You should read this discussion together with the "Selected Financial Data"
and consolidated financial statements and accompanying notes included elsewhere
herein.
Overview
We believe that we are one of the largest operators of both specialty
hospitals and outpatient rehabilitation clinics in the United States based on
number of facilities. As of December 31, 2012, we operated 110 long term acute
care hospitals and 12 acute medical rehabilitation hospitals in 28 states, and
979 outpatient rehabilitation clinics in 32 states and the District of Columbia.
We also provide medical rehabilitation services on a contracted basis to nursing
homes, hospitals, assisted living and senior care centers, schools and work
sites. We began operations in 1997 under the leadership of our current
management team. As of December 31, 2012 we had operations in 44 states and the
District of Columbia.
We manage our Company through two business segments, our specialty hospital
segment and our outpatient rehabilitation segment. We had net operating revenues
of $2,949.0 million for the year ended December 31, 2012. Of this total, we
earned approximately 75% of our net operating revenues from our specialty
hospitals and approximately 25% 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 are typically admitted
to our specialty hospitals from general acute care hospitals. These patients
have specialized needs, and serious and often complex medical conditions such as
respiratory failure, neuromuscular disorders, traumatic brain and spinal cord
injuries, strokes, non-healing wounds, cardiac disorders, renal disorders and
cancer. Our outpatient rehabilitation segment 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.
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Significant 2012 Events
Refinancing
On August 13, 2012, Select entered into an additional credit extension
amendment to its senior secured credit facility. Pursuant to the terms and
conditions of the additional credit extension amendment, the lenders extended an
aggregate principal amount of $275.0 million in additional term loans to Select
at the same interest rate and with the same term as applies to the existing term
loan amounts borrowed by Select under its senior secured credit facility. On
September 12, 2012, Select used the proceeds of the additional term loans (other
than amounts used for fees and expenses) and cash on hand to redeem an aggregate
of $275.0 million principal amount of Select's outstanding 75/8% senior
subordinated notes due 2015 at a redemption price of 101.271% of the principal
amount. Select recognized a loss on early retirement of debt of $6.1 million for
the year ended December 31, 2012 in connection with the redemption of the senior
subordinated notes, which included the write-off of unamortized deferred
financing costs and call premiums.
Stock Repurchase Program
The Company's board of directors has authorized a common stock repurchase
program of up to $250.0 million through March 31, 2013, unless extended by the
board of directors. On February 20, 2013, the Company's board of directors
increased the authorization to up to $350.0 million and extended the program
through March 31, 2014. Stock repurchases under this program may be made in the
open market or through privately negotiated transactions, and at times and in
such amounts as the Company deems appropriate. The timing of purchases of stock
will be based upon market conditions and other factors. The Company is funding
this program with cash on hand or borrowings under its revolving credit
facility. The Company repurchased 5,725,782 shares at a cost of $46.8 million,
which includes transaction costs, during the year ended December 31, 2012. Since
the inception of the program through December 31, 2012, the Company has
repurchased 22,490,389 shares at a cost of $163.6 million, or $7.28 per share,
which includes transaction costs.
Special Cash Dividend
On October 30, 2012, our board of directors declared a special cash dividend
of $1.50 per share, or $210.9 million, paid on December 12, 2012 to all common
stockholders of record (including holders of shares of restricted stock) on
December 5, 2012. Cash for the dividend came from cash on hand and borrowings
under Select's senior secured revolving credit facility.
Summary Financial Results
Year Ended December 31, 2012
For the year ended December 31, 2012, our net operating revenues increased
5.2% to $2,949.0 million compared to $2,804.5 million for the year ended
December 31, 2011. For the year ended December 31, 2012, our specialty hospital
revenues increased $102.0 million or 4.9% from the prior year and our outpatient
rehabilitation revenues increased $42.5 million or 6.0% from the prior year. We
had income from operations for the year ended December 31, 2012 of
$336.9 million compared to $310.7 million for the year ended December 31, 2011.
We had net income attributable to Holdings for the year ended December 31, 2012
of $148.2 million compared to $107.8 million for the year ended December 31,
2011. Our Adjusted EBITDA for the year ended December 31, 2012 was
$405.8 million compared to $386.0 million for the year ended December 31, 2011.
See the section entitled "Results of Operations" for a reconciliation of net
income to Adjusted EBITDA. The increases in our income from operations and
Adjusted EBITDA for the year ended December 31, 2012 are principally due to
increases in the operating performance of our specialty hospital segment. We
were able to increase our specialty hospital income from operations
$22.8 million or 7.3% and our specialty hospital Adjusted EBITDA $19.0 million
or 5.2% for the year ended December 31, 2012 as compared to the year ended
December 31, 2011.
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Net income attributable to Holdings increased $40.4 million to
$148.2 million for the year ended December 31, 2012 compared to $107.8 million
for the year ended December 31, 2011. The increase resulted primarily from an
increase in our income from operations described above, increases in our equity
in earnings of unconsolidated subsidiaries principally related to our joint
venture with the Baylor Health Care System, or the "Baylor JV," and a reduction
of interest expense. We also incurred a smaller loss on early retirement of debt
related to the refinancing transactions completed in 2012 compared to the
refinancing transactions completed in 2011.
Cash flow from operations provided $298.7 million of cash for the year ended
December 31, 2012 for Holdings and $309.4 million of cash for the year ended
December 31, 2012 for Select. The difference between Holdings and Select in cash
flow from operations primarily relates to interest payments on Holdings' senior
floating rate notes.
Year Ended December 31, 2011
For the year ended December 31, 2011, our net operating revenues increased
17.3% to $2,804.5 million compared to $2,390.3 million for the year ended
December 31, 2010. This increase in net operating revenues resulted principally
from a 23.1% increase in our specialty hospital net operating revenue. The
increase in our specialty hospital revenue is primarily due to the Regency
hospitals we acquired on September 1, 2010. We had income from operations for
the year ended December 31, 2011 of $310.7 million compared to $236.1 million
for the year ended December 31, 2010. We had net income attributable to Holdings
for the year ended December 31, 2011 of $107.8 million compared to $77.6 million
for the year ended December 31, 2010. Our Adjusted EBITDA for the year ended
December 31, 2011 was $386.0 million compared to $307.1 million for the year
ended December 31, 2010. See the section entitled "Results of Operations" for a
reconciliation of net income to Adjusted EBITDA.
The increase in income from operations, net income and Adjusted EBITDA for
the year ended December 31, 2011 from the prior year resulted from the addition
of the Regency hospitals acquired on September 1, 2010 and improved operating
performance at our other specialty hospitals. Holdings' interest expense for the
year ended December 31, 2011 was $99.2 million compared to $112.3 million for
the year ended December 31, 2010. Select's interest expense for the year ended
December 31, 2011 was $81.2 million compared to $84.5 million for the year ended
December 31, 2010. The decrease in interest expense for both Holdings and Select
is attributable to a reduction in our average interest rate that resulted from
the expiration of interest rate swaps during 2010 that carried higher fixed
interest rates, and lower interest rates on portions of the debt we refinanced
on June 1, 2011.
Cash flow from operations provided $217.1 million of cash for the year ended
December 31, 2011 for Holdings and $240.1 million of cash for the year ended
December 31, 2011 for Select. The difference between Holdings and Select in cash
flow from operations primarily relates to interest payments on Holdings' 10%
senior subordinated notes and senior floating rate notes.
Regulatory Changes
The Medicare program reimburses us for services furnished to Medicare
beneficiaries, which are generally persons age 65 and older, those who are
chronically disabled, and those suffering from end stage renal disease. Net
operating revenues generated directly from the Medicare program represented
approximately 47%, 48% and 47% of our consolidated net operating revenues for
the years ended December 31, 2010, 2011 and 2012, respectively.
The Medicare program reimburses our long term acute care hospitals,
inpatient rehabilitation facilities and outpatient rehabilitation providers,
using different payment methodologies. Those payment methodologies are complex
and are described elsewhere in this report under "Business-Government
Regulations." The following is a summary of some of the more significant
healthcare regulatory changes that have affected our financial performance in
the periods covered by this report or are likely to affect our financial
performance and financial condition in the future.
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Medicare Reimbursement of LTCH Services
In the last few years, there have been significant regulatory changes
affecting long term acute care hospitals that have affected our net operating
revenues and, in some cases, caused us to change our operating models and
strategies. We have been subject to regulatory changes that occur through the
rulemaking procedures of the Centers for Medicare & Medicaid Services, or "CMS."
Historically, rule updates occurred twice each year. All Medicare payments to
our long term acute care hospitals are made in accordance with a prospective
payment system specifically applicable to long term acute care hospitals,
referred to as "LTCH-PPS." Proposed rules specifically related to LTCHs are
generally published in May, finalized in August and effective on October 1st of
each year, coinciding with the start of the federal fiscal year.
The following is a summary of significant changes to the Medicare
prospective payment system for long term acute care hospitals which have
affected our results of operations, as well as the policies and payment rates
for fiscal year 2013 that affect our patient discharges and cost reporting
periods beginning on or after October 1, 2012.
Fiscal Year 2011. On August 16, 2010, CMS published the policies and
payment rates for LTCH-PPS for fiscal year 2011 (affecting discharges and cost
reporting periods beginning on or after October 1, 2010 through September 30,
2011). The standard federal rate for fiscal year 2011 was $39,600, which was a
decrease from the fiscal year 2010 standard federal rate of $39,897 in effect
from October 1, 2009 to March 31, 2010 and the fiscal year 2010 standard federal
rate of $39,795 that went into effect on April 1, 2010. This update to the
standard federal rate for fiscal year 2011 was based on a market basket increase
of 2.5% less a reduction of 2.5% to account for what CMS attributed as an
increase in case-mix in prior periods that resulted from changes in
documentation and coding practices less an additional market basket reduction of
0.5% as mandated by the PPACA. The final rule established a fixed-loss amount
for high cost outlier cases for fiscal year 2011 of $18,785, which was an
increase from the fiscal year 2010 fixed-loss amount of $18,425 in effect from
October 1, 2009 to March 31, 2010 and the $18,615 that went into effect on
April 1, 2010.
Fiscal Year 2012. On August 18, 2011, CMS published the policies and
payment rates for LTCH-PPS for fiscal year 2012 (affecting discharges and cost
reporting periods beginning on or after October 1, 2011 through September 30,
2012). The standard federal rate for fiscal year 2012 was $40,222, which was an
increase from the fiscal year 2011 standard federal rate of $39,600. The update
to the standard federal rate for fiscal year 2012 included a market basket
increase of 2.9%, less a productivity adjustment of 1.0%, and less an additional
market basket reduction of 0.1% as mandated by the PPACA. The final rule
established a fixed-loss amount for high cost outlier cases for fiscal year 2012
of $17,931, which was a decrease from the fixed loss amount in the 2011 fiscal
year of $18,785.
Fiscal Year 2013. On August 1, 2012, CMS published the final rule updating
the policies and payment rates for LTCH-PPS for fiscal year 2013 (affecting
discharges and cost reporting periods beginning on or after October 1, 2012
through September 30, 2013). Two different standard federal rates apply during
fiscal year 2013. The standard federal rate for discharges on or after
October 1, 2012 and before December 29, 2012 was set at $40,916 and the standard
federal rate for discharges on or after December 29, 2012 for the remainder of
fiscal year 2013 is $40,398 both of which are an increase from the fiscal year
2012 standard federal rate of $40,222. The update to the standard federal rate
for fiscal year 2013 through December 28, 2012 includes a market basket increase
of 2.6%, less a productivity adjustment of 0.7%, and less an additional
reduction of 0.1% mandated by the PPACA. The standard federal rate for the
period of December 29, 2012 through the remainder of fiscal 2013 is further
reduced by a portion of the one-time budget neutrality adjustment of 1.266%, as
discussed below. The final rule established a fixed-loss amount for high cost
outlier cases for fiscal year 2013 of $15,408, which is a decrease from the
fixed loss amount in the 2012 fiscal year of $17,931.
