Select Medical (SEM) 10-Q 2006 Q3 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the Quarter Ended September 30, 2006

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

For the Transition Period From                    to                    .

Commission File Number:333-133284

SELECT MEDICAL HOLDINGS CORPORATION

(Exact name of Registrant as specified in its charter)

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

4716 Old Gettysburg Road, P.O. Box 2034, Mechanicsburg, Pennsylvania 17055
(Address of principal executive offices and zip code)

(717) 972-1100
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods as the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YESþ      NOo

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filero      Accelerated filero     Non-accelerated filerþ

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YESo      NOþ

     As of October 31, 2006, the Company had outstanding 205,483,958 shares of common stock.

TABLE OF CONTENTS

PART I	FINANCIAL INFORMATION	3
ITEM 1.	CONSOLIDATED FINANCIAL STATEMENTS
	Consolidated balance sheets	3
	Consolidated statements of operations	4
	Consolidated statement of changes in stockholder’s equity and comprehensive income	6
	Consolidated statements of cash flows	7
	Notes to consolidated financial statements	8
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	17
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	35
ITEM 4.	CONTROLS AND PROCEDURES	36
PART II	OTHER INFORMATION	36
ITEM 1.	LEGAL PROCEEDINGS	36
ITEM 1A.	RISK FACTORS	37
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	37
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	37
ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	37
ITEM 5.	OTHER INFORMATION	37
ITEM 6.	EXHIBITS	38
SIGNATURES		38
Office Lease Agreement dated August 25, 2006
Certification of Chief Executive Officer
Certification of Senior Vice President and Chief Financial Officer
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350
Certification of Senior Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350

2

PART I FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

Select Medical Holdings Corporation

Consolidated Balance Sheets

(unaudited)

(in thousands, except share and per share amounts)

	December 31,			September 30,
	2005			2006
ASSETS
Current Assets:
Cash and cash equivalents	$	35,861		$	5,040
Restricted cash		6,345			5,247
Accounts receivable, net of allowance for doubtful accounts of $74,891 and $60,531 in 2005 and 2006, respectively		256,798			247,972
Prepaid income taxes		4,110			—
Current deferred tax asset		59,135			57,892
Current assets held for sale		13,876			—
Other current assets		19,725			16,847
Total Current Assets		395,850			332,998
Property and equipment, net		248,541			330,106
Goodwill		1,305,210			1,319,018
Other identifiable intangibles		86,789			81,456
Other assets held for sale		61,388			—
Other assets		70,607			67,483
Total Assets	$	2,168,385		$	2,131,061
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Bank overdrafts	$	19,355		$	7,531
Current portion of long-term debt and notes payable		6,516			6,309
Accounts payable		60,528			64,973
Accrued payroll		61,531			54,515
Accrued vacation		26,983			27,039
Accrued interest		36,028			16,007
Accrued professional liability		21,527			23,128
Accrued restructuring		390			252
Accrued other		69,046			65,140
Income taxes payable		—			22,346
Due to third party payors		12,175			9,006
Current liabilities held for sale		4,215			—
Total Current Liabilities		318,294			296,246
Long-term debt, net of current portion		1,622,373			1,538,516
Non-current deferred tax liability		19,438			23,869
Non-current liabilities held for sale		3,817			—
Total Liabilities		1,963,922			1,858,631
Commitments and Contingencies
Minority interest in consolidated subsidiary companies		4,356			2,285
Preferred stock (liquidation preference is $444,765 and $461,576 in 2005 and 2006, respectively)		444,765			461,576
Stockholders’ Equity:
Common stock, $0.001 par value, 250,000,000 shares authorized, 205,408,000 shares and 205,484,000 shares issued and outstanding in 2005 and 2006, respectively		205			205
Capital in excess of par		(299,028	)		(296,202	)
Retained earnings		48,808			99,971
Accumulated other comprehensive income		5,357			4,595
Total Stockholders’ Equity		(244,658	)		(191,431	)
Total Liabilities and Stockholders’ Equity	$	2,168,385		$	2,131,061

The accompanying notes are an integral part of this statement.

