Elimination of equity in earnings of subsidiary. - 22 -




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read this discussion together with our consolidated financial
statements and notes thereto contained in our Form 10-K filed with the
Securities and Exchange Commission on March 15, 2004. Forward Looking Statements This discussion contains forward-looking statements relating to the
financial condition, results of operations, plans, objectives, future
performance and business of Select Medical Corporation. These statements
include, without limitation, statements preceded by, followed by or that
include the words believes, expects, anticipates, estimates or similar
expressions. These forward-looking statements involve risks and uncertainties.
Actual results may differ materially from those contemplated by the
forward-looking statements due to factors including the following:  
    
    a change in government reimbursement for our services that
would affect our revenue;
    
    changes in Medicare admission guidelines for inpatient
rehabilitation facilities may result in lost patient volume,
operating revenues and profitability;
    
    the failure of our long-term acute care hospitals to
maintain their status as such, which could negatively impact our
profitability;
    
    a government investigation or assertion that we have
violated applicable regulations may result in increased costs and a
significant use of internal resources;
    
    shortages in qualified nurses or therapists could increase our operating costs significantly;
    
    the effects of liability and other claims asserted against us;
    
    private third party payors of our services may undertake
cost containment initiatives that would decrease our revenue; and
    
    future acquisitions may use significant resources and expose us to unforeseen risks.
    
    risks associated with the closing of the proposed merger with
EGL Acquisition Corp., a subsidiary of EGL Holding Company, including:  
    
    the possibility that the merger may not occur due to
the failure of the parties to satisfy the conditions in the
merger agreement;
    
    the inability of EGL Holding Company or EGL
Acquisition Corp. to obtain financing;
    
    the failure of a majority of our 9 1/2% Senior
Subordinated Notes and our 7 1/2% Senior Subordinated Notes
to be tendered and accepted or the failure to successfully
complete the consent solicitation regarding amendments to the
indentures underlying such notes;
    
    our failure to obtain required stockholder
approvals; and
    
    the occurrence of events that would have a material
adverse effect on us as described in the merger agreement. For a discussion of these and other factors affecting our business, see the
section captioned Risk Factors in our Form 10-K under Item 1  Business. Non-GAAP Financial Measures The SEC recently adopted rules regarding the use of non-GAAP financial
measures, such as EBITDA and Adjusted EBITDA, which we use in this report.
Prior to the quarter ended June 30, 2003, we had defined EBITDA as net income
(loss) before interest, income taxes, depreciation and amortization, special
charges, loss on early retirement of debt and minority interest, and used this
measure to report our consolidated operating - 23 -




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##### Table of Contents



results as well as our segment
results. We are now referring to this financial measure as Adjusted EBITDA.
In order to comply with the new rules, we are now using EBITDA, defined as net
income (loss) before interest, income taxes, depreciation and amortization, to
report our consolidated operating results. However, SFAS 131 requires us to
report our segment results in a manner consistent with managements internal
reporting of operating results to our chief operating decision maker (as
defined under SFAS 131) for purposes of evaluating segment performance.
Therefore, since we use Adjusted EBITDA to measure performance of our segments
for internal reporting purposes, we have used Adjusted EBITDA to report our
segment results. The difference between EBITDA and Adjusted EBITDA related to
our segments for the periods presented in this report result only from equity
in earnings from joint ventures, and minority interests, which are added back
to EBITDA for our segments in the computation of Adjusted EBITDA. We did not
experience any special charges or loss on early retirement of debt during the
periods presented in this report. Overview We are a leading operator of specialty hospitals in the United States. We
are also a leading operator of outpatient rehabilitation clinics in the United
States and Canada. As of September 30, 2004 we operated 83 long-term acute
care hospitals in 25 states, four acute medical rehabilitation hospitals in New
Jersey and 750 outpatient rehabilitation clinics in 25 states, the District of
Columbia and seven Canadian provinces. We also provide medical rehabilitation
services on a contract basis at nursing homes, assisted living and senior care
centers, schools and work sites. We began operations in 1997 under the
leadership of our current management team. We manage the company through two business segments, our specialty
hospital segment and our outpatient rehabilitation segment. For the nine
months ended September 30, 2004, we had net operating revenues of $1,241
million. Of this total, we earned approximately 65% of our net operating
revenues from our specialty hospitals and approximately 34% from our outpatient
rehabilitation business. Our specialty hospital segment consists of hospitals designed to serve the
needs of long-term stay acute patients and hospitals designed to serve patients
that require intensive medical rehabilitation care. Patients in our long-term
acute care hospitals typically suffer from serious and often complex medical
conditions that require a high degree of care. Patients in our acute medical
rehabilitation hospitals typically suffer from debilitating injuries, including
traumatic brain and spinal cord injuries, and require rehabilitation care in
the form of physical, psychological, social and vocational rehabilitation
services. Our outpatient rehabilitation business consists of clinics and
contract services that provide physical, occupational and speech rehabilitation
services. Our outpatient rehabilitation patients are typically diagnosed with
musculoskeletal impairments that restrict their ability to perform normal
activities of daily living. On August 2, 2004, the Center for Medicare & Medicaid Services (CMS)
adopted final regulatory changes applicable to long-term acute care hospitals
(LTACHs) that are operated as hospitals within hospitals or as
satellites. The new rules will be effective for hospital cost reporting
periods beginning on or after October 1, 2004. For existing long-term acute
care hospitals operated as hospitals within hospitals, the admissions
thresholds will be phased in over a four-year period starting with cost
reporting periods beginning on or after October 1, 2004. The new rules are
complex and we continue to evaluate the effects of the new rules on the LTACH
hospitals within hospitals that we operate and consider potential changes to existing
operations to adapt to the new rules which will become fully effective for cost reporting
periods beginning on or after October 1, 2007. We operated 79 LTACHs as
hospitals within hospitals at September 30, 2004. For a discussion of the
regulatory changes, see Regulatory Changes. For the three months ended September 30, 2004, our net operating revenues
increased 15.7%, income from operations increased 48.9%, net income increased
49.4% and diluted earnings per share increased 44.4% compared to the three
months ended September 30, 2003. Our specialty hospital segment was the
primary - 24 -




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source of this growth. In our specialty hospital segment, we
experienced growth in patient days and admissions that resulted from the
expansion of the number of hospitals we operate. Additionally, the inclusion
of the Kessler acquired hospitals and an increase in our revenue per patient
day contributed to the growth in this segment. Income from operations in our
specialty hospital segment increased because of the higher operating margins
generated by the Kessler rehabilitation hospitals and the improved operating
margins we are generating in our long-term acute care hospitals under the new
prospective payment reimbursement system. Our outpatient segment experienced
an increase in income from operations that resulted from the addition of the
Kessler outpatient operations. For the nine months ended September 30, 2004, our net operating revenues
increased 25.3%, income from operations increased 65.7%, net income increased
70.9% and diluted earnings per share from continuing operations increased 60.8%
compared to the nine months ended September 30, 2003. Our growth for the nine
month period occurred as a result of factors that are consistent with those
described above for the current quarter ended September 30, 2004. For the nine months ended September 30, 2004, our cash flow from
operations was $129.4 million. We did not repurchase any of our stock during
the third quarter, and we will not repurchase any of our stock under our share
repurchase program during the pendency of the proposed merger. For information
on the proposed merger see -Subsequent Event. Since the inception of our
stock repurchase program in February 2003 we have repurchased 3,399,400
shares for an aggregate cost, including fees and commissions, of $48.1 million. On September 27, 2004, we sold for $11.6 million the land, building and
certain other assets and liabilities associated with a skilled nursing facility
we acquired as part of the Kessler Rehabilitation Corporation acquisition. The
operating results of the skilled nursing facility have been reclassified and
reported as discontinued operations. Previously, the operating results of this
facility were included in our specialty hospital segment. - 25 -