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In the preamble to the proposed update to the Medicare policies and payment
rates for fiscal year 2013, CMS indicated that "within the near future" it may
recommend revisions to the payment policies addressing patient-level and
facility-level criteria. CMS also indicated that these recommendations may
render unnecessary the existing payment reductions for Medicare patients
admitted from a general acute care hospital in excess of the applicable
admission thresholds. We cannot predict whether CMS will adopt additional
patient-level and facility-level criteria in the future or, if adopted, how such
criteria would affect the application of the 25 Percent Rule to our LTCHs.
Medicare Market Basket Adjustments
The PPACA instituted a market basket payment adjustment to LTCHs. In fiscal
year 2014, the market basket update will be reduced by 0.3%. Fiscal years 2015
and 2016 the market basket update will be reduced by 0.2%. Finally, in fiscal
years 2017-2019, the market basket update will be reduced by 0.75%. The PPACA
specifically allows these market basket reductions to result in less than a 0%
payment update and payment rates that are less than the prior year.
25 Percent Rule
The 25 Percent Rule is a downward payment adjustment that applies to
Medicare patients discharged from LTCHs who were admitted from a co-located
hospital or a non-co-located hospital and caused the LTCH to exceed the
applicable percentage thresholds for discharged Medicare patients. The SCHIP
Extension Act, as amended by the ARRA and the PPACA, has limited the application
of the 25 Percent Rule, as described elsewhere in this report under
"Business-Government Regulations." CMS adopted through regulations an additional
one-year extension of relief from the full application of Medicare admission
thresholds. As a result, full implementation of the Medicare admission
thresholds will not go into effect until cost reporting periods beginning on or
after October 1, 2013, except for certain LTCHs with cost reporting periods that
begin between July 1, 2012 and September 30, 2012. Specifically, those
freestanding facilities, grandfathered HIHs and grandfathered satellites with
cost reporting periods beginning on or after July 1, 2012 and before October 1,
2012 are subject to a modified 25 Percent Rule for discharges occurring in a
three month period between July 1, 2012 and September 30, 2012. After the
expiration of the extension, our LTCHs will be subject to a downward payment
adjustment for any Medicare patients who were admitted from a co-located or a
non-co-located hospital and that exceed the applicable percentage threshold of
all Medicare patients discharged from the LTCH during the cost reporting period.
One-Time Budget Neutrality Adjustment
The regulations governing LTCH-PPS authorizes CMS to make a one-time
adjustment to the standard federal rate to correct any "significant difference
between actual payments and estimated payments for the first year" of LTCH-PPS.
In the update to the Medicare policies and payment rates for fiscal year 2013,
CMS adopted a one-time budget neutrality adjustment that results in a permanent
negative adjustment of 3.75% to the LTCH base rate. CMS is implementing the
adjustment over a three-year period by applying a factor of 0.98734 to the
standard federal rate in fiscal years 2013, 2014 and 2015, except that the
adjustment would not apply to payments for discharges occurring on or after
October 1, 2012 through December 28, 2012.
Short Stay Outlier Policy
The SCHIP Extension Act prevented CMS from applying the so-called very short
stay outlier policy for discharges occurring after July 1, 2007. This policy
would result in a payment equivalent to the general acute care hospital rate for
cases with a length of stay that is less than the average length of stay plus
one standard deviation of a case with the same diagnosis related group under
IPPS, regardless of the clinical considerations for admission to the LTCH or the
average length of stay an LTCH must satisfy for Medicare certification. The
SCHIP Extension Act as amended by PPACA precluded CMS from implementing the
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very short stay outlier policy before December 29, 2012. The very short-stay
outlier policy is again applicable to discharges occurring on or after
December 29, 2012 and will continue to be applied unless Congress or CMS takes
further action.
Moratorium on New LTCHs and New LTCH Beds
The SCHIP Extension Act imposed a moratorium on the establishment and
classification of new LTCHs, LTCH satellite facilities and LTCH beds in existing
LTCHs or satellite facilities subject to certain exceptions. PPACA extended this
moratorium by two years. The moratorium expired on December 28, 2012. Unless
Congress or CMS take further action, new LTCHs, LTCH satellite facilities and
LTCH beds may be established and enrolled in the Medicare program.
Medicare Reimbursement of Inpatient Rehabilitation Facility Services
The following is a summary of significant changes to the Medicare
prospective payment system for inpatient rehabilitation facilities which have
affected our results of operations during the periods presented in this report,
as well as the policies and payment rates for fiscal year 2013 that affect our
patient discharges and cost reporting periods beginning on or after October 1,
2012.
Fiscal Year 2011. On July 22, 2010, CMS published an update to the payment
rates for IRF-PPS for fiscal year 2011 (affecting discharges and cost reporting
periods beginning on or after October 1, 2010 through September 30, 2011). The
standard payment conversion factor for discharges during fiscal year 2011 was
$13,860, which was an increase from the standard payment conversion factor from
fiscal year 2010 of $13,627. The update to the standard payment conversion
factor for fiscal year 2011 included the market basket reduction of 0.25%
required by PPACA. CMS also increased the outlier threshold amount for fiscal
year 2011 to $11,410 from $10,721.
Fiscal Year 2012. On August 5, 2011, CMS published the policies and payment
rates for IRF-PPS for fiscal year 2012 (affecting discharges and cost reporting
periods beginning on or after October 1, 2011 and through September 30, 2012).
The standard payment conversion factor for discharges during fiscal year 2012
was $14,076 which was an increase from the fiscal year 2011 standard payment
conversion factor of $13,860. The update to the standard payment conversion
factor for fiscal year 2012 included a market basket increase of 2.9%, less a
productivity adjustment of 1.0%, and less an additional market basket reduction
of 0.1% as mandated by the PPACA. CMS decreased the outlier threshold amount for
fiscal year 2012 to $10,660 from $11,410 established in the final rule for
fiscal year 2011. In a notice published September 26, 2011, CMS corrected its
calculation of the outlier threshold amount for fiscal year 2012 to $10,713.
Fiscal Year 2013. On July 30, 2012, CMS published the policies and payment
rates for IRF-PPS for fiscal year 2013 (affecting discharges and cost reporting
periods beginning on or after October 1, 2012 through September 30, 2013). The
standard payment conversion factor for discharges for fiscal year 2013 is
$14,343, which is an increase from the fiscal year 2012 standard payment
conversion factor of $14,076. The update to the standard payment conversion
factor for fiscal year 2013 includes a market basket increase of 2.7%, less a
productivity adjustment of 0.7%, less an additional market basket reduction of
0.1% as mandated by the PPACA. CMS decreased the outlier threshold amount for
fiscal year 2013 to $10,466 from $10,713 established in the final rule for
fiscal year 2012.
Medicare Market Basket Adjustments
The PPACA instituted a market basket payment adjustment for IRFs. For fiscal
year 2014, the reduction is 0.3%. For fiscal years 2015 and 2016, the reduction
is 0.2%. For fiscal years 2017 - 2019, the reduction is 0.75%.
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Medicare Reimbursement of Outpatient Rehabilitation Services
The Medicare program reimburses outpatient rehabilitation providers based on
the Medicare physician fee schedule. The Medicare physician fee schedule rates
are automatically updated annually based on a formula, called the sustainable
growth rate ("SGR") formula, contained in legislation. The SGR formula has
resulted in automatic reductions in rates in every year since 2002; however, for
each year through 2013 CMS or Congress has taken action to prevent the SGR
formula reductions. The American Taxpayer Relief Act of 2012 froze Medicare
physician fee schedule rates at 2012 levels through December 31, 2013, averting
a scheduled 26.5% cut as a result of the SGR formula that would have taken
effect on January 1, 2013. A reduction in the Medicare physician fee schedule
payment rates will occur on January 1, 2014, unless Congress again takes
legislative action to prevent the SGR formula reductions from going into effect.
For the year ended December 31, 2012, we received approximately 10% of our
outpatient rehabilitation net operating revenues from Medicare.
Therapy Caps
Beginning on January 1, 1999, the Balanced Budget Act of 1997 subjected
certain outpatient therapy providers reimbursed under the Medicare physician fee
schedule to annual limits for therapy expenses. Effective January 1, 2013, the
annual limit on outpatient therapy services is $1,900 for combined physical and
speech language pathology services and $1,900 for occupational therapy services.
The per beneficiary caps were $1,880 for calendar year 2012. The annual limits
for therapy expenses do not apply to services furnished and billed by outpatient
hospital departments. In addition, the American Taxpayer Relief Act of 2012
extends the annual limits on therapy expenses and manual medical review
thresholds to services furnished in hospital outpatient department settings
through December 31, 2013. The application of annual limits to hospital
outpatient department settings will sunset at the end of 2013 unless Congress
extends it into 2014. We operated 979 outpatient rehabilitation clinics at
December 31, 2012, of which 145 are provider-based outpatient rehabilitation
clinics operated as departments of the inpatient rehabilitation hospitals we
operated.
In the Deficit Reduction Act of 2005, Congress implemented an exceptions
process to the annual limit for therapy expenses. Under this process, a Medicare
enrollee (or person acting on behalf of the Medicare enrollee) is able to
request an exception from the therapy caps if the provision of therapy services
was deemed to be medically necessary. Therapy cap exceptions have been available
automatically for certain conditions and on a case-by-case basis upon submission
of documentation of medical necessity. The American Taxpayer Relief Act of 2012
extends the exceptions process for outpatient therapy caps through December 31,
2013. Unless Congress extends the exceptions process, the therapy caps will
apply to all outpatient therapy services beginning January 1, 2014, except those
services furnished and billed by outpatient hospital departments.
The Middle Class Tax Relief and Job Creation Act of 2012 made several
changes to the exceptions process to the annual limit for therapy expenses. For
any claim above the annual limit, the claim must contain a modifier indicating
that the services are medically necessary and justified by appropriate
documentation in the medical record. Effective October 1, 2012, all claims
exceeding $3,700 are subject to a manual medical review process. The $3,700
threshold is applied separately to the combined physical therapy/speech therapy
cap and the occupational therapy cap. The American Taxpayer Relief Act of 2012
extends through December 31, 2013 the requirement that Medicare perform manual
medical review of therapy services when an exception is requested for cases in
which the beneficiary has reached a specified dollar aggregate threshold.
Effective October 1, 2012, all therapy claims, whether above or below the annual
limit, must include the national provider identifier (NPI) of the physician
responsible for certifying and periodically reviewing the plan of care.
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Multiple Procedure Payment Reduction
CMS adopted a multiple procedure payment reduction for therapy services in
the final update to the Medicare physician fee schedule for calendar year 2011.
This multiple procedure payment reduction policy became effective January 1,
2011 and applies to all outpatient therapy services paid under Medicare Part B.
Furthermore, the multiple procedure payment reduction policy applies across all
therapy disciplines-occupational therapy, physical therapy and speech-language
pathology. Under the policy, the Medicare program pays 100% of the practice
expense component of the therapy procedure or unit of service with the highest
Relative Value Unit, and then reduces the payment for the practice expense
component for the second and subsequent therapy procedures or units of service
furnished during the same day for the same patient, regardless of whether those
therapy services are furnished in separate sessions. In 2011 and 2012 the
practice expense component for the second and subsequent therapy service
furnished during the same day for the same patient was reduced by 20% in office
and other non-institutional settings and by 25% in institutional settings. The
American Taxpayer Relief Act of 2012 increases the payment reduction to 50%
effective April 1, 2013. Our outpatient rehabilitation therapy services are
primarily offered in institutional settings and, as such, are subject to the
applicable 25% payment reduction in the practice expense component for the
second and subsequent therapy services furnished by us to the same patient on
the same day until April 1, 2013 when the payment reduction will increase to
50%.
