##### 



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 March 31, 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
(State or other jurisdiction of
incorporation or organization)
    
    23-2872718
(I.R.S. employer identification
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 April 30, 2004, the number of outstanding shares of the Registrants
Common Stock was 102,940,660.




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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
    
    
    18ITEM 3.
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    29ITEM 4.
    
    CONTROLS AND PROCEDURES
    
    
    29PART II
    
    OTHER INFORMATION
    
    
    29ITEM 1.
    
    LEGAL PROCEEDINGS
    
    
    29ITEM 2.
    
    CHANGES IN SECURITIES AND USE OF PROCEEDS
    
    
    30ITEM 3.
    
    DEFAULTS UPON SENIOR SECURITIES
    
    
    30ITEM 4.
    
    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
    
    
    30ITEM 5.
    
    OTHER INFORMATION
    
    
    30ITEM 6.
    
    EXHIBITS AND REPORTS ON FORM 8-K
    
    
    30SIGNATURE
    
    
    
    
    31
 - 2 -




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##### 



PART I            FINANCIAL INFORMATION 
 ITEM 1.
            CONSOLIDATED
FINANCIAL STATEMENTS
 Select Medical Corporation 
 Consolidated Balance Sheets
 (in thousands, except share and per share amounts)
 March 31,
    
    December 31,2004
    
    2003(unaudited)AssetsCurrent Assets:Cash and cash equivalents
    
    $
    210,784
    
    
    $
    165,507Accounts receivable, net of allowance for doubtful accounts of $115,922
and $111,517 in 2004 and 2003, respectively
    
    
    225,715
    
    
    
    230,171Current deferred tax asset
    
    
    61,711
    
    
    
    61,699Other current assets
    
    
    27,268
    
    
    
    27,689Total Current Assets
    
    
    525,478
    
    
    
    485,066Property and equipment, net
    
    
    172,773
    
    
    
    174,902Goodwill
    
    
    308,310
    
    
    
    306,251Trademark
    
    
    58,875
    
    
    
    58,875Other intangible assets
    
    
    22,000
    
    
    
    22,876Non-current deferred tax asset
    
    
    5,878
    
    
    
    6,603Other assets
    
    
    23,672
    
    
    
    24,425Total Assets
    
    $
    1,116,986
    
    
    $
    1,078,998Liabilities and Stockholders EquityCurrent Liabilities:Bank overdrafts
    
    $
    7,858
    
    
    $
    11,427Current portion of long-term debt and notes payable
    
    
    9,279
    
    
    
    10,267Accounts payable
    
    
    48,461
    
    
    
    59,569Accrued payroll
    
    
    49,457
    
    
    
    53,260Accrued vacation
    
    
    22,217
    
    
    
    21,529Accrued restructuring
    
    
    9,512
    
    
    
    10,375Accrued other
    
    
    79,318
    
    
    
    78,308Income taxes payable
    
    
    9,426
    
    
    
    Due to third party payors
    
    
    79,072
    
    
    
    51,951Total Current Liabilities
    
    
    314,600
    
    
    
    296,686Long-term debt, net of current portion
    
    
    355,465
    
    
    
    357,236Total Liabilities
    
    
    670,065
    
    
    
    653,922Commitments and ContingenciesMinority interest in consolidated subsidiary companies
    
    
    6,161
    
    
    
    5,901Stockholders Equity:Common stock - $.01 par value: Authorized shares - 200,000,000,
Issued shares - 102,611,000 and 102,219,000 in 2004 and 2003, respectively
    
    
    1,025
    
    
    
    1,022Capital in excess of par
    
    
    288,108
    
    
    
    291,519Retained earnings
    
    
    148,017
    
    
    
    121,560Accumulated other comprehensive income
    
    
    3,610
    
    
    
    5,074Total Stockholders Equity
    
    
    440,760
    
    
    
    419,175Total Liabilities and Stockholders Equity
    
    $
    1,116,986
    
    
    $
    1,078,998
 See accompanying
notes. - 3 -




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##### 



Select Medical Corporation 
 Consolidated Statements of Operations
 (in thousands, except per share amounts)
(unaudited)
 For the Quarter EndedMarch 31,2004
    
    2003Net operating revenues
    
    $
    421,993
    
    
    $
    312,307Costs and expenses:Cost of services
    
    
    328,690
    
    
    
    252,269General and administrative
    
    
    11,613
    
    
    
    9,503Bad debt expense
    
    
    11,741
    
    
    
    12,183Depreciation and amortization
    
    
    10,429
    
    
    
    7,514Total costs and expenses
    
    
    362,473
    
    
    
    281,469Income from operations
    
    
    59,520
    
    
    
    30,838Other income and expense:Interest income
    
    
    (365
    )
    
    
    (186
    )Interest expense
    
    
    9,418
    
    
    
    6,426Income before minority interests and income taxes
    
    
    50,467
    
    
    
    24,598Minority interest in consolidated subsidiary companies
    
    
    1,006
    
    
    
    824Income before income taxes
    
    
    49,461
    
    
    
    23,774Income tax expense
    
    
    19,891
    
    
    
    9,320Net income
    
    $
    29,570
    
    
    $
    14,454Net income per common share:Basic:Income per common share
    
    $
    0.29
    
    
    $
    0.15Diluted:Income per common share
    
    $
    0.27
    
    
    $
    0.15Weighted average shares outstanding:Basic
    
    
    102,922
    
    
    
    94,299Diluted
    
    
    108,132
    
    
    
    98,401
 See accompanying notes. - 4 -




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##### 



Select Medical Corporation 
 Consolidated Statement of Changes in Stockholders Equity and Comprehensive Income
 (in thousands)
(unaudited)
 AccumulatedCommon
    
    Capital in
    
    
    
    
    
    OtherCommon
    
    Stock Par
    
    Excess
    
    Retained
    
    Comprehensive
    
    ComprehensiveStock
    
    Value
    
    of Par
    
    Earnings
    
    Income
    
    IncomeBalance at December 31, 2003
    
    
    102,219
    
    
    $
    1,022
    
    
    $
    291,519
    
    
    $
    121,560
    
    
    $
    5,074Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29,570
    
    
    
    
    
    
    $
    29,570Other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,464
    )
    
    
    (1,464
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    28,106Issuance of common stock
    
    
    1,642
    
    
    
    16
    
    
    
    9,594Cash dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,113
    )Repurchases of common stock
    
    
    (1,250
    )
    
    
    (13
    )
    
    
    (19,839
    )Valuation of non-employee options
    
    
    
    
    
    
    
    
    
    
    151Tax benefit of stock option exercises
    
    
    
    
    
    
    
    
    
    
    6,683Balance at March 31, 2004
    
    
    102,611
    
    
    $
    1,025
    
    
    $
    288,108
    
    
    $
    148,017
    
    
    $
    3,610
 See accompanying notes. - 5 -




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##### 



Select Medical Corporation 
 Consolidated Statements of Cash Flows
 (in thousands)
(unaudited) For the Quarter EndedMarch 31,2004
    
    2003Operating activitiesNet income
    
    $
    29,570
    
    
    $
    14,454Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    10,429
    
    
    
    7,514Provision for bad debts
    
    
    11,741
    
    
    
    12,183Minority interests
    
    
    1,006
    
    
    
    824Changes in operating assets and liabilities, net of
effects from acquisition of businesses:Accounts receivable
    
    
    (1,147
    )
    
    
    6,707Other current assets
    
    
    215
    
    
    
    (10
    )Other assets
    
    
    1,255
    
    
    
    1,573Accounts payable
    
    
    (11,042
    )
    
    
    (369
    )Due to third-party payors
    
    
    19,523
    
    
    
    (16,799
    )Accrued expenses
    
    
    (3,756
    )
    