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The following table sets forth operating statistics for our specialty
hospitals and our outpatient rehabilitation clinics for each of the periods
presented. The data in the table reflect the changes in the number of
specialty hospitals and outpatient rehabilitation clinics we operate that
resulted from acquisitions, start-up activities and closures/consolidations.
The operating statistics reflect data for the period of time these operations
were managed by us. Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Specialty Hospital Data (a)# of Hospitals  Start of Period
    
    
    86
    
    
    
    75
    
    
    
    83
    
    
    
    72# of Hospital Start-ups
    
    
    1
    
    
    
    2
    
    
    
    4
    
    
    
    6# of Hospitals Acquired
    
    
    
    
    
    
    4
    
    
    
    
    
    
    
    4# of Hospitals Closed
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1
    )# of Hospitals  End of Period
    
    
    87
    
    
    
    81
    
    
    
    87
    
    
    
    81# of Licensed Beds
    
    
    3,403
    
    
    
    3,151
    
    
    
    3,403
    
    
    
    3,151# of Admissions
    
    
    8,197
    
    
    
    7,025
    
    
    
    25,241
    
    
    
    19,100# of Patient Days
    
    
    198,052
    
    
    
    181,188
    
    
    
    615,304
    
    
    
    514,951Average Length of Stay
    
    
    24
    
    
    
    26
    
    
    
    24
    
    
    
    27Net Revenue Per Patient Day (b)
    
    $
    1,338
    
    
    $
    1,215
    
    
    $
    1,287
    
    
    $
    1,152Occupancy Rate
    
    
    63
    %
    
    
    68
    %
    
    
    68
    %
    
    
    69
    %% Patient Days  Medicare
    
    
    74
    %
    
    
    77
    %
    
    
    74
    %
    
    
    77
    %Outpatient Rehabilitation Data# of Clinics Owned  Start of Period
    
    
    728
    
    
    
    707
    
    
    
    758
    
    
    
    679# of Clinics Acquired
    
    
    2
    
    
    
    92
    
    
    
    4
    
    
    
    125# of Clinic Start-ups
    
    
    3
    
    
    
    5
    
    
    
    16
    
    
    
    22# of Clinics Closed/Consolidated
    
    
    (20
    )
    
    
    (19
    )
    
    
    (65
    )
    
    
    (41
    )# of Clinics Owned  End of Period
    
    
    713
    
    
    
    785
    
    
    
    713
    
    
    
    785# of Clinics Managed  End of Period
    
    
    37
    
    
    
    29
    
    
    
    37
    
    
    
    29Total # of Clinics (All)  End of Period
    
    
    750
    
    
    
    814
    
    
    
    750
    
    
    
    814# of Visits (U.S.)
    
    
    935,763
    
    
    
    1,002,354
    
    
    
    2,933,106
    
    
    
    3,002,954Net Revenue Per Visit (U.S.) (c)
    
    $
    88
    
    
    $
    87
    
    
    $
    89
    
    
    $
    88
  (a)
    
    Specialty hospitals consist of long-term acute care hospitals
and acute medical rehabilitation hospitals. Revenues and Adjusted
EBITDA for 2003 have been restated to exclude discontinued
operations.(b)
    
    Net revenue per patient day is calculated by dividing specialty
hospital patient service revenues by the total number of patient
days.(c)
    
    Net revenue per visit (U.S.) is calculated by dividing
outpatient rehabilitation clinic revenue by the total number of
visits. For purposes of this computation, outpatient rehabilitation
clinic revenue does not include our Canadian subsidiary and contract
services revenue. - 26 -




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Our goal historically has been to open approximately eight to ten new
long-term acute care hospitals each year, utilizing primarily our hospital
within a hospital model. As a result of the regulatory changes adopted by CMS
on August 2, 2004, we expect to open only four or five LTACHs in
2004. The Company now intends to open approximately four to five
long-term acute care hospitals in 2005, primarily in settings where
the HIH Rule would have little or no impact. The
regulatory changes are complex and we are continuing to evaluate the effects of
the new rules on our LTACH development strategy. We also may open new
specialty hospitals in freestanding buildings. We also intend to open new
clinics in our current markets where we can benefit from existing referral
relationships and brand awareness to produce incremental growth. With the
acquisition of the four acute medical rehabilitation hospitals through the
Kessler transaction, we are also evaluating opportunities to develop additional
freestanding acute medical rehabilitation hospitals. From time to time, we
also intend to evaluate acquisition opportunities that may enhance the scale of
our business and expand our geographic reach. Regulatory Changes On August 2, 2004, the Centers for Medicare & Medicaid Services (CMS)
announced final regulatory changes applicable to long-term acute care hospitals
operated as hospitals within hospitals or as satellites (HIHs).
Effective for hospital cost reporting periods beginning on or after October 1,
2004, the final rule, subject to certain exceptions, provides long-term acute
care HIHs with lower rates of reimbursement for Medicare admissions from their
hosts that are in excess of specified percentages. For new long-term acute
care HIHs, the Medicare admissions limitation will be 25%. For existing
long-term acute care HIHs as of October 1, 2004 that meet specified criteria,
which includes all of Selects long-term acute care HIHs, the Medicare
admissions limitations will be phased-in over a four-year period starting with
hospital cost reporting periods beginning on or after October 1, 2004, as
follows: (i) for discharges during the cost reporting period beginning on or
after October 1, 2004 and before October 1, 2005, the Medicare
admissions limitation is the percentage of patients admitted from the host during Medicare fiscal
year 2004; (ii) for discharges during the cost reporting period beginning on or
after October 1, 2005 and before October 1, 2006, the Medicare admissions
limitation is the lesser of the percentage of patients admitted from the host
during Medicare fiscal year 2004 or 75%; (iii) for discharges during the cost
reporting period beginning on or after October 1, 2006 and before October 1,
2007, the Medicare admissions limitation is the lesser of the percentage of
patients admitted from the host during Medicare fiscal year 2004 or 50%; and
(iv) for discharges during the cost reporting period beginning on or after
October 1, 2007, the Medicare admissions limitation is 25%. At September 30, 2004, we operated 83 long-term acute care hospitals. Of
this total, 79 operated as HIHs. For the nine months ended
September 30, 2004, approximately 60% of the Medicare admissions
to the Companys HIHs were from host hospitals. For the nine
months ended September 30, 2004, approximately 8% of the
Companys HIHs admitted 25% or less of their
Medicare patients from their host hospitals, approximately 29% of the
Companys HIHs admitted 50% or less of their Medicare patients from their host hospitals,
and approximately 80% of the Companys HIHs admitted 75% or less of their Medicare patients from their host hospitals. There are
several factors that should be taken into account in evaluating this
admissions data. First, the admissions data for the nine months ended
September 30, 2004 is not necessarily indicative of the admissions mix these hospitals will experience
in the future. Second, admissions data for the nine months ended
September 30, 2004 includes six hospitals that were open for less than one year, and the data
from these hospitals may not be indicative of the admissions mix these hospitals will experience
over a longer period of time. - 27 -