Budget Control Act of 2011
The Budget Control Act of 2011, enacted on August 2, 2011, increased the
federal debt ceiling in connection with deficit reductions over the next ten
years. The Budget Control Act of 2011 requires automatic reductions in federal
spending by approximately $1.2 trillion split evenly between domestic and
defense spending. Payments to Medicare providers are subject to these automatic
spending reductions, subject to a 2% cap. The American Taxpayer Relief Act of
2012 temporarily delays the automatic, across-the-board "sequestration" cuts in
federal spending imposed by the Budget Control Act of 2011, which are expected
to reduce Medicare payments by more than $11 billion in fiscal year 2013 and
$123 billion over the period of fiscal years 2013 to 2021. Unless further
legislation is enacted, we believe this will generally result in a 2% reduction
to Medicare payments for services furnished on or after April 1, 2013, which
reduction will have an adverse financial impact on our net operating revenues
and profitability.
Development of New Specialty Hospitals and Clinics
In addition to the growth of our business through the acquisition and
integration of other businesses, we have also grown our business through
specialty hospital and outpatient rehabilitation facility development
opportunities. Since our inception in 1997 through December 31, 2012, we have
internally developed 64 specialty hospitals and 355 outpatient rehabilitation
clinics. The SCHIP Extension Act as extended by PPACA instituted a moratorium on
the development of new LTCHs through December 28, 2012. As a result, we stopped
all new LTCH development during this period. Now that the moratorium on new
LTCHs and satellites has expired, we will evaluate the addition of LTCH beds at
certain of our hospitals. We will also continue to evaluate opportunities to
develop new joint venture relationships with significant health systems and from
time to time we may also develop new inpatient rehabilitation hospitals. We also
intend to open new outpatient rehabilitation clinics in the local areas that we
currently serve where we can benefit from existing referral relationships and
brand awareness to produce incremental growth.
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Critical Accounting Matters
Merger Transactions
On February 24, 2005, EGL Acquisition Corp. was merged with and into Select,
with Select continuing as the surviving corporation and a wholly owned
subsidiary of Holdings. The merger was completed pursuant to an agreement and
plan of merger, dated as of October 17, 2004, among EGL Acquisition Corp.,
Holdings and Select. We refer to the merger and the related transactions
collectively as the "Merger."
As a result of the Merger transactions, the majority of Select's assets and
liabilities were adjusted to their fair value as of February 25, 2005. The
excess of the total purchase price over the fair value of Select's tangible and
identifiable intangible assets was allocated to goodwill. Additionally, a
portion of the equity related to our continuing stockholders was recorded at the
stockholder's predecessor basis and a corresponding portion of the fair value of
the acquired assets was reduced accordingly.
Sources of Revenue
Our net operating revenues are derived from a number of sources, including
commercial, managed care, private and governmental payors. Our net operating
revenues include amounts estimated by management to be reimbursable from each of
the applicable payors and the federal Medicare program. Amounts we receive for
treatment of patients are generally less than the standard billing rates. We
account for the differences between the estimated reimbursement rates and the
standard billing rates as contractual adjustments, which we deduct from gross
revenues to arrive at net operating revenues.
Net operating revenues generated directly from the Medicare program from all
segments represented approximately 47%, 48% and 47% of net operating revenues
for the years ended December 31, 2012, 2011 and 2010, respectively.
Approximately 60%, 61% and 61% of our specialty hospital revenues for the years
ended December 31, 2012, 2011 and 2010, respectively, were received for services
provided to Medicare patients.
Most of our specialty hospitals receive bi-weekly periodic interim payments
from Medicare instead of being paid on an individual claim basis. Under a
periodic interim payment methodology, Medicare estimates a hospital's claim
volume based on historical trends and makes bi-weekly interim payments to us
based on these estimates. Twice a year per hospital, Medicare reconciles the
differences between the actual claim data and the estimated payments. To the
extent our actual hospital's experience is different from the historical trends
used by Medicare to develop the estimate, the periodic interim payment will
result in our being either temporarily over-paid or under-paid for our Medicare
claims. At each balance sheet date, we record any aggregate under-payment as an
account receivable or any aggregate over-payment as a payable to third-party
payors on our balance sheet. The timing of when we receive our bi-weekly
periodic interim payments, in relation to our balance sheet date, can have an
impact on our accounts receivable balance and our days sales outstanding as of
the end of any reporting period.
Contractual Adjustments
Net operating revenues include amounts estimated by us to be reimbursable by
Medicare and Medicaid under prospective payment systems and provisions of
cost-reimbursement and other payment methods. In addition, we are reimbursed by
non-governmental payors using a variety of payment methodologies. Amounts we
receive for treatment of patients covered by these programs are generally less
than the standard billing rates. Contractual allowances are calculated and
recorded through our internally developed systems. In our specialty hospital
segment our billing system automatically calculates estimated Medicare
reimbursement and associated contractual allowances. For non-governmental payors
in our specialty hospital segment, we either manually calculate the contractual
allowance for each patient based upon the contractual provisions associated with
the specific payor or where we have a relatively homogeneous patient population,
we monitor individual payors' historical closed paid claims data and
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apply those payment rates to the existing patient population. The net payments
are converted into per diem rates. The per diem rates are applied to unpaid
patient days to determine the expected payment and a contractual adjustment is
recorded to adjust the recorded amount to agree with the expected payment.
Quarterly, we update our analysis of historical closed paid claims. In our
outpatient segment, we perform provision testing, using internally developed
systems, whereby we monitor a payors' historical paid claims data and compare it
against the associated gross charges. This difference is determined as a
percentage of gross charges and is applied against gross billing revenue to
determine the contractual allowances for the period. Additionally, these
contractual percentages are applied against the gross receivables on the balance
sheet to determine that adequate contractual reserves are maintained for the
gross accounts receivables reported on the balance sheet. We account for any
difference as additional contractual adjustments to gross revenues to arrive at
net operating revenues in the period that the difference is determined. We
believe the processes described above and used in recording our contractual
adjustments have resulted in reasonable estimates determined on a consistent
basis.
Allowance for Doubtful Accounts
Substantially all of our accounts receivable are related to providing
healthcare services to patients. Collection of these accounts receivable is our
primary source of cash and is critical to our financial performance. Our primary
collection risks relate to non-governmental payors who insure these patients,
and deductibles, co-payments and self-insured amounts owed by the patient.
Deductibles, co-payments and self-insured amounts are an immaterial portion of
our net accounts receivable balance. At December 31, 2012, deductibles,
co-payments and self-insured amounts owed by the patient accounted for
approximately 0.2% of our net accounts receivable balance before doubtful
accounts. Our general policy is to verify insurance coverage prior to the date
of admission for a patient admitted to our hospitals, or in the case of our
outpatient rehabilitation clinics, we verify insurance coverage prior to their
first therapy visit. Our estimate for the allowance for doubtful accounts is
calculated by providing a reserve allowance based upon the age of an account
balance. Generally we reserve as uncollectible all governmental accounts over
365 days from discharge and non-governmental accounts over 180 days from
discharge. This method is monitored based on our historical cash collections
experience. Collections are impacted by the effectiveness of our collection
efforts with non-governmental payors and regulatory or administrative
disruptions with the fiscal intermediaries that pay our governmental
receivables.
We estimate bad debts for total accounts receivable within each of our
operating units. We believe our policies have resulted in reasonable estimates
determined on a consistent basis. We have historically collected substantially
all of our third-party insured receivables (net of contractual allowances) which
include receivables from governmental agencies. Historically, there has not been
a material difference between our bad debt allowances and the ultimate
historical collection rates on accounts receivable. We review our overall
reserve adequacy by monitoring historical cash collections as a percentage of
net revenue less the provision for bad debts. Uncollected accounts are charged
against the reserve when they are turned over to an outside collection agency,
or when management determines that the balance is uncollectible, whichever
occurs first.
The following table is an aging of our net (after allowances for contractual
adjustments but before doubtful accounts) accounts receivable as of the dates
indicated (in thousands):
Balance as of December 31,
2011 2012
Over 180 Over 180
0-180 Days Days 0-180 Days Days
Commercial insurance and other $ 237,171 $ 35,801 $ 230,878 $ 31,441
Medicare and Medicaid 176,616 11,624 133,318 6,146
Total net accounts receivable $ 413,787 $ 47,425 $ 364,196 $ 37,587
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The approximate percentage of total net accounts receivable (after allowance
for contractual adjustments but before doubtful accounts) summarized by aging
categories as of the dates indicated is as follows:
As of December 31,
2011 2012
0 to 90 days 82.9 % 83.0 %
91 to 180 days 6.9 % 7.6 %
181 to 365 days 4.5 % 4.8 %
Over 365 days 5.7 % 4.6 %
Total 100.0 % 100.0 %
The approximate percentage of total net accounts receivable (after allowance
for contractual adjustments but before doubtful accounts) summarized by insured
status as of the dates indicated is as follows:
As of December 31,
2011 2012
Commercial insurance and other 59.0 % 65.1 %
Medicare and Medicaid 40.8 % 34.7 %
Self-pay receivables (including deductibles and co-payments) 0.2 % 0.2 %
Total 100.0 % 100.0 %
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 principle whereby we estimate
the losses that will be incurred by us in a given 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 December 31, 2012 and December 31, 2011, we
have recorded a liability of $92.5 million and $85.7 million, respectively, for
our estimated losses under these insurance programs.
Related Party Transactions
We are party to various rental and other agreements with companies
affiliated with us through common ownership. Our payments to these related
parties amounted to $4.0 million for both the years ended December 31, 2012 and
2011. Our future commitments are related to commercial office space we lease for
our corporate headquarters in Mechanicsburg, Pennsylvania. These future
commitments as of December 31, 2012 amount to $36.4 million through 2023. These
transactions and commitments are described more fully in the notes to our
consolidated financial statements included herein. The Company's practice is
that any such transaction must receive the prior approval of both the audit and
compliance committee of the board of directors and a majority of non-interested
members of the board of directors. It is the Company's practice that an
independent third-party appraisal supporting the amount of rent for such leased
space is obtained prior to approving the related party lease of office space.
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Goodwill and Other Intangible Assets
Goodwill and certain other indefinite-lived intangible assets are subject to
periodic impairment evaluations. Our most recent impairment assessment was
completed during the fourth quarter of 2012, which indicated that there was no
impairment with respect to goodwill or other recorded intangible assets. The
majority of our goodwill resides in our specialty hospital reporting unit. In
performing periodic impairment tests, the fair value of the reporting unit is
compared to the carrying value, including goodwill and other intangible assets.
If the carrying value exceeds the fair value, an impairment condition exists,
which results in an impairment loss equal to the excess carrying value.
Impairment tests are required to be conducted at least annually, or when events
or conditions occur that might suggest a possible impairment. These events or
conditions include, but are not limited to, a significant adverse change in the
business environment, regulatory environment or legal factors; a current period
operating or cash flow loss combined with a history of such losses or a
projection of continuing losses; or a sale or disposition of a significant
portion of a reporting unit. The occurrence of one of these events or conditions
could significantly impact an impairment assessment, necessitating an impairment
charge and adversely affecting our results of operations. For purposes of
goodwill impairment assessment, we have defined our reporting units as specialty
hospitals, outpatient rehabilitation clinics and contract therapy, with goodwill
having been allocated among reporting units based on the relative fair value of
those divisions when the Merger occurred in 2005 and based on subsequent
acquisitions.
To determine the fair value of our reporting units, we use a discounted cash
flow approach. Included in the discounted cash flow are assumptions regarding
revenue growth rates, internal development of specialty hospitals and
rehabilitation clinics, future Adjusted EBITDA margin estimates, future general
and administrative expense rates and the weighted average cost of capital for
our industry. We also must estimate residual values at the end of the forecast
period and future capital expenditure requirements. Each of these assumptions
requires us to use our knowledge of (1) our industry, (2) our recent
transactions, and (3) reasonable performance expectations for our operations. If
any one of the above assumptions changes or fails to materialize, the resulting
decline in our estimated fair value could result in a material impairment charge
to the goodwill associated with any one of the reporting units.