    
    5,240Income taxes
    
    
    18,735
    
    
    
    (6,887
    )Net cash provided by operating activities
    
    
    76,529
    
    
    
    24,430Investing activitiesPurchases of property and equipment, net
    
    
    (7,762
    )
    
    
    (6,973
    )Earnout payments
    
    
    (2,977
    )
    
    
    (429
    )Acquisition of businesses, net of cash acquired
    
    
    (438
    )
    
    
    (732
    )Net cash used in investing activities
    
    
    (11,177
    )
    
    
    (8,134
    )Financing activitiesNet repayments on credit facility debt
    
    
    (1,212
    )
    
    
    (30,562
    )Principal payments on seller and other debt
    
    
    (1,635
    )
    
    
    (1,719
    )Repurchases of common stock
    
    
    (19,852
    )
    
    
    Proceeds from issuance of common stock
    
    
    9,610
    
    
    
    1,495Payment of common stock dividends
    
    
    (3,113
    )
    
    
    Repayment of bank overdrafts
    
    
    (3,569
    )
    
    
    (3,034
    )Distributions to minority interests
    
    
    (271
    )
    
    
    (127
    )Net cash used in financing activities
    
    
    (20,042
    )
    
    
    (33,947
    )Effect of exchange rate changes on cash
and cash equivalents
    
    
    (33
    )
    
    
    117Net increase (decrease) in cash and cash equivalents
    
    
    45,277
    
    
    
    (17,534
    )Cash and cash equivalents at beginning of period
    
    
    165,507
    
    
    
    56,062Cash and cash equivalents at end of period
    
    $
    210,784
    
    
    $
    38,528Supplemental Cash Flow InformationCash paid for interest
    
    $
    7,369
    
    
    $
    1,872Cash paid for income taxes
    
    $
    2,104
    
    
    $
    16,321
 See accompanying notes. - 6 -




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##### 



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. Basis of Presentation The unaudited condensed consolidated financial statements of Select
Medical Corporation (the Company) as of March 31, 2004 and for the three
month periods ended March 31, 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 months ended March 31, 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 may differ from those estimates. 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 months
ended March 31, 2004. Stock Option Plans During the three months ended March 31, 2004, the Company granted stock
options under its Second Amended and Restated 1997 Stock Option Plan totaling
1,861,500 shares of Common Stock at the exercise
price of $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. - 7 -




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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 March 31,2004
    
    2003(dollars in thousands)Net income - as reported
    
    $
    29,570
    
    
    $
    14,454Deduct: Total stock based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects
    
    
    6,529
    
    
    
    1,080Net income - pro forma
    
    $
    23,041
    
    
    $
    13,374Weighted average grant-date fair value
    
    
    6.41
    
    
    
    3.30Basic earnings per share - as reported
    
    
    0.29
    
    
    
    0.15Basic earnings per share - pro forma
    
    
    0.22
    
    
    
    0.14Diluted earnings per share - as reported
    
    
    0.27
    
    
    
    0.15Diluted earnings per share - pro forma
    
    
    0.21
    
    
    
    0.14
 Accumulated Other Comprehensive Income The components of accumulated other comprehensive income at March 31, 2004
consist of cumulative translation adjustment gains of $3,663,000 associated
with the Companys Canadian operations and unrealized losses on
available-for-sale securities of $53,000, net of tax. 3. Intangible Assets Amortization expense for intangible assets with finite lives for the three
months ended March 31, 2004 was $857,000. 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. - 8 -




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Intangible assets consist of the following: As of March 31, 2004Gross Carrying
    
    AccumulatedAmount
    
    Amortization(dollars in thousands)Amortized intangible assetsNon-Compete agreements
    
    $
    24,000
    
    
    $
    (2,000
    )Unamortized intangible assetsGoodwill
    
    $
    308,310Trademarks
    
    
    58,875Total
    
    $
    367,185
 The changes in the carrying amount of goodwill for the Companys
reportable segments for the three months ended March 31, 2004 are as follows: Specialty
    
    OutpatientHospitals
    
    Rehabilitation
    
    All Other
    
    Total(dollars in thousands)Balance as of December 31, 2003
    
    $
    180,011
    
    
    $
    125,656
    
    
    $
    584
    
    
    $
    306,251Goodwill acquired during year
    
    
    
    
    
    
    378
    
    
    
    
    
    
    
    378Income tax benefits recognized
    
    
    
    
    
    
    (1,024
    )
    
    
    
    
    
    
    (1,024
    )Earn-out payments
    
    
    
    
    
    
    2,977
    
    
    
    
    
    
    
    2,977Translation adjustment
    
    
    
    
    
    
    (272
    )
    
    
    
    
    
    
    (272
    )Balance as of March 31, 2004
    
    $
    180,011
    
    
    $
    127,715
    
    
    $
    584
    
    
    $
    308,310
 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
    
    
    (287
    )
    
    
    (576
    )
    
    
    (863
    )March 31, 2004
    
    $
    5,518
    
    
    $
    3,994
    
    
    $
    9,512
 The Company expects to pay out the remaining lease termination costs through
2007 and severance through 2005. - 9 -




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##### 



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, loss on early retirement of debt or equity in earnings from
joint ventures that effect Adjusted EBITDA. The following table summarizes selected financial data for the Companys
reportable segments: Three Months Ended March 31, 2004Specialty
    
    OutpatientHospitals
    
    Rehabilitation
    
    All Other
    
    Total(dollars in thousands)Net revenue
    
    $
    272,903
    
    
    $
    145,664
    
    
    $
    3,426
    
    
    $
    421,993Adjusted EBITDA
    
    
    58,384
    
    
    
    22,908
    
    
    
    (11,343
    )
    
    
    69,949Total assets
    
    
    479,559
    
    
    
    390,823
    
    
    
    246,604
    
    
    
    1,116,986Capital expenditures
    
    
    3,878
    
    
    
    1,746
    
    
    
    2,138
    
    
    
    7,762
 Three Months Ended March 31, 2003Specialty
    
    OutpatientHospitals
    
    Rehabilitation
    
    All Other
    
    Total(dollars in thousands)Net revenue
    
    $
    183,428
    
    
    $
    125,575
    
    
    $
    3,304
    
    
    $
    312,307Adjusted EBITDA
    
    
    25,486
    
    
    
    19,503
    
    
    
    (6,637
    )
    
    
    38,352Total assets
    
    
    311,814
    
    
    
    329,603
    
    
    
    62,643
    
    
    
    704,060Capital expenditures
    
    
    2,887
    
    
    
    2,740
    
    
    
    1,346
    
    
    
    6,973
 A reconciliation of net income to Adjusted EBITDA is as follows: For the Three Months EndedMarch 31,2004
    
    2003(dollars in thousands)Net income
    
    $
    29,570
    
    
    $
    14,454Income tax expense
    
    
    19,891
    
    
    
    9,320Minority interest
    
    
    1,006
    
    
    
    824Interest expense, net
    
    
    9,053
    
    
    
    6,240Depreciation and amortization
    
    
    10,429
    
    
    
    7,514Adjusted EBITDA
    
    $
    69,949
    
    
    $
    38,352
 - 10 -




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##### 



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 March 31,2004
    
    2003(in thousands, except per sharedata)Numerator:Net income
    
    $
    29,570
    
    
    $
    14,454Denominator:Denominator for basic earnings per
share  - weighted average shares
    
    
    102,922
    
    
    
    94,299Effect of dilutive securities:a)  Stock options
    
    
    5,210
    
    
    
    2,776b)  Warrants
    
    
    
    
    
    
    1,326Denominator for diluted earnings per
share-adjusted weighted average shares
and assumed conversions
    
    
    108,132
    
    
    