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The new Medicare host admission limitations are phased in over a four-year
period. Our existing HIHs will be unaffected by the HIH Rule until cost
reporting periods beginning on or after October 1, 2005, when the limitation on
Medicare host admissions drops to 75%. Thus, the HIH Rule will have no effect
on our 2004 financial results. Our HIHs have cost reporting periods that
commence on various dates throughout the calendar year. Consequently, any
effect of the new admissions limitations on our HIHs may be delayed depending
on when a particular HIHs cost reporting period begins. For example, although
approximately 20% of the Companys HIHs open at September 30, 2004 admitted more than
75% of their Medicare patients from their host hospitals during the nine months ended
September 30, 2004, only five of such HIHs have cost reporting periods that will begin
after October 1, 2005 and before December 31, 2005. As a
result, the HIH Rule should have only a minimal
impact on our 2005 financial results. In order to minimize the more
significant impact of the HIH Rule in 2006 and for the subsequent
years, we intend, during the
intervening period, to reevaluate our business plan in each of our HIH markets and develop appropriate
strategies to adapt to the HIH Rule, such as relocating certain HIHs to alternative settings. The HIH Rule established exceptions to the Medicare admissions limitations
with respect to patients who reach outlier status at the host hospital, HIHs
located in MSA-dominant hospitals or HIHs located in rural areas. We do not
expect that these exceptions will have any significant applicability to our
operations. Critical Accounting Matters Sources of Revenue Our net operating revenues are derived from a number of sources, including
commercial, managed care, private and governmental payors. Our net operating
revenues include amounts estimated by management to be reimbursable from each
of the applicable payors and the federal Medicare program. Amounts we receive
for treatment of patients are generally less than the standard billing rates.
We account for the differences between the estimated reimbursement rates and
the standard billing rates as contractual adjustments, which we deduct from
gross revenues to arrive at net operating revenues. Net operating revenues generated directly from the Medicare program from
all segments represented approximately 47% and 46% of net operating revenues
for the nine months ended September 30, 2004 and 2003, respectively. The
increase in the percentage of our revenues generated from the Medicare program
is due to the growth in the number of specialty hospitals and their higher
respective share of Medicare revenues generated in this segment of our business
compared to our outpatient rehabilitation segment. Approximately 68% and 69% of our specialty hospital revenues for the nine
months ended September 30, 2004 and 2003, respectively, were received in
respect of services provided to Medicare patients. For the quarter ended
September 30, 2004, all of our Medicare payments are being paid under a
prospective payment system. For the quarter ended September 30, 2003,
approximately 33% was paid by Medicare under a cost-based reimbursement
methodology. These payments are subject to final cost report settlements based
on administrative review and audit by third parties. An annual cost report was
filed for each provider to report the - 28 -




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cost of providing services and to settle the difference between the
interim payments we receive and final costs. We record adjustments to the
original estimates in the periods that such adjustments become known.
Historically these adjustments have not been significant. Substantially all of
our Medicare cost reports are settled through 2000. Because our routine
payments from Medicare are different than the final reimbursement due to us
under the cost based reimbursement system, we record a receivable or payable
for the difference. On August 30, 2002, CMS published final regulations establishing a
prospective payment system for Medicare payment of long-term acute care
hospitals (LTCH-PPS), which replaces the reasonable cost-based payment system
previously in effect. Under LTCH-PPS, each discharged patient will be assigned
to a distinct long-term care diagnosis-related group (LTC-DRG), and a
long-term acute care hospital will generally be paid a pre-determined fixed
amount applicable to the assigned LTC-DRG (adjusted for area wage differences).
As required by Congress, LTC-DRG payment rates have been set to maintain
budget neutrality with total expenditures that would have been made under the
reasonable cost-based payment system. As of October 1, 2004, 80 of our
long-term acute care hospitals have implemented LTCH-PPS. We expect that the
remaining three hospitals, all of which opened in 2004, will eventually be
certified as long-term acute care hospitals when conditions for qualification
have been met. As of September 30, 2004 and December 31, 2003 we had a net amount due to
Medicare of $20.4 million and $33.9 million, related to our specialty
hospitals. We recorded this amount as due to third party payors on our balance
sheet. Other revenue primarily represents amounts we have received for other
services, which include sales of home medical equipment, orthotics,
prosthetics, infusion/intravenous services and computer software. Insurance Under a number of our insurance programs, which include our employee
health insurance program and certain components under our property and casualty
insurance program, we are liable for a portion of our losses. In these cases
we accrue for our losses under an occurrence based principal whereby we
estimate the losses that will be incurred by us in a respective accounting
period and accrue that estimated liability. Where we have substantial
exposure, we utilize actuarial methods in estimating the losses. In cases
where we have minimal exposure, we will estimate our losses by analyzing
historical trends. We monitor these programs quarterly and revise our
estimates as necessary to take into account additional information. At
September 30, 2004 and December 31, 2003, we have recorded
a liability of $40.7
million and $29.8 million, respectively, for our estimated losses under these
insurance programs. Bad Debts We estimate our bad debts based upon the age of our accounts receivable
and our historical collection percentages. These estimates are sensitive to
changes in the economy that affect our customers. - 29 -




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Related Party We are party to various rental and other agreements with companies
affiliated through common ownership. Our payments to these related parties
amounted to $1.5 million and $1.1 million for the nine months ended September
30, 2004 and 2003, respectively. Our future commitments are related to
commercial office space we lease for our corporate headquarters in
Mechanicsburg, Pennsylvania. These future commitments amount to $18.6 million
through 2014. These transactions and commitments are described more fully in
Note 16 to Select Medical Corporations consolidated financial statements
contained in our form 10-K for the year ended December 31, 2003. Results of Operations The following table outlines, for the periods indicated, selected
operating data as a percentage of net operating revenues. Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net operating revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of services (a)
    
    
    78.2
    %
    
    
    80.0
    %
    
    
    77.8
    %
    
    
    80.0
    %General and administrative
    
    
    2.7
    %
    
    
    3.1
    %
    
    
    2.9
    %
    
    
    3.2
    %Bad debt expense
    
    
    3.2
    %
    
    
    3.9
    %
    
    
    2.9
    %
    
    
    3.8
    %Depreciation and amortization
    
    
    2.5
    %
    
    
    2.5
    %
    
    
    2.4
    %
    
    
    2.4
    %Income from operations
    
    
    13.4
    %
    
    
    10.5
    %
    
    
    14.0
    %
    
    
    10.6
    %Equity in earnings from joint ventures
    
    
    
    
    
    
    (0.1
    %)
    
    
    
    
    
    
    N/MInterest expense, net
    
    
    1.9
    %
    
    
    1.8
    %
    
    
    2.0
    %
    
    
    1.8
    %Income from continuing operations before
minority interests, and income taxes
    
    
    11.5
    %
    
    
    8.8
    %
    
    
    12.0
    %
    
    
    8.8
    %Minority interests
    
    
    0.1
    %
    
    
    0.1
    %
    
    
    0.2
    %
    
    
    0.2
    %Income from continuing operations before
income taxes
    
    
    11.4
    %
    
    
    8.7
    %
    
    
    11.8
    %
    
    
    8.6
    %Income tax expense
    
    
    4.6
    %
    
    
    3.4
    %
    
    
    4.7
    %
    
    
    3.4
    %Income from continuing operations
    
    
    6.8
    %
    
    
    5.3
    %
    
    
    7.1
    %
    
    
    5.2
    %Income from discontinued operations, net of tax
    
    
    N/M
    
    
    
    N/M
    
    
    
    N/M
    
    
    
    N/MNet income
    
    
    6.8
    %
    
    
    5.3
    %
    
    
    7.1
    %
    
    
    5.2
    %
 - 30 -




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The following table summarizes selected financial data by business segment, for
the periods indicated. Three Months Ended
    
    
    
    
    
    Nine Months EndedSeptember 30,
    
    %
    
    September 30,
    
    %2004
    
    2003
    
    Change
    
    2004
    
    2003
    
    Change(dollars in thousands)Net operating revenues:Specialty hospitals
    
    $
    270,647
    
    
    $
    220,967
    
    
    
    22.5
    %
    
    $
    807,944
    
    
    $
    596,158
    
    
    