Realization of Deferred Tax Assets
Deferred tax assets and liabilities are required to be recognized using
enacted tax rates for the effect of temporary differences between the book and
tax bases of recorded assets and liabilities. Deferred tax assets are also
required to be reduced by a valuation allowance if it is more likely than not
that some portion or all of the deferred tax asset will not be realized. As part
of the process of preparing our consolidated financial statements, we estimate
our income taxes based on our actual current tax exposure together with
assessing temporary differences resulting from differing treatment of items for
tax and accounting purposes. We also recognize as deferred tax assets the future
tax benefits from net operating loss carry forwards. We evaluate the
realizability of these deferred tax assets by assessing their valuation
allowances and by adjusting the amount of such allowances, if necessary. Among
the factors used to assess the likelihood of realization are our projections of
future taxable income streams, the expected timing of the reversals of existing
temporary differences, and the impact of tax planning strategies that could be
implemented to avoid the potential loss of future tax benefits. However, changes
in tax codes, statutory tax rates or future taxable income levels could
materially impact our valuation of tax accruals and assets and could cause our
provision for income taxes to vary significantly from period to period.
At December 31, 2012, we had deferred tax liabilities in excess of deferred
tax assets of approximately $71.6 million for both Holdings and Select
principally due to depreciation deductions that have been accelerated for tax
purposes. This amount includes approximately $13.3 million of valuation reserves
related primarily to state net operating losses.
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Uncertain Tax Positions
We record and review quarterly our uncertain tax positions. Reserves for
uncertain tax positions are established for exposure items related to various
federal and state tax matters. Income tax reserves are recorded when an exposure
is identified and when, in the opinion of management, it is more likely than not
that a tax position will not be sustained and the amount of the liability can be
estimated. While we believe that our reserves for uncertain tax positions are
adequate, the settlement of any such exposures at amounts that differ from
current reserves may require us to materially increase or decrease our reserves
for uncertain tax positions.
Stock Based Compensation
We measure the compensation costs of share-based compensation arrangements
based on the grant-date fair value and recognize the costs in the financial
statements over the period during which employees are required to provide
services. Our share-based compensation arrangements comprise both stock options
and restricted share plans. We value employee stock options using the
Black-Scholes option valuation method that uses assumptions that relate to the
expected volatility of our common stock, the expected dividend yield of our
stock, the expected life of the options and the risk free interest rate. Such
compensation amounts, if any, are amortized over the respective vesting periods
or period of service of the option grant. We value restricted stock grants by
using the public market price of our stock on the date of grant.
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Operating Statistics
The following tables set forth operating statistics for our specialty
hospitals and our outpatient rehabilitation clinics for each of the periods
presented. The data in the tables reflect the changes in the number of specialty
hospitals and outpatient rehabilitation clinics we operate that resulted from
acquisitions, start-up activities, closures and sales. The operating statistics
reflect data for the period of time these operations were managed by us.
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2010 2011 2012
Specialty hospital data(1):
Number of hospitals owned - start of
period 94 116 115
Number of hospital start-ups 1 - 1
Number of hospitals acquired 23 1 1
Number of hospitals closed/sold (2 ) (2 ) (1 )
Number of hospitals owned - end of
period 116 115 116
Number of hospitals managed - end of
period 2 4 6
Total number of hospitals (all) -
end of period 118 119 122
Long term acute care hospitals 111 110 110
Rehabilitation hospitals 7 9 12
Available licensed beds(2) 5,163 5,135 5,138
Admissions(2) 45,990 54,734 55,147
Patient days(2) 1,119,566 1,330,890 1,345,430
Average length of stay (days)(2) 24 24 24
Net revenue per patient day(2)(3) $ 1,474 $ 1,497 $ 1,534
Occupancy rate(2)
67 % 71 % 71 %
Percent patient days - Medicare(2) 64 % 65 % 64 %
Outpatient rehabilitation data:
Number of clinics owned - start of
period 883 875 850
Number of clinics acquired 1 15 12
Number of clinic start-ups 23 26 30
Number of clinics closed/sold (32 ) (66 ) (25 )
Number of clinics owned - end of
period 875 850 867
Number of clinics managed - end of
period 69 104 112
Total number of clinics (all) - end
of period 944 954 979
Number of visits(2) 4,567,153 4,470,061 4,568,821
Net revenue per visit(2)(4) $ 101 $ 103 $ 103
--------------------------------------------------------------------------------
º (1)
º Specialty hospitals consist of long term acute care hospitals and inpatient
rehabilitation facilities.
º (2)
º Data excludes specialty hospitals and outpatient clinics managed by the
Company.
º (3)
º Net revenue per patient day is calculated by dividing specialty hospital
direct patient service revenues by the total number of patient days.
º (4)
º Net revenue per visit is calculated by dividing outpatient rehabilitation
clinic direct patient service revenue by the total number of visits. For
purposes of this computation, outpatient rehabilitation clinic direct
patient service revenue does not include managed clinics or contract
services revenue.
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Results of Operations
The following table outlines, for the periods indicated, selected operating
data as a percentage of net operating revenues:
Select Medical Holdings Corporation
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2010 2011 2012
Net operating revenues 100.0 % 100.0 % 100.0 %
Cost of services(1) 82.9 82.3 82.9
General and administrative 2.6 2.2 2.2
Bad debt expense 1.7 1.8 1.3
Depreciation and amortization 2.9 2.6 2.2
Income from operations 9.9 11.1 11.4
Loss on early retirement of debt - (1.1 ) (0.2 )
Equity in earnings (losses) of
unconsolidated subsidiaries (0.0 ) 0.1 0.3
Other income 0.0 - -
Interest expense, net (4.7 ) (3.5 ) (3.2 )
Income before income taxes 5.2 6.6 8.3
Income tax expense 1.7 2.5 3.1
Net income 3.5 4.1 5.2
Net income attributable to
non-controlling interests 0.2 0.2 0.2
Net income attributable to
Holdings 3.3 % 3.9 % 5.0 %
Select Medical Corporation
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2010 2011 2012
Net operating revenues 100.0 % 100.0 % 100.0 %
Cost of services(1) 82.9 82.3 82.9
General and administrative 2.6 2.2 2.2
Bad debt expense 1.7 1.8 1.3
Depreciation and amortization 2.9 2.6 2.2
Income from operations 9.9 11.1 11.4
Loss on early retirement of debt - (0.7 ) (0.2 )
Equity in earnings (losses) of
unconsolidated subsidiaries (0.0 ) 0.1 0.3
Other income 0.0 - -
Interest expense, net (3.5 ) (2.9 ) (2.9 )
Income before income taxes 6.4 7.6 8.6
Income tax expense 2.2 2.9 3.1
Net income 4.2 4.7 5.5
Net income attributable to
non-controlling interests 0.2 0.2 0.2
Net income attributable to Select 4.0 % 4.5 % 5.3 %
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The following tables summarize selected financial data by business segment,
for the periods indicated:
Select Medical Holdings Corporation
% %
Year Ended Year Ended Year Ended Change Change
December 31, December 31, December 31, 2010- 2011-
2010 2011 2012 2011 2012
(In thousands)
Net operating
revenues:
Specialty
hospitals $ 1,702,165 $ 2,095,519 $ 2,197,529 23.1 % 4.9 %
Outpatient
rehabilitation 688,017 708,867 751,317 3.0 6.0
Other(2) 108 121 123 12.0 1.7
Total company $ 2,390,290 $ 2,804,507 $ 2,948,969 17.3 % 5.2 %
Income (loss) from
operations:
Specialty
hospitals $ 239,442 $ 311,705 $ 334,518 30.2 % 7.3 %
Outpatient
rehabilitation 63,328 67,377 73,816 6.4 9.6
Other(2) (66,633 ) (68,363 ) (71,475 ) (2.6 ) (4.6 )
Total company $ 236,137 $ 310,719 $ 336,859 31.6 % 8.4 %
Adjusted
EBITDA:(3)
Specialty
hospitals $ 284,558 $ 362,334 $ 381,354 27.3 % 5.2 %
Outpatient
rehabilitation 83,772 83,864 87,024 0.1 3.8
Other(2) (61,251 ) (60,237 ) (62,531 ) 1.7 (3.8 )
Total company $ 307,079 $ 385,961 $ 405,847 25.7 % 5.2 %
Adjusted EBITDA
margins:(3)
Specialty
hospitals 16.7 % 17.3 % 17.4 %
Outpatient
rehabilitation 12.2 11.8 11.6
Other(2) N/M N/M N/M
Total company 12.8 % 13.8 % 13.8 %
Total assets:
Specialty
hospitals $ 2,162,726 $ 2,187,767 $ 2,143,906
Outpatient
rehabilitation 481,828 429,503 434,834
Other(2) 77,532 154,877 182,621
Total company $ 2,722,086 $ 2,772,147 $ 2,761,361
Purchases of
property and
equipment, net:
Specialty
hospitals $ 39,237 $ 30,464 $ 50,005
Outpatient
rehabilitation 9,449 12,135 13,209
Other(2) 3,075 3,417 4,971
Total company $ 51,761 $ 46,016 $ 68,185
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Select Medical Corporation
% %
Year Ended Year Ended Year Ended Change Change
December 31, December 31, December 31, 2010- 2011-
2010 2011 2012 2011 2012
(In thousands)
Net operating
revenues:
Specialty hospitals $ 1,702,165 $ 2,095,519 $ 2,197,529 23.1 % 4.9 %
Outpatient
rehabilitation 688,017 708,867 751,317 3.0 6.0
Other(2) 108 121 123 12.0 1.7
Total company $ 2,390,290 $ 2,804,507 $ 2,948,969 17.3 % 5.2 %
Income (loss) from
operations:
Specialty hospitals $ 239,442 $ 311,705 $ 334,518 30.2 % 7.3 %
Outpatient
rehabilitation 63,328 67,377 73,816 6.4 9.6
Other(2) (66,633 ) (68,363 ) (71,475 ) (2.6 ) (4.6 )
Total company $ 236,137 $ 310,719 $ 336,859 31.6 % 8.4 %
Adjusted EBITDA:(3)
Specialty hospitals $ 284,558 $ 362,334 $ 381,354 27.3 % 5.2 %
Outpatient
rehabilitation 83,772 83,864 87,024 0.1 3.8
Other(2) (61,251 ) (60,237 ) (62,531 ) 1.7 (3.8 )
Total company $ 307,079 $ 385,961 $ 405,847 25.7 % 5.2 %
Adjusted EBITDA
margins:(3)
Specialty hospitals 16.7 % 17.3 % 17.4 %
Outpatient
rehabilitation 12.2 11.8 11.6
Other(2) N/M N/M N/M
Total company 12.8 % 13.8 % 13.8 %
Total assets:
Specialty hospitals $ 2,162,726 $ 2,187,767 $ 2,143,906
Outpatient
rehabilitation 481,828 429,503 434,834
Other(2) 75,018 153,468 181,573
Total company $ 2,719,572 $ 2,770,738 $ 2,760,313
Purchases of property
and equipment, net:
Specialty hospitals $ 39,237 $ 30,464 $ 50,005
Outpatient
rehabilitation 9,449 12,135 13,209
Other(2) 3,075 3,417 4,971
Total company $ 51,761 $ 46,016 $ 68,185
--------------------------------------------------------------------------------
N/M - Not Meaningful.
º (1)
º Cost of services includes salaries, wages and benefits, operating supplies,
lease and rent expense and other operating costs.
º (2)
º Other includes our general and administrative services and non-healthcare
services.