    98,401Basic income per common share
    
    $
    0.29
    
    
    $
    0.15Diluted income per common share
    
    $
    0.27
    
    
    $
    0.15
 7. 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 three months ended March 31, 2004, the Company repurchased and retired a
total of 1,249,500 shares at a cost of $19.9 million. 8. Commitments and Contingencies 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
through December 2000. In January 2001, these policies were replaced by
policies issued with other insurers. Currently, the Company has approximately
seven 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 - 11 -




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##### 



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. 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
effect on the financial position or results of operations of the Company. 9. Financial Information for Subsidiary Guarantors and Non-Guarantor Subsidiaries The Company conducts a significant portion of its business through its
subsidiaries. Presented below is condensed consolidating financial information
for the Company, the Subsidiary Guarantors and the Non-Guarantor Subsidiaries
at March 31, 2004 and for the three months ended March 31, 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 March 31,
2004:  Canadian Back Institute Limited
Cupertino Medical Center, P.C.
Kentucky Orthopedic Rehabilitation, LLC.
Medical Information Management Systems, LLC.
Metro Therapy, Inc.
Philadelphia Occupational Health, P.C.
Select Specialty Hospital - Central Pennsylvania, L.P.
Select Specialty Hospital - Houston, L.P.
Select Specialty Hospital - Mississippi Gulf Coast, Inc.
TJ Corporation I, LLC.
U.S. Regional Occupational Health II, P.C. - 12 -




---



##### 



Select Medical CorporationCondensed Consolidating Balance SheetMarch 31, 2004Select MedicalCorporation (Parent
    
    Subsidiary
    
    Non-GuarantorCompany Only)
    
    Guarantors
    
    Subsidiaries
    
    Eliminations
    
    
    
    
    
    Consolidated(dollars in thousands)AssetsCurrent Assets:Cash and cash equivalents
    
    $
    156,668
    
    
    $
    49,605
    
    
    $
    4,511
    
    
    $
    
    
    
    
    
    
    
    $
    210,784Accounts receivable, net
    
    
    49
    
    
    
    211,336
    
    
    
    14,330
    
    
    
    
    
    
    
    
    
    
    
    225,715Current deferred tax asset
    
    
    12,070
    
    
    
    47,586
    
    
    
    2,055
    
    
    
    
    
    
    
    
    
    
    
    61,711Other current assets
    
    
    7,127
    
    
    
    16,158
    
    
    
    3,983
    
    
    
    
    
    
    
    
    
    
    
    27,268Total Current Assets
    
    
    175,914
    
    
    
    324,685
    
    
    
    24,879
    
    
    
    
    
    
    
    
    
    
    
    525,478Property and equipment, net
    
    
    9,574
    
    
    
    145,241
    
    
    
    17,958
    
    
    
    
    
    
    
    
    
    
    
    172,773Investment in affiliates
    
    
    393,742
    
    
    
    58,093
    
    
    
    
    
    
    
    (451,835
    )
    
    
    (a
    )
    
    
    Goodwill
    
    
    5,853
    
    
    
    254,403
    
    
    
    48,054
    
    
    
    
    
    
    
    
    
    
    
    308,310Trademark
    
    
    
    
    
    
    58,875
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    58,875Other intangibles
    
    
    
    
    
    
    22,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    22,000Non-current deferred tax asset
    
    
    2,869
    
    
    
    4,006
    
    
    
    (997
    )
    
    
    
    
    
    
    
    
    
    
    5,878Other assets
    
    
    12,524
    
    
    
    10,140
    
    
    
    1,008
    
    
    
    
    
    
    
    
    
    
    
    23,672Total Assets
    
    $
    600,476
    
    
    $
    877,443
    
    
    $
    90,902
    
    
    $
    (451,835
    )
    
    
    
    
    
    $
    1,116,986Liabilities and Stockholders EquityCurrent Liabilities:Bank overdrafts
    
    $
    7,858
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    7,858Current portion of long-term debt and notes payable
    
    
    460
    
    
    
    8,309
    
    
    
    510
    
    
    
    
    
    
    
    
    
    
    
    9,279Accounts payable
    
    
    988
    
    
    
    40,699
    
    
    
    6,774
    
    
    
    
    
    
    
    
    
    
    
    48,461Intercompany accounts
    
    
    24,168
    
    
    
    (15,420
    )
    
    
    (8,748
    )
    
    
    
    
    
    
    
    
    
    
    Accrued payroll
    
    
    758
    
    
    
    48,579
    
    
    
    120
    
    
    
    
    
    
    
    
    
    
    
    49,457Accrued vacation
    
    
    2,441
    
    
    
    18,176
    
    
    
    1,600
    
    
    
    
    
    
    
    
    
    
    
    22,217Accrued restructuring
    
    
    
    
    
    
    9,512
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,512Accrued other
    
    
    23,029
    
    
    
    54,083
    
    
    
    2,206
    
    
    
    
    
    
    
    
    
    
    
    79,318Income taxes
    
    
    7,401
    
    
    
    8,371
    
    
    
    (6,346
    )
    
    
    
    
    
    
    
    
    
    
    9,426Due to third party payors
    
    
    5,840
    
    
    
    79,761
    
    
    
    (6,529
    )
    
    
    
    
    
    
    
    
    
    
    79,072Total Current Liabilities
    
    
    72,943
    
    
    
    252,070
    
    
    
    (10,413
    )
    
    
    
    
    
    
    
    
    
    
    314,600Long-term debt, net of current portion
    
    
    86,773
    
    
    
    233,425
    
    
    
    35,267
    
    
    
    
    
    
    
    
    
    
    
    355,465Total liabilities
    
    
    159,716
    
    
    
    485,495
    
    
    
    24,854
    
    
    
    
    
    
    
    
    
    
    
    670,065Commitments and ContingenciesMinority interest in consolidated subsidiary companies
    
    
    
    
    
    
    
    
    
    
    6,161
    
    
    
    
    
    
    
    
    
    
    
    6,161Stockholders Equity:Common stock
    
    
    1,025
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,025Capital in excess of par
    
    
    288,108
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    288,108Retained earnings
    
    
    148,017
    
    
    
    139,785
    
    
    
    30,799
    
    
    
    (170,584
    )
    
    
    (b
    )
    
    
    148,017Subsidiary investment
    
    
    
    
    
    
    252,163
    
    
    
    29,088
    
    
    
    (281,251
    )
    
    
    (a
    )
    
    
    Accumulated
other comprehensive income
    
    
    3,610
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,610Total Stockholders Equity
    
    
    440,760
    
    
    
    391,948
    
    
    
    59,887
    
    
    
    (451,835
    )
    
    
    
    
    
    
    440,760Total
Liabilities and Stockholders Equity
    
    $
    600,476
    
    
    $
    877,443
    
    
    $
    90,902
    
    
    $
    (451,835
    )
    
    
    
    
    
    $
    1,116,986
  (a)
    
    Elimination of investments in subsidiaries.(b)
    
    Elimination of investments in subsidiaries earnings. - 13 -




---



##### 



Select Medical CorporationCondensed Consolidating Statement of OperationsFor the Three Months Ended March 31, 2004Select MedicalCorporation (Parent
    
    Subsidiary
    
    Non-GuarantorCompany Only)
    
    Guarantors
    
    Subsidiaries
    
    Eliminations
    
    
    
    
    
    Consolidated(dollars in thousands)Net operating revenues
    
    $
    22
    
    
    $
    365,416
    
    
    $
    56,555
    
    
    $
    
    
    
    
    
    
    
    $
    421,993Costs and expenses:Cost of services
    
    
    
    
    
    
    281,757
    
    
    
    46,933
    
    
    
    
    
    
    
    
    
    
    
    328,690General and administrative
    
    
    11,073
    
    
    