    35.5
    %Outpatient rehabilitation
    
    
    133,522
    
    
    
    129,108
    
    
    
    3.4
    
    
    
    423,465
    
    
    
    386,730
    
    
    
    9.5Other
    
    
    3,401
    
    
    
    2,327
    
    
    
    46.2
    
    
    
    9,867
    
    
    
    8,039
    
    
    
    22.7Total company
    
    $
    407,570
    
    
    $
    352,402
    
    
    
    15.7
    %
    
    $
    1,241,276
    
    
    $
    990,927
    
    
    
    25.3
    %Income (loss) from operations:Specialty hospitals
    
    $
    54,014
    
    
    $
    34,412
    
    
    
    57.0
    %
    
    $
    160,610
    
    
    $
    83,433
    
    
    
    92.5
    %Outpatient rehabilitation
    
    
    13,414
    
    
    
    13,139
    
    
    
    2.1
    
    
    
    53,481
    
    
    
    50,019
    
    
    
    6.9Other
    
    
    (12,465
    )
    
    
    (10,646
    )
    
    
    (17.1
    )
    
    
    (40,742
    )
    
    
    (28,862
    )
    
    
    (41.2
    )Total company
    
    $
    54,963
    
    
    $
    36,905
    
    
    
    48.9
    %
    
    $
    173,349
    
    
    $
    104,590
    
    
    
    65.7
    %Adjusted EBITDA: (b)Specialty hospitals
    
    $
    58,945
    
    
    $
    38,376
    
    
    
    53.6
    %
    
    $
    174,966
    
    
    $
    94,570
    
    
    
    85.0
    %Outpatient rehabilitation
    
    
    17,349
    
    
    
    16,862
    
    
    
    2.9
    
    
    
    64,427
    
    
    
    59,756
    
    
    
    7.8Other
    
    
    (11,067
    )
    
    
    (9,602
    )
    
    
    (15.3
    )
    
    
    (36,511
    )
    
    
    (26,299
    )
    
    
    (38.8
    )Adjusted EBITDA margins: (b)Specialty hospitals
    
    
    21.8
    %
    
    
    17.4
    %
    
    
    25.3
    %
    
    
    21.7
    %
    
    
    15.9
    %
    
    
    36.5
    %Outpatient rehabilitation
    
    
    13.0
    
    
    
    13.1
    
    
    
    (0.8
    )
    
    
    15.2
    
    
    
    15.5
    
    
    
    (1.9
    )Other
    
    
    N/M
    
    
    
    N/M
    
    
    
    N/M
    
    
    
    N/M
    
    
    
    N/M
    
    
    
    N/MTotal assets:Specialty hospitals
    
    $
    509,050
    
    
    $
    427,773
    
    
    
    
    
    
    $
    509,050
    
    
    $
    427,773Outpatient rehabilitation
    
    
    367,578
    
    
    
    370,031
    
    
    
    
    
    
    
    367,578
    
    
    
    370,031Other
    
    
    229,430
    
    
    
    193,138
    
    
    
    
    
    
    
    229,430
    
    
    
    193,138Total company
    
    $
    1,106,058
    
    
    $
    990,942
    
    
    
    
    
    
    $
    1,106,058
    
    
    $
    990,942Purchases of property and
equipment, net:Specialty hospitals
    
    $
    5,397
    
    
    $
    5,970
    
    
    
    
    
    
    $
    18,422
    
    
    $
    13,386Outpatient rehabilitation
    
    
    1,219
    
    
    
    1,685
    
    
    
    
    
    
    
    4,370
    
    
    
    6,215Other
    
    
    344
    
    
    
    864
    
    
    
    
    
    
    
    3,300
    
    
    
    4,124Total company
    
    $
    6,960
    
    
    $
    8,519
    
    
    
    
    
    
    $
    26,092
    
    
    $
    23,725
 - 31 -




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The following tables reconcile net income to EBITDA for the Company and
provides the calculation of our EBITDA margin for each of the periods
presented. Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(dollars in thousands)Net income
    
    $
    27,817
    
    
    $
    18,613
    
    
    $
    88,358
    
    
    $
    51,698Income tax expense (c)
    
    
    18,777
    
    
    
    12,158
    
    
    
    59,662
    
    
    
    33,515Interest expense, net
    
    
    7,998
    
    
    
    6,142
    
    
    
    23,900
    
    
    
    17,848Depreciation and amortization (c)
    
    
    10,324
    
    
    
    8,807
    
    
    
    29,467
    
    
    
    23,513EBITDA (b)
    
    $
    64,916
    
    
    $
    45,720
    
    
    $
    201,387
    
    
    $
    126,574Net revenue
    
    $
    407,570
    
    
    $
    352,402
    
    
    $
    1,241,276
    
    
    $
    990,927EBITDA margin (b)
    
    
    15.9
    %
    
    
    13.0
    %
    
    
    16.2
    %
    
    
    12.8
    %
 The following table reconciles same hospitals information. Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(dollars in thousands)Net Operating RevenueSpecialty hospitals net operating revenue
    
    $
    270,647
    
    
    $
    220,967
    
    
    $
    807,944
    
    
    $
    596,158Less: Specialty hospitals opened or acquired
after 1/1/03
    
    
    56,839
    
    
    
    15,146
    
    
    
    157,116
    
    
    
    15,435Closed specialty hospital
    
    
    
    
    
    
    64
    
    
    
    
    
    
    
    1,537Specialty hospitals same store net operating revenue
    
    $
    213,808
    
    
    $
    205,757
    
    
    $
    650,828
    
    
    $
    579,186Adjusted EBITDA (b)Specialty hospitals Adjusted EBITDA (b)
    
    $
    58,945
    
    
    $
    38,376
    
    
    $
    174,966
    
    
    $
    94,570Less: Specialty hospitals opened or acquired after
1/1/03
    
    
    12,869
    
    
    
    1,830
    
    
    
    36,184
    
    
    
    207Closed specialty hospital
    
    
    
    
    
    
    24
    
    
    
    
    
    
    
    (15
    )Specialty hospitals same store Adjusted EBITDA (b)
    
    $
    46,076
    
    
    $
    36,522
    
    
    $
    138,782
    
    
    $
    94,378All specialty hospitals Adjusted EBITDA margin (b)
    
    
    21.8
    %
    
    
    17.4
    %
    
    
    21.7
    %
    
    
    15.9
    %Specialty hospitals same store Adjusted EBITDA margin (b)
    
    
    21.6
    %
    
    
    17.8
    %
    
    
    21.3
    %
    
    
    16.3
    %
 NM  Not Meaningful  (a)
    
    Cost of services include salaries, wages and benefits, operating
supplies, lease and rent expense and other operating costs.(b)
    
    We define Adjusted EBITDA as net income before interest, income taxes,
depreciation and amortization, equity in earnings from joint ventures, and
minority interest. Minority interest and equity in earnings from joint
ventures are then deducted from Adjusted EBITDA to derive EBITDA. We
believe that the presentation of EBITDA is important to investors because
EBITDA is commonly used as an analytical indicator of performance by
investors within the healthcare industry. Adjusted EBITDA is used by
management to evaluate financial performance and determine resource
allocation for each of our operating units. EBITDA and Adjusted EBITDA
are not measures of financial performance under generally accepted
accounting principles. Items excluded from EBITDA and Adjusted EBITDA are
significant components in understanding and assessing financial
performance. EBITDA and Adjusted EBITDA should not be considered in
isolation or as an alternative to, or substitute for, net income, cash
flows generated by operations, investing or financing activities, or other
financial statement data presented in the consolidated financial
statements as indicators of financial performance or liquidity. Because
EBITDA and Adjusted EBITDA are not measurements determined in accordance
with generally accepted accounting principles and are thus susceptible to
varying calculations, EBITDA and Adjusted EBITDA as presented may not be
comparable to other similarly titled measures of other companies. See
footnote 5 to our unaudited consolidated interim financial statements for
a reconciliation of net income to Adjusted EBITDA as utilized by us in
reporting our segment performance in accordance with SFAS No. 131.(c)
    