º (3)
º We define Adjusted EBITDA as net income before interest, income taxes,
depreciation and amortization, gain (loss) on early retirement of debt,
stock compensation expense, equity in earnings (losses) of unconsolidated
subsidiaries, and other income (expense). We believe that the presentation
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of Adjusted EBITDA is important to investors because Adjusted 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. Adjusted EBITDA is not a measure of financial performance
under generally accepted accounting principles. Items excluded from
Adjusted EBITDA are significant components in understanding and assessing
financial performance. 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 Adjusted
EBITDA is not a measurement determined in accordance with generally
accepted accounting principles and is thus susceptible to varying
calculations, Adjusted EBITDA as presented may not be comparable to other
similarly titled measures of other companies.
Select Medical Holdings Corporation
Year Ended December 31,
2010 2011 2012
(In thousands)
Net income $ 82,364 $ 112,762 $ 153,893
Income tax expense 41,628 70,968 89,657
Other income (632 ) - -
Loss on early retirement of debt - 31,018 6,064
Interest expense, net of interest income 112,337 98,894 94,950
Equity in (earnings) losses of
unconsolidated subsidiaries 440 (2,923 ) (7,705 )
Stock compensation expense:
Included in general and administrative 763 1,996 3,538
Included in cost of services 1,473 1,729 2,139
Depreciation and amortization 68,706 71,517 63,311
Adjusted EBITDA $ 307,079 $ 385,961 $ 405,847
Select Medical Corporation
Year Ended December 31,
2010 2011 2012
(In thousands)
Net income $ 100,477 $ 131,363 $ 161,167
Income tax expense 51,380 80,984 93,574
Other income (632 ) - -
Loss on early retirement of debt - 20,385 6,064
Interest expense, net of interest income 84,472 80,910 83,759
Equity in (earnings) losses of unconsolidated
subsidiaries 440 (2,923 ) (7,705 )
Stock compensation expense:
Included in general and administrative 763 1,996 3,538
Included in cost of services 1,473 1,729 2,139
Depreciation and amortization 68,706 71,517 63,311
Adjusted EBITDA $ 307,079 $ 385,961 $ 405,847
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Year Ended December 31, 2012 Compared to Year Ended December 31, 2011
In the following discussion, we address the results of operations of Select
and Holdings. With the exception of interest expense, other income (expense),
loss on early retirement of debt and income taxes, the results of operations of
Holdings are identical to those of Select. Therefore, discussion related to net
operating revenues, operating expenses, Adjusted EBITDA, income from operations,
equity in earnings (losses) of unconsolidated subsidiaries and non-controlling
interest is identical for Holdings and Select.
Net Operating Revenues
Our net operating revenues increased by 5.2% to $2,949.0 million for the
year ended December 31, 2012 compared to $2,804.5 million for the year ended
December 31, 2011.
Specialty Hospitals. Our specialty hospital net operating revenues
increased by 4.9% to $2,197.5 million for the year ended December 31, 2012
compared to $2,095.5 million for the year December 31, 2011. The growth in net
operating revenue for the year ended December 31, 2012 resulted from increases
in patient volumes, increases in both Medicare and non-Medicare reimbursement
rates and revenues generated from contracted labor services provided to the
Baylor JV. Our patient days increased 1.1% compared to the year ended
December 31, 2011 to 1,345,430 days for the year ended December 31, 2012. Our
specialty hospital occupancy was 71% for both the years ended December 31, 2012
and 2011. Our average net revenue per patient day was $1,534 for the year ended
December 31, 2012 compared to $1,497 for the year ended December 31, 2011. For
the year ended December 31, 2012, we experienced increases in both our Medicare
and non-Medicare net revenue per patient day from the prior year. The increase
in our Medicare net revenue per patient day was due to increases in our Medicare
base rate. The increases in our non-Medicare net revenue per patient day
resulted from increases in our non-government payment rates that have occurred
through contract renewal and from Medicaid bonus payments we received during the
three months ended June 30, 2012.
Outpatient Rehabilitation. Our outpatient rehabilitation net operating
revenues increased 6.0% to $751.3 million for the year ended December 31, 2012
compared to $708.9 million for the year ended December 31, 2011. The net
operating revenues generated by our outpatient rehabilitation clinics for the
year ended December 31, 2012 increased 3.0% to $561.4 million compared to
$545.1 million for the year ended December 31, 2011. The increase was
principally related to volume growth in our owned outpatient rehabilitation
clinics and revenues we generated from contract labor services provided to the
Baylor JV. The number of patient visits in our owned outpatient rehabilitation
clinics increased 2.2% for the year ended December 31, 2012 to 4,568,821 visits
compared to 4,470,061 visits for the year ended December 31, 2011. Net revenue
per visit in our owned outpatient rehabilitation clinics was $103 for both the
years ended December 31, 2012 and 2011. Our contract services business increased
net operating revenues 16.0% to $189.9 million compared to $163.8 million for
the year ended December 31, 2011, which primarily resulted from the addition of
new contracts in the fourth quarter of 2011. During the fourth quarter of 2012,
our outpatient rehabilitation operations in the mid-Atlantic and Northeastern
states were adversely affected by hurricane Sandy. We currently estimate that
the lost patient revenue from this event in the three months ended December 31,
2012 was approximately $3.9 million, of which $3.2 million occurred in our
outpatient rehabilitation clinics and $0.7 million occurred in our contract
services business.
Operating Expenses
Our operating expenses include our cost of services, general and
administrative expense and bad debt expense. Our operating expenses increased by
5.2% to $2,548.8 million for the year ended December 31, 2012 compared to
$2,422.3 million for the year ended December 31, 2011. As a percentage of our
net operating revenues, our operating expenses were 86.4% for both the years
ended December 31, 2012 and December 31, 2011. Our cost of services, a major
component of which is labor expense, were $2,443.6 million or 82.9% of net
operating revenues for the year ended December 31, 2012 compared to
$2,308.6 million or 82.3% of net operating revenues for the year ended
December 31, 2011. The increase in
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cost of services as a percentage of net operating revenues resulted primarily
from increased relative labor costs in both our specialty hospital and our
outpatient rehabilitation segments. Our specialty hospitals experienced an
increase in relative labor costs due to the labor costs associated with the
Baylor JV services agreement and increased staffing costs during the year ended
December 31, 2012 compared to the year ended December 31, 2011. Our outpatient
rehabilitation segment experienced an increase in relative labor costs
associated with the Baylor JV services agreement and increased relative staffing
costs of providing patient services in our outpatient rehabilitation clinics.
Additionally, our outpatient rehabilitation segment experienced higher relative
labor costs during the year ended December 31, 2012 as a result of hurricane
Sandy, as we incurred continuing labor costs in our affected outpatient
rehabilitation clinics without corresponding revenue. Facility rent expense,
which is a component of cost of services, was $124.2 million for year ended
December 31, 2012 compared to $118.4 million for the year ended December 31,
2011. General and administrative expenses were 2.2% of net operating revenue or
$66.2 million for the year ended December 31, 2012 compared to 2.2% of net
operating revenue or $62.4 million for the year ended December 31, 2011. This
increase in general and administrative expense resulted principally from
increases in executive compensation. Our bad debt expense was $39.1 million or
1.3% of net operating revenues for the year ended December 31, 2012 compared to
$51.3 million or 1.8% for the year ended December 31. 2011. The decline in our
bad debt expense was attributed to our favorable collections experience of
accounts receivable in both our operating segments for the year ended
December 31, 2012 as compared to the year ended December 31, 2011.
Adjusted EBITDA
Specialty Hospitals. Our Adjusted EBITDA for our specialty hospitals
increased by 5.2% to $381.4 million for the year ended December 31, 2012
compared to $362.3 million for the year ended December 31, 2011. Our Adjusted
EBITDA margins for the segment increased to 17.4% for the year ended
December 31, 2012 from 17.3% for the year ended December 31, 2011. The increase
in the Adjusted EBITDA for our specialty hospitals was primarily the result of
both rate improvements and patient volume increases discussed above under "Net
Operating Revenues" and a reduction in bad debt expense discussed above under
"Operating Expenses." The increase in the Adjusted EBITDA margin is principally
due to the decline in bad debt expense, offset in part by increases in cost of
services as discussed above under "Operating Expenses."
Outpatient Rehabilitation. Adjusted EBITDA for our outpatient
rehabilitation segment increased 3.8% to $87.0 million for the year ended
December 31, 2012 compared to $83.9 million for the year ended December 31,
2011. Our Adjusted EBITDA margins decreased to 11.6% for the year ended
December 31, 2012 from 11.8% for the year ended December 31, 2011. Our Adjusted
EBITDA in our outpatient rehabilitation segment was adversely affected by
hurricane Sandy as discussed above under "Net Operating Revenues." The Adjusted
EBITDA in our outpatient rehabilitation clinics increased by $1.3 million to
$72.9 million for the year ended December 31, 2012 compared to $71.6 for the
year ended December 31, 2011. Our Adjusted EBITDA margins for our outpatient
rehabilitation clinics decreased to 13.0% for the year ended December 31, 2012
from 13.1% for the year ended December 31, 2011. The decrease in our Adjusted
EBITDA margin in our outpatient rehabilitation clinics was principally due to
the incurrence of labor costs in the outpatient rehabilitation clinics affected
by hurricane Sandy without any corresponding patient revenue as discussed above
under "Net Operating Revenues." The Adjusted EBITDA in our contract services
business increased by $1.8 million to $14.1 million for the year ended
December 31, 2012 compared to $12.3 million for the year ended December 31,
2011. The Adjusted EBITDA margins for our contract services business declined to
7.4% for the year ended December 31, 2012 compared to 7.5% for the year ended
December 31, 2011. The decline in Adjusted EBITDA margins for our contract
services business was principally due to increased labor costs associated with
new business and lower productivity resulting from regulatory changes that
became effective on October 1, 2011.
Other. The Adjusted EBITDA loss was $62.5 million for the year ended
December 31, 2012 compared to an Adjusted EBITDA loss of $60.2 million for the
year ended December 31, 2011 and is
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principally related to increases in executive compensation that are a component
of our general and administrative expense.
Income from Operations
For the year ended December 31, 2012 we had income from operations of
$336.9 million compared to $310.7 million for the year ended December 31, 2011.
The increase in our income from operations resulted principally from increases
in our operating performance of our specialty hospital and outpatient
rehabilitation segments described above and a decline in depreciation and
amortization expense.
Loss on Early Retirement of Debt
Select Medical Corporation. On September 12, 2012 we redeemed an aggregate
of $275.0 million principal amount of Select's 75/8% senior subordinated notes
at a redemption price of 101.271% of the principal amount. We recognized a loss
on early retirement of debt of $6.1 million for the year ended December 31, 2012
in connection with the redemption of the senior subordinated notes, which
included the write-off of unamortized deferred financing costs and call
premiums.
On June 1, 2011, we refinanced our senior secured credit facility. A portion
of the proceeds from this transaction were used to repurchase and retire
$266.5 million of Select's 75/8% senior subordinated notes. We recognized a loss
on early retirement of debt of $20.4 million for the year ended December 31,
2011, which included the write-off of unamortized deferred financing costs and
tender premiums.
Select Medical Holdings Corporation. On September 12, 2012 we redeemed an
aggregate of $275.0 million principal amount of Select's 75/8% senior
subordinated notes at a redemption price of 101.271% of the principal amount. We
recognized a loss on early retirement of debt of $6.1 million for the year ended
December 31, 2012 in connection with the redemption of the senior subordinated
notes, which included the write-off of unamortized deferred financing costs and
call premiums.
On June 1, 2011, we refinanced our senior secured credit facility. A portion
of the proceeds from this transaction were used to repurchase and retire
$266.5 million of Select's 75/8% senior subordinated notes and $150.0 million to
repurchase and retire our 10% senior subordinated notes. We recognized a loss on
early retirement of debt of $31.0 million for the year ended December 31, 2011,
which included the write-off of unamortized deferred financing costs, tender
premiums and original issue discount.