    540
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,613Bad debt expense
    
    
    
    
    
    
    11,300
    
    
    
    441
    
    
    
    
    
    
    
    
    
    
    
    11,741Depreciation and amortization
    
    
    467
    
    
    
    8,848
    
    
    
    1,114
    
    
    
    
    
    
    
    
    
    
    
    10,429Total costs and expenses
    
    
    11,540
    
    
    
    302,445
    
    
    
    48,488
    
    
    
    
    
    
    
    
    
    
    
    362,473Income (loss) from operations
    
    
    (11,518
    )
    
    
    62,971
    
    
    
    8,067
    
    
    
    
    
    
    
    
    
    
    
    59,520Other (income) and expense:Intercompany interest and royalty fees
    
    
    7,526
    
    
    
    (7,512
    )
    
    
    (14
    )
    
    
    
    
    
    
    
    
    
    
    Intercompany management fees
    
    
    (21,526
    )
    
    
    20,717
    
    
    
    809
    
    
    
    
    
    
    
    
    
    
    
    Interest income
    
    
    (269
    )
    
    
    (96
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (365
    )Interest expense
    
    
    3,307
    
    
    
    5,206
    
    
    
    905
    
    
    
    
    
    
    
    
    
    
    
    9,418Income (loss) before minority interests and income taxes
    
    
    (556
    )
    
    
    44,656
    
    
    
    6,367
    
    
    
    
    
    
    
    
    
    
    
    50,467Minority interest in consolidated subsidiary companies
    
    
    
    
    
    
    87
    
    
    
    919
    
    
    
    
    
    
    
    
    
    
    
    1,006Income (loss) before income taxes
    
    
    (556
    )
    
    
    44,569
    
    
    
    5,448
    
    
    
    
    
    
    
    
    
    
    
    49,461Income tax expense
    
    
    1,119
    
    
    
    17,539
    
    
    
    1,233
    
    
    
    
    
    
    
    
    
    
    
    19,891Equity in earnings of subsidiaries
    
    
    31,245
    
    
    
    2,433
    
    
    
    
    
    
    
    (33,678
    )
    
    
    (a
    )
    
    
    Net income
    
    $
    29,570
    
    
    $
    29,463
    
    
    $
    4,215
    
    
    $
    (33,678
    )
    
    
    
    
    
    $
    29,570
  (a)
    
    Elimination of equity in net income (loss) from consolidated subsidiaries. - 14 -




---



##### 



Select Medical CorporationCondensed Consolidating Statement of Cash FlowsFor the Three Months Ended March 31, 2004Select MedicalCorporation
    
    
    
    
    
    Non-(Parent Company
    
    Subsidiary
    
    GuarantorOnly)
    
    Guarantors
    
    Subsidiaries
    
    Eliminations
    
    
    
    
    
    Consolidated(dollars in thousands)Operating activitiesNet income
    
    $
    29,570
    
    
    $
    29,463
    
    
    $
    4,215
    
    
    $
    (33,678
    )
    
    
    (a
    )
    
    $
    29,570Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    467
    
    
    
    8,848
    
    
    
    1,114
    
    
    
    
    
    
    
    
    
    
    
    10,429Provision for bad debts
    
    
    
    
    
    
    11,300
    
    
    
    441
    
    
    
    
    
    
    
    
    
    
    
    11,741Minority interests
    
    
    
    
    
    
    87
    
    
    
    919
    
    
    
    
    
    
    
    
    
    
    
    1,006Changes in operating assets and liabilities, net of
effects from acquisition of businesses:Equity in earnings of subsidiaries
    
    
    (31,245
    )
    
    
    (2,433
    )
    
    
    
    
    
    
    33,678
    
    
    
    (a
    )
    
    
    Intercompany
    
    
    64,116
    
    
    
    (50,173
    )
    
    
    (13,943
    )
    
    
    
    
    
    
    
    
    
    
    Accounts receivable
    
    
    (17
    )
    
    
    (13,060
    )
    
    
    11,930
    
    
    
    
    
    
    
    
    
    
    
    (1,147
    )Other current assets
    
    
    (2,954
    )
    
    
    (2,058
    )
    
    
    5,227
    
    
    
    
    
    
    
    
    
    
    
    215Other assets
    
    
    1,201
    
    
    
    118
    
    
    
    (64
    )
    
    
    
    
    
    
    
    
    
    
    1,255Accounts payable
    
    
    (7,471
    )
    
    
    (3,420
    )
    
    
    (151
    )
    
    
    
    
    
    
    
    
    
    
    (11,042
    )Due to third-party payors
    
    
    4,183
    
    
    
    19,516
    
    
    
    (4,176
    )
    
    
    
    
    
    
    
    
    
    
    19,523Accrued expenses
    
    
    (4,467
    )
    
    
    1,651
    
    
    
    (940
    )
    
    
    
    
    
    
    
    
    
    
    (3,756
    )Income taxes
    
    
    18,117
    
    
    
    
    
    
    
    618
    
    
    
    
    
    
    
    
    
    
    
    18,735Net cash
provided by (used in) operating activities
    
    
    71,500
    
    
    
    (161
    )
    
    
    5,190
    
    
    
    
    
    
    
    
    
    
    
    76,529Investing activitiesPurchases of property and equipment, net
    
    
    (2,075
    )
    
    
    (4,861
    )
    
    
    (826
    )
    
    
    
    
    
    
    
    
    
    
    (7,762
    )Earnout payments
    
    
    
    
    
    
    (2,977
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,977
    )Acquisition of businesses, net of cash acquired
    
    
    
    
    
    
    
    
    
    
    (438
    )
    
    
    
    
    
    
    
    
    
    
    (438
    )Net cash used in investing activities
    
    
    (2,075
    )
    
    
    (7,838
    )
    
    
    (1,264
    )
    
    
    
    
    
    
    
    
    
    
    (11,177
    )Financing activitiesIntercompany debt reallocation
    
    
    2,211
    
    
    
    (1,759
    )
    
    
    (452
    )
    
    
    
    
    
    
    
    
    
    
    Net repayments on credit facility debt
    
    
    
    
    
    
    
    
    
    
    (1,212
    )
    
    
    
    
    
    
    
    
    
    
    (1,212
    )Principal payments on seller and other debt
    
    
    
    
    
    
    (1,515
    )
    
    
    (120
    )
    
    
    
    
    
    
    
    
    
    
    (1,635
    )Repurchases of common stock
    
    
    (19,852
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (19,852
    )Proceeds from issuance of common stock
    
    
    9,610
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,610Payment of common stock dividends
    
    
    (3,113
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,113
    )Repayment of bank overdrafts
    
    
    (3,569
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,569
    )Distributions to minority interests
    
    
    
    
    
    
    
    
    
    
    (271
    )
    
    
    
    
    
    
    
    
    
    
    (271
    )Net cash used in financing activities
    
    
    (14,713
    )
    
    
    (3,274
    )
    
    
    (2,055
    )
    
    
    
    
    
    
    
    
    
    
    (20,042
    )Effect of exchange rate changes on cash
and cash equivalents
    
    
    (33
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (33
    )Net increase (decrease) in cash and cash equivalents
    
    
    54,679
    
    
    
    (11,273
    )
    
    
    1,871
    
    
    
    
    
    
    
    
    
    
    
    45,277Cash and cash equivalents at beginning of period
    
    
    101,989
    
    
    
    60,878
    
    
    
    2,640
    
    
    
    
    
    
    
    
    
    
    
    165,507Cash and cash equivalents at end of period
    
    $
    156,668
    
    
    $
    49,605
    
    
    $
    4,511
    
    
    $
    
    
    
    
    
    
    
    $
    210,784
  (a)
    