    Includes amounts associated with discontinued operations. - 32 -




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Three Months Ended September 30, 2004 Compared to Three Months Ended September
30, 2003 Net Operating Revenues Our net operating revenues increased by 15.7% to $407.6 million for the
three months ended September 30, 2004 compared to $352.4 million for the three
months ended September 30, 2003. The reasons for the increase in net operating
revenues are discussed below. Specialty Hospitals.Our specialty hospital net operating revenues
increased 22.5% to $270.6 million for the three months ended September 30, 2004
compared to $221.0 million for the three months ended September 30, 2003. Net
operating revenues for the 71 specialty hospitals opened before January 1, 2003
and operated throughout both periods increased 3.9% to $213.8 million for the
three months ended September 30, 2004 from $205.8 million for the three months
ended September 30, 2003. The increase in same hospital revenues resulted
primarily from higher net revenue per patient day for both Medicare and
non-Medicare patients. The higher net revenue per patient day was offset by a
reduction in Medicare patient days. The remaining increase of $41.6 million
resulted from the acquisition of the Kessler facilities, which contributed
$24.1 million of net revenue, and the internal development of new specialty
hospitals that commenced operations in 2003 and 2004. Outpatient Rehabilitation.Our outpatient rehabilitation net operating
revenues increased 3.4% to $133.5 million for the three months ended September
30, 2004 compared to $129.1 million for the three months ended September 30,
2003. The increase in net operating revenues was principally related to the
acquisition of the Kessler operations, which contributed $6.5 million of net
operating revenue. Net revenue per visit in our U.S. based outpatient
rehabilitation clinics increased to $88 for the three months ended September
30, 2004 compared to $87 for the three months ended September 30, 2003. The
number of patient visits in these clinics for the three months ended September
30, 2004 were 935,763 compared to 1,002,354 visits for the three months ended
September 30, 2003. Excluding the effects of the Kessler operations in both
periods, visits declined by 11.4%. The majority of this decline is related to
clinic closures. Other.Our other revenues increased to $3.4 million for the three months
ended September 30, 2004 compared to $2.3 million for the three months ended
September 30, 2003. The increase in revenues was related to the other
businesses we acquired from Kessler that are now being reported under this
category. These businesses generated approximately $2.3 million of incremental
net operating revenues during the three months ended September 30, 2004. We
experienced a decline of $1.1 million in Medicare net operating revenues
associated with reimbursement for our general and administrative costs. This
revenue item has been eliminated as a result of our long-term acute care
hospitals converting to LTCH-PPS. Operating Expenses Our operating expenses increased by 11.6% to $342.3 million for the three
months ended September 30, 2004 compared to $306.8 million for the three months
ended September 30, 2003. Our operating expenses include our cost of services,
general and administrative expense and bad debt expense. The increase in
operating expenses was principally related to the acquisition of Kessler and
the internal development of new specialty hospitals that commenced operations
in 2003 and 2004. As a percentage of our net operating revenues, our operating
expenses were 84.1% for the three months ended September 30, 2004 compared to
87.0% for the three months ended September 30, 2003. Cost of services as a
percentage of operating revenues decreased to 78.2% for the three months ended
September 30, 2004 from 80.0% for the three months ended September 30, 2003.
These costs primarily reflect our labor expenses. This decrease resulted
because we experienced a larger rate of growth in our specialty hospital
revenues compared to the growth in our specialty hospital cost of services.
Another component of cost of services is rent expense, which was $26.5 million for - 33 -




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the three months ended September 30, 2004 compared to $24.3 million for
the three months ended September 30, 2003. This increase is principally
related to our new hospitals that opened during 2003 and 2004 and the rent
expense for the acquired Kessler clinics. During the same time period, general
and administrative expense as a percentage of net operating revenues declined
to 2.7% for the three months ended September 30, 2004 from 3.1% for the three
months ended September 30, 2003. This decrease in general and administrative
expense as a percentage of net operating revenue is the result of growth in net
operating revenues that exceeded the growth in our general and administrative
costs and a reduction in our general and administrative expenses related to
Kessler. Our bad debt expense as a percentage of net operating revenues was
3.2% for the three months ended September 30, 2004 compared to 3.9% for the
three months ended September 30, 2003. This decrease in bad debt expense
resulted from an improvement in the composition and aging of our accounts
receivable. EBITDA and Adjusted EBITDA Our total EBITDA increased 42.0% to $64.9 million for the three months
ended September 30, 2004 compared to $45.7 million for the three months ended
September 30, 2003. Our EBITDA margins increased to 15.9% for the three months
ended September 30, 2004 compared to 13.0% for the three months ended September
30, 2003. For cash flow information, see -Capital Resources and Liquidity. Specialty Hospitals.Adjusted EBITDA increased by 53.6% to $58.9 million
for the three months ended September 30, 2004 compared to $38.4 million for the
three months ended September 30, 2003. Our Adjusted EBITDA margins increased
to 21.8% for the three months ended September 30, 2004 from 17.4% for the three
months ended September 30, 2003. The hospitals opened before January 1, 2003
and operated throughout both periods had Adjusted EBITDA of $46.1 million, an
increase of 26.2% over the Adjusted EBITDA of these hospitals in the same
period last year. This increase in same hospital Adjusted EBITDA resulted from
an increase in revenue per patient day, attributable to the improved
reimbursement we are receiving from Medicare under LTCH-PPS. For additional
information on LTCH-PPS see Critical Accounting Matters  Sources of Revenue.
Our Adjusted EBITDA margin in these same store hospitals increased to 21.6%
for the three months ended September 30, 2004 from 17.8% for the three months
ended September 30, 2003. Outpatient Rehabilitation.Adjusted EBITDA increased by 2.9% to $17.3
million for the three months ended September 30, 2004 compared to $16.9 million
for the three months ended September 30, 2003. This Adjusted EBITDA increase
resulted from the growth in operating revenues. Our Adjusted EBITDA margins
were 13.0% for the three months ended September 30, 2004 compared to 13.1% for
the three months ended September 30, 2003. Other.The Adjusted EBITDA loss was $11.1 million for the three months
ended September 30, 2004 compared to a loss of $9.6 million for the three
months ended September 30, 2003. This decrease in Adjusted EBITDA was
primarily the result of the decline in Medicare reimbursements for corporate
support costs of $1.1 million resulting from the implementation of LTCH-PPS. Income from Operations Income from operations increased 48.9% to $55.0 million for the three
months ended September 30, 2004 compared to $36.9 million for the three months
ended September 30, 2003. The increase in income from operations resulted from
the Adjusted EBITDA increases described above, and was offset by an increase in
depreciation and amortization expense of $1.5 million. The increase in
depreciation and amortization expense resulted primarily from the additional
depreciation associated with the acquired Kessler assets, the amortization of
the value of the seven year non-compete agreement that we received from
Kesslers selling stockholder, and increases in depreciation on fixed asset
additions that are principally related to new hospital and clinic development. - 34 -