Equity in Earnings of Unconsolidated Subsidiaries
For the year ended December 31, 2012, we had equity in earnings of
unconsolidated subsidiaries of $7.7 million compared to equity in earnings of
unconsolidated subsidiaries of $2.9 million for the year ended December 31,
2011. The increase in our equity in earnings of unconsolidated subsidiaries
resulted principally from an increase in the income contribution from the Baylor
JV.
Interest Expense
Select Medical Corporation. Interest expense was $83.8 million for the year
ended December 31, 2012 compared to $81.2 million for the year ended
December 31, 2011. The increase in interest expense resulted primarily from the
refinancing of $150.0 million of Holdings' debt, for which Select was not
previously obligated through indebtedness incurred by Select under the new
senior secured credit facility on June 1, 2011.
Select Medical Holdings Corporation. Interest expense was $95.0 million for
the year ended December 31, 2012 compared to $99.2 million for the year ended
December 31, 2011. The decrease in interest expense resulted primarily from the
lower interest rates on the portions of the debt that were refinanced on June 1,
2011, lower interest rates on portions of the debt that we refinanced in the
third quarter of 2012 and lower average debt balances during the year ended
December 31, 2012 compared to the year ended December 31, 2011.
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Income Taxes
Select Medical Corporation. We recorded income tax expense of $93.6 million
for the year ended December 31, 2012. The expense represented an effective tax
rate of 36.7%. We recorded income tax expense of $81.0 million for the year
ended December 31, 2011. The expense represented an effective tax rate of 38.1%.
Select Medical Corporation is part of the consolidated federal tax return for
Select Medical Holdings Corporation. We allocate income taxes between Select and
Holdings for purposes of financial statement presentation. Because Holdings is a
passive investment company incorporated in Delaware, it does not incur any state
income tax expense or benefit on its specific income or loss and, as such,
receives a tax allocation equal to the federal statutory rate of 35% on its
specific income or loss. Based upon the relative size of Holdings' income or
loss, this can cause the effective tax rate for Select to differ from the
effective tax rate for the consolidated company.
Select Medical Holdings Corporation. We recorded income tax expense of
$89.7 million for the year ended December 31, 2012. The expense represented an
effective tax rate of 36.8%. We recorded income tax expense of $71.0 million for
the year ended December 31, 2011. The expense represented an effective tax rate
of 38.6%. The decline in our effective tax rate is primarily a consequence of an
Internal Revenue Service penalty abatement and a lower effective state tax rate.
Non-Controlling Interests
Non-controlling interests in consolidated earnings were $5.7 million for the
year ended December 31, 2012 and $4.9 million for the year ended December 31,
2011.
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010
Net Operating Revenues
Our net operating revenues increased by 17.3% to $2,804.5 million for the
year ended December 31, 2011 compared to $2,390.3 million for the year ended
December 31, 2010.
Specialty Hospitals. Our specialty hospital net operating revenues
increased by 23.1% to $2,095.5 million for the year ended December 31, 2011
compared to $1,702.2 million for the year December 31, 2010. The Regency
hospitals acquired on September 1, 2010 contributed $339.6 million of net
operating revenues in 2011 and provided $245.7 million of the $393.4 million
increase in net operating revenues for 2011. The remaining increase primarily
resulted from an increase in patient volumes in our other specialty hospitals.
Our patient days increased 18.9% to 1,330,890 days for 2011, which was
principally related to the addition of the Regency hospitals. The Regency
hospitals contributed a net increase in patient days of 146,065 days. Excluding
the effect of the Regency hospitals, patient days would have increased 6.2% in
2011 over 2010 as a result of similar increases in both Medicare and
non-Medicare volumes. The occupancy percentage increased to 71% for 2011 from
67% for 2010. Our average net revenue per patient day was $1,497 for 2011
compared to $1,474 for 2010. The increase in our net revenue per patient day was
principally due to increases in our average Medicare net revenue per patient
day.
Outpatient Rehabilitation. Our outpatient rehabilitation net operating
revenues increased 3.0% to $708.9 million for the year ended December 31, 2011
compared to $688.0 million for the year ended December 31, 2010. The net
operating revenues generated by our outpatient rehabilitation clinics in 2011
grew approximately 2.3% compared to 2010. The increase was principally related
to revenues we are generating from services provided to the Baylor JV. The
number of patient visits in our owned outpatient rehabilitation clinics
decreased 2.1% for 2011 to 4,470,061 visits compared to 4,567,153 visits for
2010. The decrease in visits, which also slowed our revenue growth, resulted
primarily from the 18 clinics in the Dallas-Fort Worth metroplex that were
contributed to the Baylor JV, which is accounted for as an unconsolidated joint
venture. Net revenue per visit in our clinics increased 2.0% to $103 for 2011,
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compared to $101 for 2010. Our contract services business experienced an
increase in net operating revenues of approximately 5.4% compared to 2010 which
resulted from the addition of new contracts.
Operating Expenses
Our operating expenses include our cost of services, general and
administrative expense and bad debt expense. Our operating expenses increased by
$336.9 million to $2,422.3 million for the year ended December 31, 2011 compared
to $2,085.4 million for the year ended December 31, 2010. As a percentage of our
net operating revenues, our operating expenses were 86.4% for the year ended
December 31, 2011 compared to 87.2% for the year ended December 31, 2010. Our
cost of services, a major component of which is labor expense, were
$2,308.6 million for the year ended December 31, 2011 compared to
$1,982.2 million for the year ended December 31, 2010. The principal cause of
the increase in cost of services resulted from the addition of the Regency
hospitals. Additionally facility rent expense, which is a component of cost of
services, was $118.4 million for year ended December 31, 2011 compared to
$118.3 million for the year ended December 31, 2010. General and administrative
expenses were 2.2% of net operating revenue or $62.4 million for the year ended
December 31, 2011 compared to 2.6% of net operating revenue or $62.1 million for
the year ended December 31, 2010. In 2010, our general and administrative
expenses included $9.0 million of non-recurring costs related to the transition
and closing of the Regency corporate office and a $4.8 million charge due to an
increase in employee healthcare costs. Additionally, in 2010 there was no
incentive compensation paid to our executive officers. In 2011, our general and
administrative expenses included increased legal expenses of approximately
$7.8 million primarily related to the Columbus qui tam matter and increased
compensation costs of approximately $8.1 million related to executive incentive
compensation. These cost increases in 2011 were offset by gains of $5.4 million
on the sale of assets. Our bad debt expense as a percentage of net operating
revenues remained relatively stable at 1.8% for the year ended December 31, 2011
compared to 1.7% for the year ended December 31, 2010.
Adjusted EBITDA
Specialty Hospitals. Adjusted EBITDA for our specialty hospitals increased
by 27.3% to $362.3 million for the year ended December 31, 2011 compared to
$284.6 million for the year ended December 31, 2010. Our Adjusted EBITDA margins
increased to 17.3% for the year ended December 31, 2011 from 16.7% for the year
ended December 31, 2010. For the year ended December 31, 2011, the Regency
hospitals acquired on September 1, 2010 contributed $45.9 million of the
$77.8 million increase in specialty hospital Adjusted EBITDA for 2011. Excluding
the effect of the Regency hospitals in both periods, the Adjusted EBITDA margin
would have been 18.0% and 17.7% for 2011 and 2010, respectively. In addition to
the contribution from the Regency hospitals, the increase in the Adjusted EBITDA
for the remainder of our specialty hospitals was primarily the result of an
increase in patient volumes and an increase in our Medicare net revenue per
patient day described above under "Net Operating Revenues-Specialty Hospitals."
Outpatient Rehabilitation. Adjusted EBITDA for our outpatient
rehabilitation segment was $83.9 million for the year ended December 31, 2011
compared to $83.8 million for the year ended December 31, 2010. Our Adjusted
EBITDA margins decreased to 11.8% for the year ended December 31, 2011 from
12.2% for the year ended December 31, 2010. The principal reason for the
decrease in the Adjusted EBITDA margin for the segment was related to our
contract services business. We experienced a decline in the Adjusted EBITDA and
Adjusted EBITDA margin of our contract services business that resulted from
(1) the loss of significant contracts during the second quarter of 2010 that had
generated higher Adjusted EBITDA margins and (2) higher labor costs for the
treatment models required by RUGS IV/MDS 3.0 rules that became effective on
October 1, 2010. The Adjusted EBITDA in our outpatient rehabilitation clinics
increased by $6.4 million for the year ended December 31, 2011 compared to the
year ended December 31, 2010. Additionally, our Adjusted EBITDA margins for our
outpatient rehabilitation clinics grew to 13.0% for the year ended December 31,
2011 from 12.1% for the year ended December 31,
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2010. The increase in our Adjusted EBITDA and Adjusted EBITDA margin in our
rehabilitation clinics was principally due to an improvement in the performance
in the clinics acquired in 2007 from HealthSouth Corporation and the increase in
our net revenue per visit.
Other. The Adjusted EBITDA loss was $60.2 million for the year ended
December 31, 2011 compared to an Adjusted EBITDA loss of $61.3 million for the
year ended December 31, 2010 and is primarily related to our general and
administrative expenses, as described under "Operating Expenses."
Income from Operations
For the year ended December 31, 2011 we had income from operations of
$310.7 million compared to $236.1 million for the year ended December 31, 2010.
The increase in income from operations resulted primarily from the Regency
hospitals acquired on September 1, 2010 which contributed $41.3 million of the
$74.6 million increase in income from operations for the year ended December 31,
2011, and improved operating performance at our other specialty hospitals.
Loss on Early Retirement of Debt
Select Medical Corporation. On June 1, 2011 we refinanced our senior
secured credit facility. We recognized a loss on early retirement of debt of
$20.4 million for the year ended December 31, 2011 which included the write-off
of unamortized deferred financing costs and tender premiums.
Select Medical Holdings Corporation. On June 1, 2011 we refinanced our
senior secured credit facility. We recognized a loss on early retirement of debt
of $31.0 million for the year ended December 31, 2011, which included the
write-off of unamortized deferred financing costs, tender premiums and original
issue discount.
Interest Expense
Select Medical Corporation. Interest expense was $81.2 million for the year
ended December 31, 2011 compared to $84.5 million for the year ended
December 31, 2010. The decrease in interest expense resulted primarily from the
expiration of interest rate swaps in 2010 that carried higher fixed interest
rates, which was offset in part by the refinancing of $150.0 million of
Holdings' debt, for which Select was not previously obligated through
indebtedness incurred by Select under the new senior secured credit facility on
June 1, 2011.
Select Medical Holdings Corporation. Interest expense was $99.2 million for
the year ended December 31, 2011 compared to $112.3 million for the year ended
December 31, 2010. The decrease in interest expense resulted primarily from the
expiration of interest rate swaps in 2010 that carried higher fixed interest
rates and lower interest rates on the portions of the debt that were refinanced
on June 1, 2011.
Income Taxes
Select Medical Corporation. We recorded income tax expense of $81.0 million
for the year ended December 31, 2011. The expense represented an effective tax
rate of 38.1%. We recorded income tax expense of $51.4 million for the year
ended December 31, 2010. The expense represented an effective tax rate of 33.8%.
Select Medical Corporation is part of the consolidated federal tax return for
Select Medical Holdings Corporation. We allocate income taxes between Select and
Holdings for purposes of financial statement presentation. Because Holdings is a
passive investment company incorporated in Delaware, it does not incur any state
income tax expense or benefit on its specific income or loss and, as such,
receives a tax allocation equal to the federal statutory rate of 35% on its
specific income or loss. Based upon the relative size of Holdings' income or
loss, this can cause the effective tax rate for Select to differ from the
effective tax rate for the consolidated company. The analysis in the following
paragraph discusses the change in our consolidated tax rate.