    Elimination of equity in earnings of subsidiary. - 15 -




---



##### 



Select Medical CorporationCondensed Consolidating Statement of OperationsFor the Three Months Ended March 31, 2003Select MedicalCorporation
    
    
    
    
    
    Non-(Parent Company
    
    Subsidiary
    
    GuarantorOnly)
    
    Guarantors
    
    Subsidiaries
    
    Eliminations
    
    
    
    
    
    Consolidated(dollars in thousands)Net operating revenues
    
    $
    2,795
    
    
    $
    260,872
    
    
    $
    48,640
    
    
    $
    
    
    
    
    
    
    
    $
    312,307Costs and expenses:Cost of services
    
    
    
    
    
    
    212,712
    
    
    
    39,557
    
    
    
    
    
    
    
    
    
    
    
    252,269General and administrative
    
    
    9,503
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,503Bad debt expense
    
    
    
    
    
    
    10,699
    
    
    
    1,484
    
    
    
    
    
    
    
    
    
    
    
    12,183Depreciation and amortization
    
    
    898
    
    
    
    5,662
    
    
    
    954
    
    
    
    
    
    
    
    
    
    
    
    7,514Total costs and expenses
    
    
    10,401
    
    
    
    229,073
    
    
    
    41,995
    
    
    
    
    
    
    
    
    
    
    
    281,469Income (loss) from operations
    
    
    (7,606
    )
    
    
    31,799
    
    
    
    6,645
    
    
    
    
    
    
    
    
    
    
    
    30,838Other (income) and expense:Intercompany interest and royalty fees
    
    
    5,854
    
    
    
    (5,859
    )
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    Intercompany management fees
    
    
    (15,162
    )
    
    
    14,697
    
    
    
    465
    
    
    
    
    
    
    
    
    
    
    
    Interest income
    
    
    (113
    )
    
    
    (73
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (186
    )Interest expense
    
    
    2,115
    
    
    
    3,015
    
    
    
    1,296
    
    
    
    
    
    
    
    
    
    
    
    6,426Income (loss) before minority interests and income taxes
    
    
    (300
    )
    
    
    20,019
    
    
    
    4,879
    
    
    
    
    
    
    
    
    
    
    
    24,598Minority interest in consolidated subsidiary companies
    
    
    
    
    
    
    117
    
    
    
    707
    
    
    
    
    
    
    
    
    
    
    
    824Income (loss) before income taxes
    
    
    (300
    )
    
    
    19,902
    
    
    
    4,172
    
    
    
    
    
    
    
    
    
    
    
    23,774Income tax expense (benefit)
    
    
    (84
    )
    
    
    7,865
    
    
    
    1,539
    
    
    
    
    
    
    
    
    
    
    
    9,320Equity in earnings of subsidiaries
    
    
    14,670
    
    
    
    1,228
    
    
    
    
    
    
    
    (15,898
    )
    
    
    (a
    )
    
    
    Net income
    
    $
    14,454
    
    
    $
    13,265
    
    
    $
    2,633
    
    
    $
    (15,898
    )
    
    
    
    
    
    $
    14,454
  (a)
    
    Elimination of equity in net income (loss) from consolidated subsidiaries. - 16 -




---



##### 



Select Medical CorporationCondensed Consolidating Statement of Cash FlowsFor the Year Ended March 31, 2003Select MedicalCorporation
    
    
    
    
    
    Non-(Parent Company
    
    Subsidiary
    
    GuarantorOnly)
    
    Guarantors
    
    Subsidiaries
    
    Eliminations
    
    
    
    
    
    Consolidated(dollars in thousands)Operating activitiesNet income
    
    $
    14,454
    
    
    $
    13,265
    
    
    $
    2,633
    
    
    $
    (15,898
    )
    
    
    (a
    )
    
    $
    14,454Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    898
    
    
    
    5,662
    
    
    
    954
    
    
    
    
    
    
    
    
    
    
    
    7,514Provision for bad debts
    
    
    
    
    
    
    10,699
    
    
    
    1,484
    
    
    
    
    
    
    
    
    
    
    
    12,183Minority interests
    
    
    
    
    
    
    117
    
    
    
    707
    
    
    
    
    
    
    
    
    
    
    
    824Changes in operating assets and liabilities, net of
effects from acquisition of businesses:Equity in earnings of subsidiaries
    
    
    (14,670
    )
    
    
    (1,228
    )
    
    
    
    
    
    
    15,898
    
    
    
    (a
    )
    
    
    Intercompany
    
    
    17,034
    
    
    
    (15,156
    )
    
    
    (1,878
    )
    
    
    
    
    
    
    
    
    
    
    Accounts receivable
    
    
    195
    
    
    
    5,320
    
    
    
    1,192
    
    
    
    
    
    
    
    
    
    
    
    6,707Other current assets
    
    
    320
    
    
    
    (263
    )
    
    
    (67
    )
    
    
    
    
    
    
    
    
    
    
    (10
    )Other assets
    
    
    85
    
    
    
    1,173
    
    
    
    315
    
    
    
    
    
    
    
    
    
    
    
    1,573Accounts payable
    
    
    (172
    )
    
    
    28
    
    
    
    (225
    )
    
    
    
    
    
    
    
    
    
    
    (369
    )Due to third-party payors
    
    
    3,156
    
    
    
    (15,933
    )
    
    
    (4,022
    )
    
    
    
    
    
    
    
    
    
    
    (16,799
    )Accrued expenses
    
    
    1,053
    
    
    
    2,897
    
    
    
    1,290
    
    
    
    
    
    
    
    
    
    
    
    5,240Income taxes
    
    
    (6,197
    )
    
    
    
    
    
    
    (690
    )
    
    
    
    
    
    
    
    
    
    
    (6,887
    )Net cash provided by operating activities
    
    
    16,156
    
    
    
    6,581
    
    
    
    1,693
    
    
    
    
    
    
    
    
    
    
    
    24,430Investing activitiesPurchases of property and equipment, net
    
    
    (1,339
    )
    
    
    (4,118
    )
    
    
    (1,516
    )
    
    
    
    
    
    
    
    
    
    
    (6,973
    )Earnout payments
    
    
    
    
    
    
    (429
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (429
    )Acquisition of businesses, net of cash acquired
    
    
    
    
    
    
    (732
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (732
    )Net cash used in investing activities
    
    
    (1,339
    )
    
    
    (5,279
    )
    
    
    (1,516
    )
    
    
    
    
    
    
    
    
    
    
    (8,134
    )Financing activitiesIntercompany debt reallocation
    
    
    6,140
    
    
    
    (6,355
    )
    
    
    215
    
    
    
    
    
    
    
    
    
    
    
    Net repayments on credit facility debt
    
    
    (29,743
    )
    
    
    
    
    
    
    (819
    )
    
    
    
    
    
    
    
    
    
    
    (30,562
    )Principal payments on seller and other debt
    
    
    
    
    
    
    (1,719
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,719
    )Proceeds from issuance of common stock
    
    
    1,495
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,495Repayment of bank overdrafts
    
    
    (3,034
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,034
    )Distributions to minority interests
    
    
    
    
    
    
    
    
    
    
    (127
    )
    
    
    
    
    
    
    
    
    
    
    (127
    )Net cash used in financing activities
    
    
    (25,142
    )
    
    
    (8,074
    )
    
    
    (731
    )
    
    
    
    
    
    
    
    
    
    
    (33,947
    )Effect of exchange rate changes on cash
and cash equivalents
    
    
    117
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    117Net decrease in cash and cash equivalents
    
    
    (10,208
    )
    
    
    (6,772
    )
    
    
    (554
    )
    
    
    
    
    
    
    
    
    
    
    (17,534
    )Cash and cash equivalents at beginning of period
    
    
    25,378
    
    
    