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Interest Expense Interest expense increased by $2.2 million to $8.6 million for the three
months ended September 30, 2004 from $6.4 million for the three months ended
September 30, 2003. The increase in interest expense is the result of higher
debt levels outstanding in 2004 compared to 2003 resulting from the issuance of
$175.0 million of 7 1⁄2% senior subordinated notes due 2013 on August 12, 2003
to fund the Kessler acquisition, offset by a reduction in borrowings under our
senior credit facility. The lower debt levels on our senior credit facility
resulted from scheduled term amortization payments and principal pre-payments.
All repayments have been made with cash flows generated from operations. Minority Interests Minority interests in consolidated earnings were $0.6 million for the
three months ended September 30, 2004 compared to $0.4 million for the three
months ended September 30, 2003. This increase is the result of the improved
profitability of these jointly owned entities. Income Taxes We recorded income tax expense of $18.7 million for the three months ended
September 30, 2004. The expense represented an effective tax rate of 40.3%.
We recorded income tax expense of $12.1 million for the three months ended
September 30, 2003. This expense represented an effective tax rate of 39.5%.
The increase in the effective tax rate is the result of a larger portion of our
net income being earned in states with higher tax rates and the
non-deductibility of certain expenses. Nine Months Ended September 30, 2004 Compared to Nine Months Ended September 30, 2003 Net Operating Revenues Our net operating revenues increased by 25.3% to $1,241.3 million for the
nine months ended September 30, 2004 compared to $990.9 million for the nine
months ended September 30, 2003. The reasons for the increase in net operating
revenues are discussed below. Specialty Hospitals.Our specialty hospital net operating revenues
increased 35.5% to $807.9 million for the nine months ended September 30, 2004
compared to $596.2 million for the nine months ended September 30, 2003. Net
operating revenues for the 71 specialty hospitals opened before January 1, 2003
and operated throughout both periods increased 12.4% to $650.8 million for the
nine months ended September 30, 2004 from $579.2 million for the nine months
ended September 30, 2003. The increase in same hospital revenues resulted
primarily from higher net revenue per patient day, which is primarily
attributable to the improved reimbursement we are receiving from Medicare under
LTCH-PPS. The remaining increase of $140.1 million resulted from the
acquisition of the Kessler facilities, which contributed $93.1 million of net
revenue, and the internal development of new specialty hospitals that commenced
operations in 2003 and 2004. Outpatient Rehabilitation.Our outpatient rehabilitation net operating
revenues increased 9.5% to $423.5 million for the nine months ended September
30, 2004 compared to $386.7 million for the nine months ended September 30,
2003. The increase in net operating revenues was principally related to the
acquisition of the Kessler operations, which contributed $37.0 million of net
operating revenue. Net revenue per visit in our U.S. based outpatient
rehabilitation clinics increased to $89 for the nine months ended September 30,
2004 compared to $88 for the nine months ended September 30, 2003. The number
of patient visits in these clinics for the nine months ended September 30, 2004
were 2,933,106 visits compared to 3,002,954 visits for the nine months ended
September 30, 2003. Excluding the effects of the Kessler operations in both
periods, visits declined by 10.2%. The majority of this decline is related to
clinic closures. In addition, during the first and second quarters of 2004
various market factors such as elimination of unprofitable contracts and
competition - 35 -




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from referring physicians who are now developing their own rehabilitation
therapy practices contributed to the decline. Other.Our other revenues increased to $9.9 million for the nine months
ended September 30, 2004 compared to $8.0 million for the nine months ended
September 30, 2003. The increase in revenues was related to the other
businesses we acquired from Kessler that are now being reported under this
category. These businesses generated approximately $7.9 million of incremental
net operating revenues during the nine months ended September 30, 2004. We
experienced a decline of $6.1 million in Medicare net operating revenues
associated with reimbursement for our general and administrative costs. This
revenue item has been eliminated as a result of our long-term acute care
hospitals converting to LTCH-PPS. Operating Expenses Our operating expenses increased by 20.3% to $1,038.4 million for the nine
months ended September 30, 2004 compared to $862.9 million for the nine months
ended September 30, 2003. Our operating expenses include our cost of services,
general and administrative expense and bad debt expense. The increase in
operating expenses was principally related to the acquisition of Kessler and
the internal development of new specialty hospitals that commenced operations
in 2003 and 2004. As a percentage of our net operating revenues, our operating
expenses were 83.6% for the nine months ended September 30, 2004 compared to
87.0% for the nine months ended September 30, 2003. Cost of services as a
percentage of operating revenues decreased to 77.8% for the nine months ended
September 30, 2004 from 80.0% for the nine months ended September 30, 2003.
These costs primarily reflect our labor expenses. This decrease resulted
because we experienced a greater rate of growth in our specialty hospital
revenues compared to the growth in our specialty hospital cost of services.
Another component of cost of services is rent expense, which was $79.4 million
for the nine months ended September 30, 2004 compared to $69.0 million for the
nine months ended September 30, 2003. This increase is principally related to
our new hospitals that opened during 2003 and 2004 and the rent expense for the
acquired Kessler clinics. During the same time period, general and
administrative expense as a percentage of net operating revenues declined to
2.9% for the nine months ended September 30, 2004 from 3.2% for the nine months
ended September 30, 2003. This decrease in general and administrative expense
as a percentage of net operating revenue is the result of growth in net
operating revenues that exceeded the growth in our general and administrative
costs. Our bad debt expense as a percentage of net operating revenues was 2.9%
for the nine months ended September 30, 2004 compared to 3.8% for the nine
months ended September 30, 2003. This decrease in bad debt expense resulted
from an improvement in the composition and aging of our accounts receivable. EBITDA and Adjusted EBITDA Our total EBITDA increased 59.1% to $201.4 million for the nine months
ended September 30, 2004 compared to $126.6 million for the nine months ended
September 30, 2003. Our EBITDA margins increased to 16.2% for the nine months
ended September 30, 2004 compared to 12.8% for the nine months ended September
30, 2003. For cash flow information, see -Capital Resources and Liquidity. Specialty Hospitals.Adjusted EBITDA increased by 85.0% to $175.0
million for the nine months ended September 30, 2004 compared to $94.6 million
for the nine months ended September 30, 2003. Our Adjusted EBITDA margins
increased to 21.7% for the nine months ended September 30, 2004 from 15.9% for
the nine months ended September 30, 2003. The hospitals opened before January
1, 2003 and operated throughout both periods had Adjusted EBITDA of $138.8
million, an increase of 47.0% over the Adjusted EBITDA of these hospitals in
the same period last year. This increase in same hospital Adjusted EBITDA
resulted from an increase in revenue per patient day, which is primarily
attributable to the improved reimbursement we are receiving from Medicare under
LTCH-PPS. For additional information on LTCH-PPS see Critical Accounting
Matters  Sources of Revenue. Our Adjusted EBITDA margin in these same store - 36 -