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Select Medical Holdings Corporation. We recorded income tax expense of
$71.0 million for the year ended December 31, 2011. The expense represented an
effective tax rate of 38.6%. We recorded income tax expense of $41.6 million for
the year ended December 31, 2010. The expense represented an effective tax rate
of 33.6%. Although our effective tax rate for the year ended December 31, 2011
approximates our statutory tax rate, the rate was affected by two significant
items that offset each other in the effective rate. We experienced an increase
in our effective tax rate from a difference between the tax accounting basis and
the financial accounting basis associated with a hospital exchange that occurred
in early 2011 and an increase in our reserves for uncertain tax positions
resulting from the settlement costs associated with the Columbus matter. These
increases were offset by a release in reserves for uncertain tax positions
associated with the tax basis of an acquisition we consummated in 1999. During
2011, additional information was discovered that further supported the tax basis
of entities acquired through this acquisition and resulted in a change in the
estimates related to this tax uncertainty. Our low effective tax rate for the
year ended December 31, 2010 is below the statutory rate due to the reversal of
certain valuation allowances that had been provided on losses in previous years.
A substantial portion of this reversal in our valuation allowance relates to our
ability to utilize a Federal capital loss generated in 2007 to offset a taxable
capital gain on a recently completed transaction.
Non-Controlling Interests
Non-controlling interests in consolidated earnings were $4.9 million for the
year ended December 31, 2011 and $4.7 million for the year ended December 31,
2010.
Liquidity and Capital Resources
Years Ended December 31, 2010, 2011 and 2012
Select Medical Holdings Corporation Select Medical Corporation
Year Ended December 31, Year Ended December 31,
2010 2011 2012 2010 2011 2012
(In thousands) (In thousands)
Cash flows
provided by
operating
activities $ 144,537 $ 217,128 $ 298,682 $ 170,064 $ 240,053 $ 309,371
Cash flows
used in
investing
activities (216,998 ) (54,735 ) (72,406 ) (216,998 ) (54,735 ) (72,406 )
Cash flows
used in
financing
activities (6,854 ) (154,715 ) (198,175 ) (32,381 ) (177,640 ) (208,864 )
Net
increase
(decrease)
in cash and
cash
equivalents (79,315 ) 7,678 28,101 (79,315 ) 7,678 28,101
Cash and
cash
equivalents
at
beginning
of period 83,680 4,365 12,043 83,680 4,365 12,043
Cash and
cash
equivalents
at end of
period $ 4,365 $ 12,043 $ 40,144 $ 4,365 $ 12,043 $ 40,144
Operating activities for Select provided $309.4 million of cash flows for
the year ended December 31, 2012. The increase in cash flow provided by
operating activities is principally related to a reduction in our days sales
outstanding. Our days sales outstanding were 45 days at December 31, 2012
compared to 53 days at December 31, 2011. The reduction in days sales
outstanding is primarily due to timing of the periodic interim payments we
receive from Medicare for the services provided at our specialty hospitals and a
reduction in our non-Medicare receivables.
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Operating activities for Select provided $240.1 million for the year ended
December 31, 2011. The increase in cash flow provided by operating activities
for the year ended December 31, 2011 is principally related to the increase in
our income from operations. Additionally, we were able to offset the cash impact
of an increase in our tax expense through an one-time deferral of income
effectuated through a tax accounting change related to how we recognize our
specialty hospital Medicare revenues for tax reporting purposes. This tax
accounting change had the effect of deferring $16.5 million of tax liability in
2011. Our days sales outstanding were 53 days at December 31, 2011 compared to
51 days at December 31, 2010. The increase is principally related to the timing
and settlement of our Medicare accounts receivable for services provided at our
specialty hospitals.
Operating activities for Select provided $170.1 million for the year ended
December 31, 2010. The decrease in cash flow provided by operating activities in
comparison to our operating cash flow provided by operating activities for the
year ended December 31, 2009 is principally related to the increase in our
accounts receivable at December 31, 2010. Our days sales outstanding were
51 days at December 31, 2010 compared to 49 days at December 31, 2009 and falls
within our historical range of days sales outstanding.
The operating cash flow of Select exceeds the operating cash flow of
Holdings by $10.7 million, $22.9 million and $25.5 million for the years ended
December 31, 2012, 2011 and 2010, respectively. The difference relates to
interest payments on Holdings' indebtedness.
Investing activities used $72.4 million, $54.7 million and $217.0 million of
cash flow for the years ended December 31, 2012, 2011, and 2010, respectively.
Of this amount, we incurred acquisition related payments of $6.0 million,
$0.9 million and $165.8 million, respectively in 2012, 2011 and 2010. The
acquisition payments for 2012 related principally to several small acquisitions
of clinics in our outpatient rehabilitation segment. The acquisition payments
for 2011 relate primarily to small acquisitions of outpatient businesses and
specialty hospitals. The acquisition payments in 2010 related principally to the
acquisition of Regency which was $165.6 million. Investing activities also used
cash for the purchases of property and equipment of $68.2 million, $46.0 million
and $51.8 million in 2012, 2011, and 2010, respectively. We sold business units
and real property which generated $16.5 million, $7.9 million and $0.6 million
in cash during the years ended December 31, 2012, 2011 and 2010, respectively.
Investment in businesses relates to equity investments in unconsolidated
businesses. The $14.7 million of investments for the year ended December 31,
2012 and $15.7 million of investments for the year ended December 31, 2011
related primarily to our investment in the Baylor JV partnership units. In
addition, Select purchased minority investment interests in other healthcare
related businesses that provide specialized technology, services to healthcare
entities, and other healthcare services during the year ended December 31, 2012.
Financing activities for Select used $208.9 million of cash flow for the
year ended December 31, 2012. The primary use of cash related to dividends paid
to Holdings of $268.5 million principally to fund the payment of dividends to
stockholders on December 12, 2012, fund interest payments, and the repurchase of
common stock. Select also used $6.5 million for debt issuances costs and paid
$3.3 million in distributions to non-controlling interests, offset in part by
net borrowings of debt of $66.4 million, $1.2 million of proceeds from bank
overdrafts and $1.8 million of equity investment made by Holdings.
Financing activities for Select used $177.6 million of cash flow for the
year ended December 31, 2011. The primary use of cash related to dividends paid
to Holdings of $245.7 million to fund interest payments, repurchase of common
stock and the repurchase of all $150.0 million principal amount of Holdings 10%
senior subordinated notes, $18.6 million of debt issuance costs, repayment of
bank overdrafts of $2.2 million and $4.6 million in distributions to
non-controlling interests offset by net borrowings of debt of $93.2 million.
Financing activities for Select used $32.4 million of cash flow for the year
ended December 31, 2010. The primary usage of cash was related to dividends paid
to Holdings of $69.7 million to fund interest payments and stock repurchases and
was offset by a net borrowing under our revolving senior secured credit
facility.
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The difference in cash flows used in financing activities of Holdings
compared to Select of $10.7 million, $22.9 million and $25.5 million for the
years ended December 31, 2012, 2011 and 2010, respectively, relates to dividends
paid by Select to Holdings to service Holdings' interest obligations related to
its indebtedness.
Capital Resources
Select Medical Corporation. Select had net working capital of $63.2 million
at December 31, 2012 compared to net working capital of $97.3 million at
December 31, 2011.
Select Medical Holdings Corporation. Holdings had net working capital of
$65.2 million at December 31, 2012 compared to net working capital of
$99.5 million at December 31, 2011.
On June 1, 2011, Select entered into a new senior secured credit agreement
that originally provided for $1.15 billion in senior secured credit facilities
comprised of an $850.0 million, seven-year term loan facility, which we refer to
as the Original Term Loan, and a $300.0 million, five-year revolving credit
facility, including a $75.0 million sublimit for the issuance of standby letters
of credit and a $25.0 million sublimit for swingline loans. Borrowings under the
senior secured credit facilities are guaranteed by Holdings and substantially
all of Select's current domestic subsidiaries and will be guaranteed by Select's
future domestic subsidiaries and secured by substantially all of Select's
existing and future property and assets and by a pledge of Select's capital
stock, the capital stock of Select's domestic subsidiaries and up to 65% of the
capital stock of Select's foreign subsidiaries, if any.
On August 13, 2012, Select entered into an additional credit extension
amendment to its senior secured credit facilities providing for a $275.0 million
additional term loan tranche, which we refer to as the Series A Tranche B Term
Loan, to Select at the same interest rate and with the same term as the Original
Term Loan.
Borrowings under the Original Term Loan and the Series A Tranche B Term Loan
will bear interest at a rate equal to Adjusted LIBO plus 3.75%, or Alternate
Base Rate plus 2.75%.
Borrowings under the revolving credit facility will bear interest at a rate
equal to Adjusted LIBO plus a percentage ranging from 2.75% to 3.75%, or
Alternate Base Rate plus a percentage ranging from 1.75% to 2.75%, in each case
based on Select's leverage ratio (the ratio of indebtedness to consolidated
EBITDA, as defined in the senior secured credit agreement). The applicable
margin percentage for revolving loans as of December 31, 2012 was (1) 3.25% for
Adjusted LIBO loans and (2) 2.25% for Alternate Base Rate loans.
The Original Term Loan and the Series A Tranche B Term Loan amortize in
equal quarterly installments on the last day of each March, June, September and
December in aggregate annual amounts equal to $11.3 million. The balance of the
Original Term Loan and the Series A Tranche B Term Loan will be payable on
June 1, 2018 and the revolving credit facility will be payable on June 1, 2016.
On February 20, 2013, Select entered into an additional credit extension
amendment to its senior secured credit facilities providing for a $300.0 million
additional term loan tranche, which we refer to as the Series B Tranche B Term
Loan, to Select.
Borrowings under the Series B Tranche B Term Loan will bear interest at a
rate equal to Adjusted LIBO plus 3.25%, or Alternate Base Rate plus 2.25%. The
Series B Tranche B Term Loan amortizes in equal quarterly installments on the
last day of each March, June, September and December in aggregate annual amounts
equal to $3.0 million. The balance of the Series B Tranche B Term Loan will be
payable on February 20, 2016.
"Adjusted LIBO" is defined as, with respect to any interest period, the
London interbank offered rate for such interest period, adjusted for any
applicable statutory reserve requirements; provided that Adjusted LIBO, when
used in reference to the Original Term Loan and Series A Tranche B Term Loan,
will at no time be less than 1.75% per annum.
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"Alternate Base Rate" is defined as the highest of (a) the administrative
agent's Prime Rate, (b) the Federal Funds Effective Rate plus 1/2 of 1.00% and
(c) the Adjusted LIBO from time to time for an interest period of one month,
plus 1.00%.
Select will be required to prepay borrowings under the senior secured credit
facilities with (1) 100% of the net cash proceeds received from non-ordinary
course asset sales or other dispositions, or as a result of a casualty or
condemnation, subject to reinvestment provisions and other customary carveouts
and the payment of certain indebtedness secured by liens subject to a first lien
intercreditor agreement, (2) 100% of the net cash proceeds received from the
issuance of debt obligations other than certain permitted debt obligations, and
(3) 50% of excess cash flow (as defined in the credit agreement) if Select's
leverage ratio is greater than 3.75 to 1.00 and 25% of excess cash flow if
Select's leverage ratio is less than or equal to 3.75 to 1.00 and greater than
3.25 to 1.00, in each case, reduced by the aggregate amount of term loans
optionally prepaid during the applicable fiscal year. Select will not be
required to prepay borrowings with excess cash flow if Select's leverage ratio
is less than or equal to 3.25 to 1.00.
The senior secured credit facilities require Select to maintain a leverage
ratio (based upon the ratio of indebtedness to consolidated EBITDA, as defined
in the credit agreement), which is tested quarterly, and prohibits Select from
making capital expenditures in excess of $125.0 million in any fiscal year
(subject to a 50% carry-over provision). As of December 31, 2012, Select was
required to maintain its leverage ratio at less than 4.75 to 1.00, and Select's
leverage ratio was 3.18 to 1.00 as of December 31, 2012. Failure to comply with
these covenants would result in an event of default under the senior secured
credit facilities and, absent a waiver or an amendment from the lenders,
preclude Select from making further borrowings under the revolving credit
facility and permit the lenders to accelerate all outstanding borrowings under
the senior secured credit facilities.