    28,022
    
    
    
    2,662
    
    
    
    
    
    
    
    
    
    
    
    56,062Cash and cash equivalents at end of period
    
    $
    15,170
    
    
    $
    21,250
    
    
    $
    2,108
    
    
    $
    
    
    
    
    
    
    
    $
    38,528
  (a)
    
    Elimination of equity in earnings of subsidiary. - 17 -




---



##### 



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;
    
    unexpected difficulties in integrating our and Kesslers
operations or realizing the anticipated benefits from our acquisition
of Kessler; and
    
    future acquisitions may use significant resources and
expose us to unforeseen risks. For a discussion of these and other factors affecting our business, see the
sections 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 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 for the
periods presented in this report result only from minority interests, which are
added back to EBITDA in the computation of Adjusted EBITDA. We did not
experience - 18 -




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##### 



any special charges, loss on early retirement of debt or equity in
earnings from joint ventures 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 March 31, 2004 we operated 79 long-term acute care
hospitals in 24 states, four acute medical rehabilitation hospitals in New
Jersey and 777 outpatient rehabilitation clinics in 27 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 three
months ended March 31, 2004, we had net operating revenues of $422.0 million.
Of this total, we earned approximately 65% of our net operating revenues from
our specialty hospitals and approximately 35% 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. For the three months ended March 31, 2004, our net operating revenues
increased 35.1%, income from operations increased 93.0%, net income increased
104.6% and diluted earnings per share increased 80.0% compared to the three
months ended March 31, 2003. Our specialty hospital segment was the primary
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 and the maturation of hospitals opened in 2001 and
2002. Additionally, the addition 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 our revenue per patient day increased at a greater rate than our costs
per patient day. Our outpatient segment experienced an increase in income from
operations that was comparable with the growth in net operating
revenue for the segment. This
growth resulted from the addition of the Kessler outpatient operations and
organic growth from our existing operations. We also experienced significant cash flow from operations resulting from
our growth in net income and a continued reduction in accounts receivable days
that allowed us to increase our revenue base without a corresponding increase
in working capital. Our ability to defer estimated tax payments until the
second quarter of 2004 and the timing of our payments from Medicare also
contributed to the strong operating cash flow for the quarter. During the quarter we also
commenced a stock repurchase program and retired a total of 1,249,500 shares
through March 31, 2004. Additional explanation and analysis of these topics
are found in the following discussion. 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 - 19 -




---



##### 



activities and closures/consolidations. The operating statistics reflect
data for the period of time these operations were managed by us. Three Months Ended March 31,2004
    
    2003Specialty Hospital Data# of Hospitals - Start of Period
    
    
    83
    
    
    
    72# of Hospital Start-ups
    
    
    
    
    
    
    # of Hospitals - End of Period
    
    
    83
    
    
    
    72# of Licensed Beds
    
    
    3,256
    
    
    
    2,616# of Admissions
    
    
    8,738
    
    
    
    5,958# of Patient Days
    
    
    212,727
    
    
    
    165,818Average Length of Stay
    
    
    25
    
    
    
    29Net Revenue Per Patient Day (a)
    
    $
    1,243
    
    
    $
    1,106Occupancy Rate
    
    
    72
    %
    
    
    71
    %% Patient Days - Medicare
    
    
    75
    %
    
    
    78
    %
 Three Months Ended March 31,2004
    
    2003# of Clinics Owned - Start of Period
    
    
    758
    
    
    
    679# of Clinics Acquired
    
    
    2
    
    
    
    33# of Clinic Start-ups
    
    
    4
    
    
    
    6# of Clinics Closed/Sold/Consolidated
    
    
    (23
    )
    
    
    (10
    )# of Clinics Owned - End of Period
    
    
    741
    
    
    
    708# of Clinics Managed - End of Period
    
    
    36
    
    
    
    31Total # of Clinics (All) - End of Period
    
    
    777
    
    
    
    739# of Visits (U.S.)
    
    
    1,004,106
    
    
    
    981,572Net Revenue Per Visit (U.S.) (b)
    
    $
    91
    
    
    $
    88
  (a)
    
    Net revenue per patient day is calculated by dividing specialty
hospital patient service revenues by the total number of patient
days. For purposes of this computation, hospital patient service
revenue excludes the net operating revenues and patient days of the
one skilled nursing facility operated as part of this segment.  (b)
    
    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. Our
goal is to open approximately eight to ten new long-term acute care
hospitals each year, utilizing primarily our hospital within a hospital
model. 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. - 20 -




---



##### 



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 48% and 45% of net operating revenues
for the three months ended March 31, 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 72% and 69% of our specialty hospital revenues for the three
months ended March 31, 2004 and 2003, respectively, were received in respect of
services provided to Medicare patients. For the quarter ended March 31, 2004,
all of our Medicare payments are being paid under a prospective payment system.
For the quarter ended March 31, 2003, approximately 53% 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 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, the Centers for Medicare & Medicaid Services (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 April 1, 2004, all 79 long-term acute care hospitals have
implemented LTCH-PPS. As of March 31, 2004 and December 31, 2003 we had a net amount due to
Medicare of $53.8 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 computer software, home medical equipment,
orthotics, prosthetics and infusion/intravenous services. 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 - 21 -




---



##### 



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 March 31, 2004 and December 31, 2003, we have
recorded a liability of $33.4 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. 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 $0.6 million and $0.4 million for the three months ended March 31,
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 $19.5 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 EndedMarch 31,2004
    
    2003Net operating revenues
    
    
    100.0
    %
    
    
    100.0
    %Cost of services (a)
    
    
    77.9
    %
    
    
    80.8
    %General and administrative
    
    
    2.7
    %
    
    
    3.0
    %Bad debt expense
    
    
    2.8
    %
    
    
    3.9
    %Depreciation and amortization
    
    
    2.5
    %
    
    
    2.4
    %Income from operations
    
    
    14.1
    %
    
    
    9.9
    %Interest expense, net
    
    
    2.1
    %
    
    
    2.0
    %Income before minority interests, and
income taxes
    
    
    12.0
    %
    
    
    7.9
    %Minority interests
    
    
    0.3
    %
    
    
    0.3
    %Income before income taxes
    
    
    11.7
    %
    
    
    7.6
    %Income tax expense
    
    
    4.7
    %
    
    
    3.0
    %Net income
    
    
    7.0
    %
    
    
    4.6
    %
 - 22 -




---



##### 



The following table summarizes selected financial data by business segment, for
the periods indicated. Three Months Ended March 31,
    
    %2004
    
    2003
    
    Change(Dollars in thousands)Net operating revenues:Specialty hospitals
    
    $
    272,903
    
    
    $
    183,428
    
    
    
    48.8
    %Outpatient rehabilitation
    
    
    145,664
    
    
    
    125,575
    
    
    
    16.0Other
    
    
    3,426
    
    
    
    3,304
    
    
    
    3.7Total company
    
    $
    421,993
    

    
    $
    312,307
    
    
    
    35.1
    %Income (loss) from operations:Specialty hospitals
    
    $
    53,315
    
    
    $
    21,859
    
    
    
    143.9
    %Outpatient rehabilitation
    
    
    19,339
    
    
    
    16,588
    
    
    
    16.6Other
    
    
    (13,134
    )
    
    
    (7,609
    )
    
    
    (72.6
    )Total company
    
    $
    59,520
    
    
    $
    30,838
    
    
    
    93.0
    %Adjusted EBITDA: (b)Specialty hospitals
    
    $
    58,384
    
    
    $
    25,486
    
    
    
    129.1
    %Outpatient rehabilitation
    
    
    22,908
    
    
    
    19,503
    
    
    
    17.5Other
    
    
    (11,343
    )
    