3

Select Medical Holdings Corporation

Consolidated Statements of Operations

(unaudited)

(in thousands)

	For the Quarter Ended September 30,
	2005			2006
Net operating revenues	$	460,658		$	443,872
Costs and expenses:
Cost of services		363,480			362,070
General and administrative		27,221			9,762
Bad debt expense		4,378			5,333
Depreciation and amortization		11,828			12,394
Total costs and expenses		406,907			389,559
Income from operations		53,751			54,313
Other income and expense:
Other income		247			—
Interest income		241			319
Interest expense		(29,639	)		(33,002	)
Income from continuing operations before minority interests and income taxes		24,600			21,630
Minority interest in consolidated subsidiary companies		494			369
Income from continuing operations before income taxes		24,106			21,261
Income tax expense		9,800			8,717
Income from continuing operations		14,306			12,544
Income from discontinued operations, net of tax		1,061			—
Net income	$	15,367		$	12,544

The accompanying notes are an integral part of this statement.

4

Select Medical Holdings Corporation
Consolidated Statements of Operations
(unaudited)
(in thousands)

	Predecessor			Successor
				Period from
	Period from			February 25			For the Nine
	January 1			through			Months Ended
	through February			September 30,			September 30,
	24, 2005			2005			2006
Net operating revenues	$	277,736		$	1,122,748		$	1,405,756
Costs and expenses:
Cost of services		244,321			875,566			1,119,767
General and administrative		122,509			48,960			33,511
Bad debt expense		6,588			14,244			18,766
Depreciation and amortization		5,933			28,110			34,955
Total costs and expenses		379,351			966,880			1,206,999
Income (loss) from operations		(101,615	)		155,868			198,757
Other income and expense:
Loss on early retirement of debt		(42,736	)		—			—
Merger related charges		(12,025	)		—			—
Other income		267			658			—
Interest income		523			511			738
Interest expense		(4,651	)		(69,876	)		(98,525	)
Income (loss) from continuing operations before minority interests and income taxes		(160,237	)		87,161			100,970
Minority interest in consolidated subsidiary companies		330			1,350			1,095
Income (loss) from continuing operations before income taxes		(160,567	)		85,811			99,875
Income tax expense (benefit)		(59,794	)		34,702			41,889
Income (loss) from continuing operations		(100,773	)		51,109			57,986
Income from discontinued operations, net of tax (Includes pre-tax gain of $13,950 in 2006)		522			3,367			10,018
Net income (loss)	$	(100,251	)	$	54,476		$	68,004

The accompanying notes are an integral part of this statement.

5

Select Medical Holdings Corporation

Consolidated Statement of Changes in Stockholders’ Equity and Comprehensive Income

(unaudited)

(in thousands)

	Common Stock Issued			Common Stock Par Value			Capital in Excess of Par			Retained Earnings			Accumulated Other Comprehensive Income			Comprehensive Income
Balance at December 31, 2005		205,408		$	205		$	(299,028	)	$	48,808		$	5,357
Net income											68,004						$68,004
Unrealized gain on interest rate swap, net of tax														1,056			1,056
Changes in foreign currency translation														1,013			1,013
Sale of foreign subsidiary														(2,831	)		(2,831	)
Total comprehensive income																	$67,242
Restricted stock issuance		100			1
Repurchase of common shares		(24	)		(1	)		(10	)
Vesting of restricted stock								2,826
Stock option expense								10
Accretion of dividends on preferred stock											(16,841	)
Balance at September 30, 2006		205,484		$	205		$	(296,202	)	$	99,971		$	4,595

The accompanying notes are an integral part of this statement.

6

Select Medical Holdings Corporation

Consolidated Statements of Cash Flows

(unaudited)

(in thousands)