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hospitals increased to 21.3% for the nine months ended September 30, 2004
from 16.3% for the nine months ended September 30, 2003. Outpatient Rehabilitation.Adjusted EBITDA increased by 7.8% to $64.4
million for the nine months ended September 30, 2004 compared to $59.8 million
for the nine months ended September 30, 2003. Our Adjusted EBITDA margins were
15.2% for the nine months ended September 30, 2004 compared to 15.5% for the
nine months ended September 30, 2003. This Adjusted EBITDA margin decline was
the result of an increase in labor costs offset by a decline in bad debt
expense. We have experienced an increase in labor costs due to increased
competition for hiring therapists. Other.The Adjusted EBITDA loss was $36.5 million for the nine months
ended September 30, 2004 compared to a loss of $26.3 million for the nine
months ended September 30, 2003. This decrease in Adjusted EBITDA was
primarily the result of the decline in Medicare reimbursements for corporate
support costs of $6.1 million resulting from the implementation of LTCH-PPS and
an increase in general and administrative costs of $4.2 million. Income from Operations Income from operations increased 65.7% to $173.3 million for the nine
months ended September 30, 2004 compared to $104.6 million for the nine months
ended September 30, 2003. The increase in income from operations resulted from
the Adjusted EBITDA increases described above, and was offset by an increase in
depreciation and amortization expense of $6.1 million. The increase in
depreciation and amortization expense resulted primarily from the additional
depreciation associated with the acquired Kessler assets, the amortization of
the value of the seven year non-compete agreement that we received from
Kesslers selling stockholder, and increases in depreciation on fixed asset
additions that are principally related to new hospital and clinic development. Interest Expense Interest expense increased by $6.9 million to $25.4 million for the nine
months ended September 30, 2004 from $18.5 million for the nine months ended
September 30, 2003. The increase in interest expense is the result of higher
debt levels outstanding in 2004 compared to 2003 resulting from the issuance of
$175.0 million of 7 1⁄2% senior subordinated notes due 2013 on August 12,
2003, offset by a reduction in borrowings under our senior credit facility. The
lower debt levels on our senior credit facility resulted from scheduled term
amortization payments and principal pre-payments. All repayments have been
made with cash flows generated from operations. Minority Interests Minority interests in consolidated earnings were $2.8 million for the nine
months ended September 30, 2004 compared to $1.9 million for the nine months
ended September 30, 2003. This increase is the result of the improved
profitability of these jointly owned entities. Income Taxes We recorded income tax expense of $59.1 million for the nine months ended
September 30, 2004. The expense represented an effective tax rate of 40.3%.
We recorded income tax expense of $33.5 million for the nine months ended
September 30, 2003. This expense represented an effective tax rate of 39.3%.
The increase in the effective tax rate is the result of a larger portion of our
net income being earned in states with higher tax rates and the
non-deductibility of certain expenses. - 37 -




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Capital Resources and Liquidity For the nine months ended September 30, 2004, operating activities
provided $129.4 million of cash flow. Our accounts receivable days outstanding
were 51 days at September 30, 2004 compared to 52 days at December 31, 2003.
Our accounts receivable days outstanding were 54 days at September 30, 2003
compared to 73 days at December 31, 2002. For the nine months ended September
30, 2003, operating activities provided $164.2 million of cash flow. The
substantial reduction in the first nine months of 2003 in our accounts
receivable days outstanding was a major contributor to the significant cash
flow during that period. Investing activities used $13.1 and $254.0 million of cash flow for the
nine months ended September 30, 2004 and 2003, respectively. This usage
resulted from purchases of property and equipment of $26.1 and $23.7 million in
2004 and 2003, respectively, that relate principally to new hospital and clinic
development. Additionally in 2004, we incurred $3.0 million in earn out
payments and $0.3 million in acquisition costs. We also realized $16.3 million
of proceeds from the sale of business and membership interests. This compares
to $0.4 million in earn out payments and $232.2 million of acquisition costs in
the nine months ended September 30, 2003. The significant acquisition costs in
2003 relates to the acquisition of Kessler Rehabilitation Corporation. Financing activities used $62.1 million of cash for the nine months ended
September 30, 2004. This principally relates to the repurchase of our common
stock during 2004 in accordance with the stock repurchase program we announced
on February 23, 2004. During 2004, we have repurchased a total of 3,399,400
shares at a cost, including fees and commissions, of $48.1 million. The
repurchase program provides for the repurchase of up to $80 million of our
common stock through August 31, 2005. Additionally, during 2004, we repaid all
outstanding balances under our credit facility of $8.5 million and repaid $3.0
million of seller loans. Cash dividend payments in the first nine months of
2004 were $9.2 million. During the nine months ended September 30, 2004, we
had $18.0 million of cash flow from the issuance of common stock under our
stock option plans. During the nine months ended September 30, 2003, financing
activities produced $114.8 million of cash. This principally related to the
$175 million proceeds from the sale of our 7 1⁄2% Senior Subordinated Notes
due 2013 used to finance the Kessler acquisition offset by the repayment of
our credit facility debt. Capital Resources Net working capital increased to $271.5 million at September 30, 2004
compared to $188.4 million at December 31, 2003. The increase in working
capital is principally related to an increase in cash and a reduction in our
current liabilities. A reduction in accounts payable and amounts due to third
party payors were the primary contributors to the reduction in current
liabilities. Our accounts payable balance was larger at December 31, 2003 due
to a slow down in payable processing over the year-end holidays. The reduction
in amounts due to third party payors is a result of filing and settling cost
reports and refinements in the bi-weekly payments we receive from our Medicare
fiscal intermediary related to our Medicare patients. We expect this liability
to continue to decline over the next few quarters. At September 30, 2004, our credit facility consisted of a revolving credit
facility of approximately $152.4 million. As of September 30, 2004 there were
no borrowings under our credit facility. We have $13.8 million outstanding
under letters of credit issued through the credit facility. As of September
30, 2004 we had the ability to borrow an additional $138.6 million under our
revolving facility subject to certain limitations. The revolving credit
facility terminates in September 2005. Borrowings under the credit facility
bear interest at a fluctuating rate of interest based upon financial covenant
ratio tests. During the nine months ended September 30, 2004, we have declared and paid
cash dividends of $0.09 per share. - 38 -




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We believe that existing cash balances, internally generated cash flows
and borrowings under our revolving credit facility will be sufficient to
finance capital expenditures and working capital requirements related to our
routine operations and development activities for at least the next twelve
months. Our goal historically has been to open eight to ten long-term acute care
hospitals per year utilizing our hospital within a hospital model. A new
long-term acute care hospital using the hospital within a hospital model has
typically required approximately $3.6 million per hospital over the initial
year of operations to fund leasehold improvements, equipment, start-up losses
and working capital. As a result of the regulatory changes adopted by CMS on
August 2, 2004, we continue to evaluate the effect of the new rules on our
hospital within a hospital model including the mix and pace of development of
future LTACHs. We expect to open only four or five LTACHs in 2004.
The Company now intends to open approximately four to five long-term
acute care hospitals in 2005, primarily in settings where the HIH Rule
would have little or no impact. From time
to time, we may complete acquisitions of specialty hospitals and outpatient
rehabilitation businesses. We currently have approximately $138.6 million of
unused capacity under our revolving credit facility which can be used for
acquisitions. Based on the size of the acquisition, approval of the
acquisition by our lenders may be required. In addition, the merger agreement
described below provides that we are not permitted to take certain actions
without the prior written consent of EGL Holding Company, including certain
acquisitions. If funds required for future acquisitions exceed existing
sources of capital, we will need to increase our credit facilities or obtain
additional capital by other means. Our capitalization structure will change as
a result of the proposed merger discussed below. We
also have the right to call our 9 1⁄2% senior subordinated notes due
2009 on or after June 15, 2005. The redemption price would be $183.3 million
plus accrued interest on June 15, 2005. Under the terms of the proposed merger
discussed below, we intend to commence a tender offer to purchase our 7 1⁄2% and 9 1⁄2% senior
subordinated notes. Subsequent Event On October 18, 2004 we signed an agreement to merge with a subsidiary of
EGL Holding Company, an affiliate of Welsh, Carson, Anderson & Stowe IX, L.P.
Under the terms of the merger agreement, each share of our common stock, other
than certain shares held by the stockholders participating in the buying group,
will be converted into the right to receive $18.00 per share in cash. For a
more detailed description of the merger and the merger agreement, please refer
to our Current Report on Form 8-K filed with the Securities and Exchange
Commission by us on October 20, 2004. Inflation The health care industry is labor intensive. Wages and other expenses
increase during periods of inflation and when labor shortages occur in the
marketplace. In addition, suppliers pass along rising costs to us in the form
of higher prices. We have implemented cost control measures, including our case
and resource management program, to curtail increases in operating costs and
expenses. We have, to date, offset increases in operating costs by increasing
reimbursement for services and expanding services. However, we cannot predict
our ability to cover or offset future cost increases. Recent Accounting Pronouncements In December 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46R (FIN 46R) which replaced Interpretation No. 46,
Consolidation of Variable Interest Entities, an interpretation of Accounting
Research Bulletin No. 51, Consolidated Financial Statements, to improve
financial reporting of special purpose and other entities. In accordance with
the interpretation, business enterprises that represent the primary beneficiary
of another entity by retaining a controlling financial interest in that
entitys assets, liabilities and results of operations, must consolidate the
entity in their financial statements. Prior to the issuance of FIN 46R,
consolidation generally occurred when an enterprise controlled another entity
through voting interests. - 39 -