    
    (6,637
    )
    
    
    (70.9
    )Adjusted EBITDA margins: (b)Specialty hospitals
    
    
    21.4
    %
    
    
    13.9
    %
    
    
    54.0
    %Outpatient rehabilitation
    
    
    15.7
    
    
    
    15.5
    
    
    
    1.3Other
    
    
    N/M
    
    
    
    N/M
    
    
    
    N/MTotal assets:Specialty hospitals
    
    $
    479,559
    
    
    $
    311,814Outpatient rehabilitation
    
    
    390,823
    
    
    
    329,603Other
    
    
    246,604
    
    
    
    62,643Total company
    
    $
    1,116,986
    
    
    $
    704,060Purchases of property and
equipment, net:Specialty hospitals
    
    $
    3,878
    
    
    $
    2,887Outpatient rehabilitation
    
    
    1,746
    
    
    
    2,740Other
    
    
    2,138
    
    
    
    1,346Total company
    
    $
    7,762
    
    
    $
    6,973
 - 23 -




---



##### 



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 March 31,2004
    
    2003(Dollars in thousands)Net income
    
    $
    29,570
    
    
    $
    14,454Income tax expense
    
    
    19,891
    
    
    
    9,320Interest expense, net
    
    
    9,053
    
    
    
    6,240Depreciation and amortization
    
    
    10,429
    
    
    
    7,514EBITDA (b)
    
    $
    68,943
    
    
    $
    37,528Net revenue
    
    $
    421,993
    
    
    $
    312,307EBITDA margin (b)
    
    
    16.3
    %
    
    
    12.0
    %
 The following table reconciles same hospitals information. Three Months EndedMarch 31,2004
    
    2003(Dollars in thousands)Net Operating RevenueSpecialty hospitals net operating revenue
    
    $
    272,903
    
    
    $
    183,428Less: Specialty hospitals opened or acquired after
1/1/03
    
    
    51,597
    
    
    
    Closed specialty hospital
    
    
    
    
    
    
    1,463Specialty hospitals same store net operating revenue
    
    $
    221,306
    
    
    $
    181,965Adjusted EBITDA (b)Specialty hospitals Adjusted EBITDA (b)
    
    $
    58,384
    
    
    $
    25,486Less: Specialty hospitals opened or acquired after
1/1/03
    
    
    12,605
    
    
    
    (315
    )Closed specialty hospital
    
    
    
    
    
    
    206Specialty hospitals same store Adjusted EBITDA (b)
    
    $
    45,779
    
    
    $
    25,595All specialty hospitals Adjusted EBITDA margin(b)
    
    
    21.4
    %
    
    
    13.9
    %Specialty hospitals same store Adjusted EBITDA margin (b)
    
    
    20.7
    %
    
    
    14.1
    %
 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 and minority interest. Minority interest is
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. - 24 -




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Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003 Net Operating Revenues Our net operating revenues increased by 35.1% to $422.0 million for the
three months ended March 31, 2004 compared to $312.3 million for the three
months ended March 31, 2003. The reasons for the increase in net operating
revenues are discussed below. Specialty Hospitals.Our specialty hospital net operating revenues
increased 48.8% to $272.9 million for the three months ended March 31, 2004
compared to $183.4 million for the three months ended March 31, 2003. Net
operating revenues for the 71 specialty hospitals opened before January 1, 2003
and operated throughout both periods increased 21.6% to $221.3 million for the
three months ended March 31, 2004 from $182.0 million for the three months
ended March 31, 2003. This increase resulted primarily from higher net revenue per
patient day, which is primarily attributable to the improved reimbursement we
are receiving from Medicare under the LTCH-PPS. The remaining increase of
$50.2 million resulted from the acquisition of the Kessler facilities, which
contributed $37.8 million of net revenue, and the internal development of new
specialty hospitals that commenced operations in 2003. Outpatient Rehabilitation.Our outpatient rehabilitation net operating
revenues increased 16.0% to $145.7 million for the three months ended March 31,
2004 compared to $125.6 million for the three months ended March 31, 2003. The
increase in net operating revenues was principally related to the acquisition
of the Kessler operations, which contributed $15.6 million of net operating
revenue. Net revenue per visit in our U.S. based outpatient rehabilitation
clinics increased to $91 for the three months ended March 31, 2004 compared to
$88 for the three months ended March 31, 2003. The number of patient visits in
these clinics increased 2.3% for the three months ended March 31, 2004 to
1,004,106 visits compared to 981,572 visits for the three months ended March
31, 2003. Excluding the effects of the Kessler operations, the number of U.S.
based visits would have been 904,754. This reflects an 8% decline in
visits for the three months ended March 31, 2004 compared to the three months
ended March 31, 2003 which principally relates to the closure of
outpatient clinics over the last twelve months. Other.Our other revenues increased to $3.4 million for the three months
ended March 31, 2004 compared to $3.3 million for the three months ended March
31, 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 $2.9 million of net operating revenues
during the three months ended March 31, 2004. We experienced a decline of
$2.8 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. See Critical Accounting Matters-Sources of Revenue for a further
discussion of this change. Operating Expenses Our operating expenses increased by 28.5% to $352.0 million for the three
months ended March 31, 2004 compared to $274.0 million for the three months
ended March 31, 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, the
internal development of new specialty hospitals that commenced operations in
2003 and costs associated with increased patient volumes. As a percentage of
our net operating revenues, our operating expenses were 83.4% for the three
months ended March 31, 2004 compared to 87.7% for the three months ended March
31, 2003. Cost of services as a percentage of operating revenues decreased to
77.9% for the three months ended March 31, 2004 from 80.8% for the three months
ended March 31, 2003. These costs primarily reflect our labor expenses. This
decrease resulted because - 25 -




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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 the
three months ended March 31, 2004 compared to $22.2 million for the three
months ended March 31, 2003. This increase is principally related to our new
hospitals that opened during 2003 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 March 31, 2004 from 3.0% for the three months ended March 31, 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 2.8% for the three months ended March
31, 2004 compared to 3.9% for the three months ended March 31, 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 83.7% to $68.9 million for the three months
ended March 31, 2004 compared to $37.5 million for the three months ended March
31, 2003. Our EBITDA margins increased to 16.3% for the three months ended
March 31, 2004 compared to 12.0% for the three months ended March 31, 2003.
For cash flow information, see -Capital Resources and Liquidity. Specialty Hospitals.Adjusted EBITDA increased by 129.1% to $58.4
million for the three months ended March 31, 2004 compared to $25.5 million for
the three months ended March 31, 2003. Our Adjusted EBITDA margins increased
to 21.4% for the three months ended March 31, 2004 from 13.9% for the three
months ended March 31, 2003. The hospitals opened before January 1, 2003 and
operated throughout both periods had Adjusted EBITDA of $45.8 million, an
increase of 78.9% 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 hospitals
increased to 20.7% for the three months ended March 31, 2004 from 14.1% for the
three months ended March 31, 2003. Outpatient Rehabilitation.Adjusted EBITDA increased by 17.5% to $22.9
million for the three months ended March 31, 2004 compared to $19.5 million for
the three months ended March 31, 2003. Our Adjusted EBITDA margins increased to
15.7% for the three months ended March 31, 2004 from 15.5% for the three months
ended March 31, 2003. This Adjusted EBITDA margin increase was the result of a
decline in bad debt expense offset by an increase in labor costs. We have
experienced an increase in labor costs due to increased competition for hiring
therapists. Other.The Adjusted EBITDA loss was $11.3 million for the three months
ended March 31, 2004 compared to a loss of $6.6 million for the three months
ended March 31, 2003. This decrease in the Adjusted EBITDA was primarily the
result of the decline in Medicare reimbursements for corporate support costs of
$2.8 million resulting from the implementation of LTCH-PPS and an increase in
general and administrative costs of $2.1 million. Income from Operations Income from operations increased 93.0% to $59.5 million for the three
months ended March 31, 2004 compared to $30.8 million for the three months
ended March 31, 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 $2.9 million. The increase in
depreciation and amortization expense resulted primarily from the additional
depreciation associated with acquired Kessler assets, the amortization of the
value - 26 -