	Predecessor			Successor
				Period from
	Period from			February 25			For the Nine
	January 1 through			through September			Months Ended
	February 24, 2005			30, 2005			September 30, 2006
Operating activities
Net income (loss)	$	(100,251	)	$	54,476		$	68,004
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		6,177			28,898			35,131
Provision for bad debts		6,661			14,425			18,853
Gain from sale of business		—			—			(13,950	)
Loss on early retirement of debt (non-cash)		7,977			—			—
Non-cash stock compensation expense		—			7,567			2,837
Amorization of debt discount		—			607			868
Minority interests		469			2,335			1,435
Loss on disposal of assets		—			715			1,418
Changes in operating assets and liabilities, net of effects from acquisition of businesses:
Accounts receivable		(48,976	)		(23,516	)		(10,811	)
Other current assets		1,816			(1,250	)		2,494
Other assets		(622	)		1,448			3,591
Accounts payable		5,250			2,484			4,300
Due to third-party payors		667			(2,598	)		(3,169	)
Accrued interest		(4,839	)		13,885			(20,021	)
Accrued expenses		204,748			(190,801	)		(9,991	)
Income taxes and deferred taxes		(60,021	)		27,520			24,177
Net cash provided by (used in) operating activities		19,056			(63,805	)		105,166
Investing activities
Purchases of property and equipment		(2,586	)		(70,459	)		(112,132	)
Earnout payments		—			—			(100	)
Proceeds from sale of business		—			—			76,806
Restricted cash		108			217			1,098
Acquisition of businesses, net of cash acquired		(108,279	)		(2,747	)		(3,261	)
Net cash used in investing activities		(110,757	)		(72,989	)		(37,589	)
Financing activities
Issuance of senior floating rate notes		—			175,000			—
Equity investment		—			574,042			—
Proceeds from credit facility		—			780,000			—
Proceeds from 7 5/8% senior subordinated notes		—			660,000			—
Proceeds from 10% senior subordinated notes		—			150,000			—
Repayment of senior subordinated notes		—			(350,000	)		—
Payment of deferred financing costs		—			(60,053	)		—
Costs associated with equity investment		—			(8,686	)		—
Net repayments on credit facility debt		—			(62,900	)		(84,350	)
Principal payments on seller and other debt		(528	)		(4,004	)		(614	)
Repurchases of common stock, preferred stock and options		—			(1,687,994	)		(41	)
Payment of preferred stock dividends		—			(175,000	)		—
Proceeds from issuance of common stock		1,023			—			—
Borrowing (repayment) of bank overdrafts		—			689			(11,824	)
Distributions to minority interests		(401	)		(1,240	)		(1,604	)
Net cash provided by (used in) financing activities		94			(10,146	)		(98,433	)
Effect of exchange rate changes on cash and cash equivalents		(149	)		584			35
Net decrease in cash and cash equivalents		(91,756	)		(146,356	)		(30,821	)
Cash and cash equivalents at beginning of period		247,476			155,720			35,861
Cash and cash equivalents at end of period	$	155,720		$	9,364		$	5,040
Supplemental Cash Flow Information
Cash paid for interest	$	10,630		$	48,345		$	114,504
Cash paid for taxes	$	1,502		$	8,931		$	21,840

The accompanying notes are an integral part of this statement.

7

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. Basis of Presentation

          Select Medical Holdings Corporation (“Holdings”) was formed in October 2004. On February 24, 2005, Select Medical Corporation (“Select”), merged with a subsidiary of Holdings (“Merger”), formerly known as EGL Holding Company, which resulted in Select becoming a wholly-owned subsidiary of Holdings. Holdings, Select and its subsidiaries are referred to herein as the “Company.” The Company’s financial position and results of operations prior to the Merger are presented separately in the consolidated financial statements as “Predecessor” financial statements, while the Company’s financial position and results of operations following the Merger are presented as “Successor” financial statements. Due to the revaluation of assets as a result of purchase accounting associated with the Merger, the pre-merger financial statements are not comparable with those after the Merger in certain respects.

          The unaudited condensed consolidated financial statements of the Company as of September 30, 2006 (Successor) and for the periods of January 1, 2005 to February 24, 2005 (Predecessor) and February 25, 2005 to September 30, 2005 (Successor), the three months ended September 30, 2005 (Successor) and the three and nine months ended September 30, 2006 (Successor) have been prepared in accordance with generally accepted accounting principles. In the opinion of management, such information contains all adjustments necessary for a fair statement of the results for such periods. All significant intercompany transactions and balances have been eliminated. The results of operations for the three and nine months ended September 30, 2006 are not necessarily indicative of the results to be expected for the full fiscal year ending December 31, 2006.