The senior secured credit facilities also contain a number of affirmative
and restrictive covenants, including limitations on mergers, consolidations and
dissolutions; sales of assets; investments and acquisitions; indebtedness;
liens; affiliate transactions; and dividends and restricted payments. The senior
secured credit facilities contain events of default for non-payment of principal
and interest when due, cross-default and cross-acceleration provisions and an
event of default that would be triggered by a change of control.
In June 2011, Select used borrowings under the senior secured credit
facilities to refinance all of its outstanding indebtedness under its existing
senior secured credit facilities, to repurchase $266.5 million aggregate
principal amount of its 75/8% senior subordinated notes due 2015 and to repay
all of Holdings' 10% senior subordinated notes due 2015.
In August 2012, Select used borrowings under the senior secured credit
facilities to repurchase $275.0 million aggregate principal amount of its 75/8%
senior subordinated notes due 2015.
Select intends to use borrowings under the Series B Tranche B Term Loan to
redeem all of its outstanding 75/8% senior subordinated notes due 2015, to
finance Holdings redemption of all of Holdings' senior floating rate notes due
2015 and to reduce a portion of the balance outstanding under its revolving
credit facility. On February 20, 2013, Select and Holdings each instructed U.S.
Bank Trust National Association, as trustee, to deliver an irrevocable notice of
redemption to the holders of all of Select's outstanding 75/8% senior
subordinated notes due 2015 and all of Holdings' outstanding senior floating
rate notes due 2015, respectively, all of which will be redeemed at 100% of the
principal amount plus any accrued and unpaid interest to the redemption date on
or about March 22, 2013.
As of December 31, 2012, we had outstanding borrowings of $1,096.6 million
(net of unamortized original issue discount of $14.2 million) under the term
loans and outstanding borrowings of $130.0 million under the revolving loan
portion of our senior secured credit facilities. As of December 31, 2012, we had
$135.9 million of availability under our revolving credit facility (after giving
effect to $34.1 million of outstanding letters of credit).
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On February 24, 2005, EGL Acquisition Corp. issued and sold $660.0 million
in aggregate principal amount of 75/8% senior subordinated notes due 2015, which
Select assumed in connection with the Merger. The net proceeds of the offering
were used to finance a portion of the funds needed to consummate the Merger with
EGL Acquisition Corp. The notes were issued under an indenture between EGL
Acquisition Corp. and U.S. Bank Trust National Association, as trustee. Interest
on the notes is payable semi-annually in arrears on February 1 and August 1 of
each year. The notes are guaranteed by all of Select's wholly-owned
subsidiaries, subject to certain exceptions.
During 2008, we repurchased and retired senior subordinated notes having a
carrying value of $2.0 million. During 2009, we repurchased and retired senior
subordinated notes having a carrying value of $46.5 million.
On June 1, 2012, Select used a portion of the proceeds from its senior
secured credit facilities to repurchase $266.5 million aggregate principal
amount of its 75/8% senior subordinated notes.
On September 12, 2012, Select used the proceeds of the incremental term
loans and cash on hand to redeem $275.0 million aggregate principal amount of
its 75/8% senior subordinated notes.
On September 29, 2005, Holdings sold $175.0 million of senior floating rate
notes due 2015, which bear interest at a rate per annum, reset semi-annually,
equal to the 6-month LIBOR plus 5.75%. Interest is payable semi-annually in
arrears on March 15 and September 15 of each year, with the principal due in
full on September 15, 2015. The senior floating rate notes are general unsecured
obligations of Holdings and are not guaranteed by Select or any of its
subsidiaries. The net proceeds of the issuance of the senior floating rate
notes, together with cash was used to reduce the amount of our preferred stock,
to make a payment to participants in our long-term incentive plan and to pay
related fees and expenses.
During 2009, we repurchased and retired senior floating rate notes having a
carrying value of $7.7 million.
We may from time to time seek to retire or purchase our outstanding debt
through cash purchases and/or exchanges for equity securities, in open market
purchases, privately negotiated transactions or otherwise. Such repurchases or
exchanges, if any, may be funded from operating cash flows or other sources and
will depend on prevailing market conditions, our liquidity requirements,
contractual restrictions and other factors. The amounts involved may be
material.
Holdings has authorized a program to repurchase up to $350.0 million worth
of shares of our common stock. The program will remain in effect until March 31,
2014, unless extended by the board of directors. During the year ended
December 31, 2012, Holdings has repurchased 5,725,782 shares at a cost of
$46.8 million and since the inceptions of the program has repurchased 22,490,389
shares under the program at a cost of $163.6 million, which includes related
transaction costs. We anticipate funding this program through available
operating cash flow and borrowings under our senior secured credit facility.
We believe our internally generated cash flows and borrowing capacity under
our senior secured credit facility will be sufficient to finance operations over
the next twelve months
We routinely pursue opportunities to develop new joint ventures
relationships with significant health systems, and from time to time we may also
develop new inpatient rehabilitation hospitals. With the expiration on
December 28, 2012 of the moratorium on new LTCHs and new LTCH beds, we are
evaluating the addition of new LTCH beds at certain of our hospitals. We also
intend to open new outpatient rehabilitation clinics in local areas that we
currently serve where we can benefit from existing referral relationships and
brand awareness to produce incremental growth. In addition to our development
activities, we may grow our network of specialty hospitals through opportunistic
acquisitions.
Commitments and Contingencies
The following tables summarize contractual obligations at December 31, 2012,
and the effect such obligations are expected to have on liquidity and cash flow
in future periods. Reserves for uncertain tax positions of $15.4 million have
been excluded from the tables below as we cannot reasonably estimate the amounts
or periods in which these liabilities will be paid.
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Select Medical Holdings Corporation:
Contractual Obligations Total 2013 2014-2016 2017-2018 After 2018
(in thousands)
75/8% senior subordinated
notes(1) $ 70,000 $ - $ 70,000 $ - $ -
Senior secured credit
facility(2)(3) 1,226,641 8,584 155,860 1,062,197 -
Senior floating rate
notes(1) 167,300 - 167,300 - -
Other debt obligations 6,302 3,062 1,794 46 1,400
Total debt 1,470,243 11,646 394,954 1,062,243 1,400
Interest(4) 382,820 82,966 217,041 82,757 56
Letters of credit
outstanding 34,072 - 34,072 - -
Purchase obligations 6,240 3,479 2,358 403 -
Construction contracts 7,246 7,246 - - -
Naming, promotional and
sponsorship agreement 42,977 2,870 9,017 6,365 24,725
Operating leases 675,028 121,272 223,326 74,840 255,590
Related party operating
leases 36,436 3,481 9,910 6,992 16,053
Total contractual cash
obligations $ 2,655,062 $ 232,960 $ 890,678 $ 1,233,600 $ 297,824
Select Medical Corporation:
Contractual Obligations Total 2013 2014-2016 2017-2018 After 2018
(in thousands)
75/8% senior subordinated
notes(1) $ 70,000 $ - $ 70,000 $ - $ -
Senior secured credit
facility(2)(3) 1,226,641 8,584 155,860 1,062,197 -
Other debt obligations 6,302 3,062 1,794 46 1,400
Total debt 1,302,943 11,646 227,654 1,062,243 1,400
Interest(4) 353,704 72,209 198,682 82,757 56
Letters of credit
outstanding 34,072 - 34,072 - -
Purchase obligations 6,240 3,479 2,358 403 -
Construction contracts 7,246 7,246 - - -
Naming, promotional and
sponsorship agreement 42,977 2,870 9,017 6,365 24,725
Operating leases 675,028 121,272 223,326 74,840 255,590
Related party operating
leases 36,436 3,481 9,910 6,992 16,053
Total contractual cash
obligations $ 2,458,646 $ 222,203 $ 705,019 $ 1,233,600 $ 297,824
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º (1)
º On February 20, 2013, Select and Holdings each instructed U.S. Bank Trust
National Association, as trustee, to deliver an irrevocable notice of
redemption to the holders of all of Select's outstanding 75/8% senior
subordinated notes due 2015 and all of Holdings' outstanding senior
floating rate notes due 2015, respectively, all of which will be redeemed
on or about March 22, 2013 using a portion of the proceeds from the
Series B Tranche B Term Loan.
º (2)
º Reflects the balance sheet liability of the senior secured credit facility
calculated in accordance with GAAP. The balance sheet liability so
reflected is less than the $1,125.1 million aggregate principal amount of
term loans that were issued with original issue discount. The remaining
unamortized original issue discount on the term loans was $14.2 million at
December 31, 2012. Interest on the
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senior secured credit facility accrued on the full principal amount thereof
and Holdings will be obligated to repay the full principal thereof at
maturity or upon any mandatory or voluntary prepayment thereof.
º (3)
º The balance of the term loans will be payable on June 1, 2018 and the
revolving credit facility will be payable on June 1, 2016.
º (4)
º The interest obligation for the senior secured credit facility term loans
was calculated using the average interest rate at December 31, 2012 of 5.5%
and the revolving portion was calculated at the average interest rate at
December 31, 2012 of 4.3%. The interest obligation was calculated using the
stated interest rate for the 75/8% senior subordinated notes, 6.4% for the
senior floating rate notes and 6.0% for the other debt obligations.
Inflation
The healthcare industry is labor intensive and susceptible to wage increases
during periods of inflation and when labor shortages occur in the marketplace.
In addition, suppliers which include pharmaceutical costs, pass along rising
costs to us in the form of higher prices. Our ability to pass on increased costs
associated with providing healthcare to Medicare and Medicaid patients is
limited due to federal and state laws that established fixed reimbursement
rates. In recent years, inflation has not had a material impact on our results
of operations. We cannot predict the impact that future economic conditions may
have on our ability to contain or offset future cost increases.
Recent Accounting Pronouncements
In July 2012, the Financial Accounting Standards Board ("FASB") issued
Accounting Standards Update ("ASU") 2012-02, "Intangibles - Goodwill and Other
(Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment,"
("Update 2012-02"). In accordance with Update 2012-02, an entity has the option
to first assess qualitative factors to determine whether it is more likely than
not that the fair value of an indefinite-lived intangible asset is less than its
carrying value. If the entity determines that it is more likely than not that
the fair value of the indefinite-lived intangible asset is less than the
carrying value, the entity will be required to perform the quantitative
impairment test. Update 2012-02 is effective for annual and interim impairment
tests performed for fiscal years beginning after September 15, 2012. However,
early adoption is permitted. Update 2012-02 will not have an impact on our
consolidated financial statements.
In June 2011, the FASB issued ASU 2011-05, "Comprehensive Income (Topic
220) - Presentation of Comprehensive Income" ("Update 2011-05") that improves
the comparability, consistency and transparency of financial reporting and
increases the prominence of items reported in other comprehensive income by
eliminating the option to present components of other comprehensive income as
part of the statement of changes in stockholders' equity. Update 2011-05
requires that all non-owner changes in stockholders' equity be presented either
in a single continuous statement of comprehensive income or in two separate but
consecutive statements. Under either method, adjustments must be displayed for
items that are reclassified from other comprehensive income ("OCI") to net
income, in both net income and OCI. Update 2011-05 does not change the current
option for presenting components of OCI gross or net of the effect of income
taxes, provided that such tax effects are presented in the statement in which
OCI is presented or disclosed in the notes to the financial statements.
Additionally, Update 2011-05 does not affect the calculation or reporting of
earnings per share. Update 2011-05 was effective for fiscal years, and interim
periods within those years, beginning after December 15, 2011 and is to be
applied retrospectively. With the adoption of Update 2011-05, the Company opted
to change its presentation of its components of other comprehensive income to a
single continuous statement of operations and other comprehensive income.
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