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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 $3.0 million to $9.4 million for the three
months ended March 31, 2004 from $6.4 million for the three months ended March
31, 2003. The increase in interest expense is the result of higher debt levels
outstanding in 2004 compared to 2003 related to the issuance of $175.0 million
of 71⁄2% 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 was $1.0 million for the three
months ended March 31, 2004 compared to $0.8 million for the three months ended
March 31, 2003. This increase is the result of improved profitability of these
jointly owned entities. Income Taxes We recorded income tax expense of $19.9 million for the three months ended
March 31, 2004. The expense represented an effective tax rate of 40.2%. We
recorded income tax expense of $9.3 million for the three months ended March
31, 2003. This expense represented an effective tax rate of 39.2%. The
effective tax rates in both 2004 and 2003 approximate the federal and state
statutory tax rates. The increase in the tax rate is the result of a larger
portion of our net income being earned in states with higher tax rates. Capital Resources and Liquidity For the three months ended March 31, 2004, operating activities provided
$76.5 million of cash flow compared to $24.4 million for the three months ended
March 31, 2003. Our cash flow from operations benefited from strong collections
of our accounts receivable, the timing of our payments from Medicare and our
deferral of estimated tax payments. We anticipate that the positive cash
effects we experienced during this quarter related to deferred tax payments and
Medicare payments that will reverse during the next quarter. Our accounts
receivable days outstanding were 49 days at March 31, 2004 compared to 52 days
at December 31, 2003 and 64 days at March 31, 2003. Investing activities used $11.2 and $8.1 million of cash flow for the
three months ended March 31, 2004 and 2003, respectively. This usage resulted
from purchases of property and equipment of $7.8 and $7.0 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 $0.4 million in acquisition costs. This compares to $0.4 million
in earn out payments and $0.7 of acquisition costs in the three months ended
March 31, 2003. Financing activities utilized $20.0 million of cash for the three months
ended March 31, 2004. This principally relates to the repurchase of our common
stock during the quarter in accordance with the stock repurchase program we
announced on February 23, 2004. During the quarter, we repurchased and retired
a total of 1,249,500 shares at a cost of $19.9 million. The repurchase program
provides for the repurchase of up to $80 million of our common stock through
August 31, 2005. During the three months ended March 31, 2003, financing
activities utilized $33.9 million of cash. This principally related to the
repayment of our credit facility debt. - 27 -




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Capital Resources Net working capital increased to $210.9 million at March 31, 2004 compared
to $188.4 million at December 31, 2003. The increase in working capital is
principally related to the increase in cash and cash equivalents that we are
now holding, offset by the accelerated payments we received from Medicare which
are classified as a current liability. At March 31, 2004, our credit facility consisted of a Canadian term
facility of approximately $7.3 million (USD), and a revolving credit facility
of approximately $152.4 million. The Canadian term facility was repaid on
April 2, 2004. As of March 31, 2004 we had the ability to borrow an additional
$140.6 million under our revolving facility subject to certain limitations. We
have $11.8 million outstanding under letters of credit issued through the
credit facility. The revolving facility terminates in September 2005. Borrowings under the credit facility bear interest at a fluctuating rate
of interest based upon financial covenant ratio tests. As of March 31, 2004,
our weighted average interest rate under our credit agreement was approximately
5.5% compared to 5.6% at December 31, 2003. See Item 3, Quantitative and
Qualitative Disclosures on Market Risk for a discussion of our floating
interest rates on borrowings under our credit facility. On February 11, 2004, our Board of Directors declared a cash dividend of
$0.03 per share. The dividend was paid on March 18, 2004 to stockholders of
record as of the close of business on February 27, 2004. 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 is to open eight to ten long-term acute care hospitals before the end of 2004. A new
long-term acute care hospital 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. From time to
time, we may complete acquisitions of specialty hospitals and outpatient
rehabilitation businesses. We currently have approximately $140.6 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. 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. 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 - 28 -




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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 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 months ended March 31, 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. Because of our small
outstanding balance of credit facility debt, a change in interest rates by one
percentage point on variable rate debt would have an insignificant effect on
interest expense for the three months ended March 31, 2004. All of our term-loan borrowings under our credit agreement are denominated
in Canadian dollars. Although we are not required by our credit agreement to
maintain a hedge on our foreign currency risk, we have entered into a five year
agreement that allows us to limit the cost of Canadian dollars to a range of
U.S.$0.6631 to U.S.$0.6711 per Canadian dollar to limit our risk on the
potential fluctuation in the exchange rate of the Canadian dollar to the U.S.
dollar. On April 2, 2004 in conjunction with the repayment of
our Canadian term facility, we terminated the foreign currency hedge. 
 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 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. - 29 -




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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. 
 ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND PURCHASES OF EQUITY SECURITIES. 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)
    
    ProgramsJanuary 1 through January 31, 2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    February 1 through February 29,
2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    80,000,000March 1 through March 31, 2004
    
    
    1,249,500
    

    
    $
    15.86
    
    
    
    1,249,500
    
    
    $
    60,185,000Total
    
    
    1,249,500
    
    
    $
    15.86
    
    
    
    1,249,500
 (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. 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 
 ITEM 5. OTHER INFORMATION None. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits The exhibits to this report are listed in the Exhibit Index
appearing on page 32 hereof. - 30 -




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b. Reports on Form 8-K Form 8-K dated January 12, 2004, furnished pursuant to Item 9,
in connection with an investor presentation. Form 8-K dated January 13, 2004, furnished pursuant to Item 9,
in connection with our issuance of a press release on January 12,
2004 announcing a presentation at a healthcare conference. Form 8-K dated February 5, 2004, furnished pursuant to Item 12,
in connection with our issuance of a press release on February 4,
2004 reporting our results for the three months ended December 31,
2003. Form 8-K dated February 12, 2004, furnished pursuant to Item 12,
in connection with the script of the earnings call held
February 5, 2004. Form 8-K dated February 12, 2004, furnished pursuant to Item 9,
in connection with our issuance of a press release on February 11,
2004 announcing the declaration of a quarterly cash dividend, and our
issuance of a press release on February 11, 2004 announcing the
appointment of Thomas Scully to the Board of Directors. Form 8-K dated February 17, 2004, furnished pursuant to Item 9,
in connection with an investor presentation. Form 8-K dated February 24, 2004, furnished pursuant to Item 9,
in connection with our issuance of a press release on February 23,
2004 announcing the authorization of a stock repurchase program. 
 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: May 10, 2004 - 31 -




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EXHIBIT INDEX Exhibit
    
    Description10.1
    
    Consulting Agreement dated as of January 1, 2004 by and between Select
Medical Corporation and Thomas Scully.10.2
    
    Seventh Amendment dated as of February 20, 2004 to the Credit Agreement
dated as of September 22, 2000 among Select Medical Corporation, Canadian
Back Institute Limited, JPMorgan Chase Bank, JPMorgan Chase Bank, Toronto
Branch, Banc of America Securities, LLC and CIBC, Inc.10.3
    
    Office Lease Agreement dated as of March 19, 2004 by and between Select
Medical Corporation and Old Gettysburg Associates II.10.4
    
    Office Lease Agreement dated as of March 19, 2004 by and between Select
Medical Corporation and Old Gettysburg Associates.31.1
    
    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.
 - 32 -