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The disclosure requirements of FIN 46R are effective for financial
statements issued after December 31, 2003. The initial recognition provisions
of FIN 46R were implemented during the reporting period that ended March 31,
2004. The adoption of FIN 46R did not have a material impact on our financial
statements for the three and nine months ended September 30, 2004. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Quantitative and Qualitative Disclosures About Market Risk We are exposed to interest rate changes, primarily as a result of floating
interest rates on borrowings under our credit facility. As of September 30,
2004 there were no borrowings under our credit facility. 
 ITEM 4. CONTROLS AND PROCEDURES We carried out an evaluation, under the supervision and with the
participation of our principal executive officer and principal financial
officer, of the effectiveness of the design and operation of our disclosure
controls and procedures as of the end of the period covered in this report.
Based on this evaluation, our principal executive officer and principal
financial officer concluded that our disclosure controls and procedures provide
reasonable assurance that material information required to be included in our
periodic SEC reports is recorded, processed, summarized and reported within the
time periods specified in the relevant SEC rules and forms. In addition, we reviewed our internal controls, and there have been no
significant changes in our internal controls or in other factors that could
significantly affect those controls subsequent to the date of their last
evaluation. 
 PART II            OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS On August 24, 2004, Clifford C. Marsden and Ming Xu filed a purported
class action complaint in the United States District Court for the Eastern
District of Pennsylvania on behalf of the public stockholders of Select against
Martin Jackson, Robert A. Ortenzio, Rocco A. Ortenzio, Patricia Rice and
Select. The complaint alleges, among other things, failure to disclose adverse
information regarding a potential regulatory change affecting reimbursement for
our services applicable to long-term acute care hospitals operated as
hospitals within hospitals or as satellites, and the issuance of false and
misleading statements about the financial outlook of Select. The complaint
seeks, among other things, damages in an unspecified amount, interest and
attorneys fees. We believe that the allegations in the complaint are without
merit and intend to vigorously defend against this action. On October 18, 2004, Garco Investments, LLP filed a purported class action
complaint in the Court of Chancery of the State of Delaware, New Castle County,
on behalf of the unaffiliated stockholders of Select against Russell L. Carson,
David S. Chernow, Bryan C. Cressey, James E. Dalton, Jr., Meyer Feldberg,
Robert A. Ortenzio, Rocco A. Ortenzio, Thomas A. Scully, Leopold Swergold and
LeRoy S. Zimmerman, who are all of our directors, Select and Welsh Carson
Anderson & Stowe. The complaint alleges, among other things, that our
directors violated their fiduciary duties by approving the merger agreement
before engaging in a full and fair sale process or an active market check, and
that Welsh Carson knowingly aided and abetted the alleged breaches of fiduciary
duty committed by the director defendants. The complaint seeks, among other
things, to enjoin the defendants from consummating the merger or,
alternatively, to rescind the proposed merger in the - 40 -




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event it has been consummated or award rescissory damages. We believe that the
allegations in the complaint are without merit and intend to vigorously defend
against this action. On November 3, 2004, Terrence C. Davey filed a purported class action
complaint in the Court of Chancery of the State of Delaware, New Castle County,
on behalf of the unaffiliated stockholders of Select against Russell L. Carson,
David S. Chernow, Bryan C. Cressey, James E. Dalton, Jr., Meyer Feldberg,
Robert A. Ortenzio, Rocco A. Ortenzio, Thomas A. Scully, Leopold Swergold and
LeRoy S. Zimmerman, who are all of our directors, Select and Welsh Carson
Anderson & Stowe. The complaint alleges, among other things, that the
defendants have breached their fiduciary duties owed to the plaintiff and the
stockholders of Select and that the proposed merger consideration is not fair
or adequate. The complaint seeks, among other things, to enjoin the defendants
from consummating the merger or, alternatively, to rescind the proposed merger
in the event it has been consummated or award rescissory damages. We believe
that the allegations in the complaint are without merit and intend to
vigorously defend against this action. As part of our business, we are subject to legal actions alleging liability on
our part. To cover claims arising out of the operations of our hospitals and
outpatient rehabilitation facilities, we maintain professional malpractice
liability insurance and general liability insurance in amounts and with
deductibles that we believe to be sufficient for our operations. We also
maintain umbrella liability coverage covering claims which, due to their nature
or amount, are not covered by our insurance policies. We cannot assure you
that professional liability insurance will cover all claims against us or
continue to be available at reasonable costs for us to maintain adequate levels
of insurance. These insurance policies also do not cover punitive damages. In recent years, physicians, hospitals and other healthcare providers have
become subject to an increasing number of legal actions alleging malpractice,
product liability or related legal theories. Many of these actions involve
large claims and significant defense costs. We are also subject to lawsuits
under a federal whistleblower statute designed to combat fraud and abuse in the
healthcare industry. These lawsuits can involve significant monetary damages
and award bounties to private plaintiffs who successfully bring the suits. - 41 -




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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS The following table contains information regarding the Companys
repurchase of its common stock during the quarter. ApproximateDollar Value ofTotal Number of
    
    Shares thatShares Purchased
    
    May Yet beTotal
    
    
    
    
    
    as Part of
    
    PurchasedNumber of
    
    Average Price
    
    Publicly
    
    Under theShares
    
    Paid per
    
    Announced Plans
    
    Plans orPeriod
    
    Purchased
    
    Share
    
    or Programs (a)
    
    ProgramsJuly 1 through July 31, 2004
    
    
    0
    
    
    
    
    
    
    
    0
    
    
    $
    32,044,000August 1 through August 31, 2004
    
    
    0
    
    
    
    
    
    
    
    0
    
    
    $
    32,044,000September 1 through September
30, 2004
    
    
    0
    
    
    
    
    
    
    
    0
    
    
    $
    32,044,000Total
    
    
    0
    
    
    
    
    
    
    
    0
 (a) On, February 23, 2004, the Companys Board of Directors authorized and
publicly announced a program to repurchase up to $80.0 million of our
common stock. This program will remain in effect until August 31, 2005,
unless extended or cancelled by the Board of Directors. We will not
repurchase any of our stock under the share repurchase program during the
pendency of the proposed merger. 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES  Not applicable. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS  Not applicable. 
 ITEM 5. OTHER INFORMATION  None. 
 ITEM 6. EXHIBITS  The exhibits to this report are listed in the Exhibit Index appearing on
page 44 hereof. - 42 -




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized. SELECT MEDICAL CORPORATIONBy:
    
    /s/ Martin F. JacksonMartin F. JacksonSenior Vice President and Chief Financial Officer(Duly Authorized Officer)By:
    
    /s/ Scott A. RombergerScott A. RombergerVice President, Chief Accounting Officer and Controller(Principal Accounting Officer)
 Dated: November 9, 2004 - 43 -




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EXHIBIT INDEX Exhibit
    
    Description31.1
    
    Certification of President and Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Senior Vice President and Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of President and Chief Executive Officer Pursuant to 18
U.S.C Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Senior Vice President and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
 - 44 -