          Certain information and disclosures normally included in the notes to consolidated financial statements have been condensed or omitted as permitted by the rules and regulations of the Securities and Exchange Commission, although the Company believes the disclosure is adequate to make the information presented not misleading. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2005 contained in Amendment No. 4 to the Company’s Form S-4 filed with the Securities and Exchange Commission on July 28, 2006.

2. Accounting Policies

Use of Estimates

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

Reclassifications

          The Company revised the classification of restricted cash from cash flows from financing activities to cash flows from investing activities for the periods of January 1, 2005 to February 24, 2005 (Predecessor) and February 25, 2005 to September 30, 2005 (Successor). In addition, certain reclassifications have been made to prior periods’ consolidated financial statements and disclosures to conform to current period presentation.

8

Recent Accounting Pronouncements

     In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides guidance on how to evaluate prior period financial statement misstatements for purposes of assessing their materiality in the current period. Correcting prior year financial statements for immaterial misstatements would not require amending previous filings; rather such corrections may be made in subsequent filings. The cumulative effect of initially applying SAB 108, if any, can be recorded as an adjustment to opening retained earnings. SAB 108 does not change the SEC staff’s previous positions regarding qualitative considerations in assessing the materiality of misstatements. SAB 108 is effective for the Company beginning in the fourth quarter of this fiscal year. The Company does not believe SAB 108 will have a material impact on its financial statements.

     In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. The changes to current practice resulting from the application of this Statement relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company does not believe that the adoption of the provisions of SFAS No. 157 will materially impact its consolidated financial statements.

     In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”). SFAS No. 158 requires the employer to recognize the overfunded or underfunded status of a single-employer defined benefit postretirement plan as an asset or liability in its balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. SFAS No. 158 also requires an employer to measure the funded status of a plan as of the date of its year-end balance sheet. SFAS No. 158 is effective for fiscal years ending after December 15, 2006. The Company believes that the adoption of SFAS No. 158 will have no impact on its consolidated financial statements.

     In July 2006, FASB issued Financial Accounting Standards Board Interpretation (“FIN No. 48”), “Accounting for Uncertainty in Income Taxes.” FIN No. 48 is an interpretation of Statement of Financial Accounting Standards (“SFAS No. 109”), “Accounting for Income Taxes.” FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in an enterprise’s tax return. This interpretation also provides guidance on the derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition of tax positions. The recognition threshold and measurement attribute is part of a two step tax position evaluation process prescribed in FIN No. 48. FIN No. 48 is effective after the beginning of an entity’s first fiscal year that begins after December 15, 2006. The Company is currently evaluating its uncertain tax positions as required under the accounting standard in order to implement the new standard during the first quarter of 2007. The Company has not yet determined the impact, if any, to its consolidated financial statements.

     In March 2006, FASB issued SFAS No. 156 “Accounting for Servicing of Financial Assets an amendment of SFAS No. 140” (“SFAS No. 156”). SFAS No. 156 requires that all separately recognized servicing assets and servicing liabilities associated with a transfer of assets (e.g., a sale of receivables) be initially measured at fair value, if practicable. SFAS No. 156 permits, but does not require, the subsequent measurement of servicing assets and servicing liabilities at fair value and requires an entity that uses derivative instruments to mitigate the risks inherent in servicing assets and servicing liabilities to account for those

9

derivative instruments at fair value. SFAS No. 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006 although early adoption is permitted. The Company has evaluated SFAS No. 156 and has determined that there is no impact to the consolidated financial statements.

          In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments – an amendment of FASB Statements No. 133 and No. 140” (“SFAS No. 155”). SFAS No. 155 simplifies the accounting for certain hybrid financial instruments, eliminates the FASB’s interim guidance which provides that beneficial interests in securitized financial assets are not subject to the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and eliminates the restriction on the passive derivative instruments that a qualifying special-purpose entity may hold. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company does not anticipate that the implementation of this standard will have a material impact on its financial position, results of operations or cash flows.

3. Intangible Assets

          Intangible assets consist of the following:

	Successor
	As of September 30, 2006
	Gross Carrying		Accumulated
	Amount		Amortization
	(in thousands)
Amortized intangible assets
Contract therapy relationships	$	20,456	$	(6,478	)
Non-compete agreements		20,809		(5,889	)
Total	$	41,265	$	(12,367	)
Indefinite-lived intangible assets
Goodwill	$	1,319,018
Trademarks		47,058
Certificates of need		3,608
Accreditations		1,892
Total	$	1,371,576

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          Amortization expense for intangible assets with finite lives follows:

	Successor				Predecessor		Successor
							Period
	Three		Three		Period from		from		Nine
	Months		Months		January 1		February		Months
	Ended		Ended		through		25 through		Ended
	September		September		February 24,		September		September
	30, 2005		30, 2006		2005		30, 2005		30, 2006
	(in thousands)
Amortization expense	$	2,580	$	1,953	$	576	$	6,019	$	5,858

          Estimated amortization expense for intangible assets for each of the five years commencing January 1, 2006 will be approximately $7.8 million and primarily relates to the amortization of the value associated with the non-compete agreements entered into in connection with the acquisitions of Kessler Rehabilitation Corporation and SemperCare Inc. and the value assigned to the Company’s contract therapy relationships. The useful lives of the Kessler non-compete, SemperCare non-compete and the Company’s contract therapy relationships are approximately six, seven and five years, respectively.

          The changes in the carrying amount of goodwill for the Company’s reportable segments for the nine months ended September 30, 2006 are as follows:

	Specialty		Outpatient
	Hospitals		Rehabilitation		Total
	(in thousands)
Balance as of December 31, 2005	$	1,221,776	$	83,434	$	1,305,210
Tax adjustments related to Merger		112		10,800		10,912
Goodwill acquired during year		299		1,201		1,500
Earnouts		—		100		100
Other		—		1,296		1,296
Balance as of September 30, 2006	$	1,222,187	$	96,831	$	1,319,018

          In conjunction with recording the gain on sale of the Canadian Back Institute Limited (“CBIL”) (Note 6), the Company determined that deferred taxes should have been recorded as of the date of the Merger related to differences between the Company’s book and tax investment basis in CBIL. This adjustment was recorded in the first quarter of 2006 and is not considered to be material on a qualitative or quantitative basis.

4. Accumulated Other Comprehensive Income

          The components of accumulated other comprehensive income at December 31, 2005 consist of cumulative translation adjustment gains of $1.8 million, associated with the Company’s Canadian subsidiary which was sold on March 1, 2006 (Note 6) and a gain of $3.5 million, net of tax of $2.5 million, on interest

11

rate swap transactions. At September 30, 2006, accumulated other comprehensive income consisted of a gain of $4.6 million, net of tax of $3.3 million, on interest rate swap transactions.

5. Segment Information

          The Company’s segments consist of (i) specialty hospitals and (ii) outpatient rehabilitation. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. All other primarily includes the Company’s general and administrative services. The Company evaluates performance of the segments based on Adjusted EBITDA. Adjusted EBITDA is defined as net income (loss) before interest, income taxes, stock compensation expense, long-term incentive compensation, depreciation and amortization, income from discontinued operations, loss on early retirement of debt, merger related charges, other income and minority interest.

          The following table summarizes selected financial data for the Company’s reportable segments:

	Successor
	Three Months Ended September 30, 2005
	Specialty		Outpatient
	Hospitals		Rehabilitation		All Other			Total
	(in thousands)
Net operating revenue	$	341,835	$	118,263	$	560		$	460,658
Adjusted EBITDA		77,571		15,302		(11,417	)		81,456
Total assets		1,589,460		516,697		38,674			2,144,831
Capital expenditures		13,814		324		113			14,251

	Successor
	Three Months Ended September 30, 2006
	Specialty		Outpatient
	Hospitals		Rehabilitation		All Other			Total
	(in thousands)
Net operating revenue	$	329,324	$	114,043	$	505		$	443,872
Adjusted EBITDA		60,812		15,737		(8,896	)		67,653
Total assets		1,773,586		254,865		102,610			2,131,061
Capital expenditures		38,671		876		771			40,318

	Predecessor
	Period from January 1 through February 24, 2005
	Specialty		Outpatient
	Hospitals		Rehabilitation		All Other			Total
	(in thousands)
Net revenue	$	202,781	$	73,344	$	1,611		$	277,736
Adjusted EBITDA		44,384		9,848		(7,701	)		46,531
Total assets		904,754		239,019		87,640			1,231,413
Capital expenditures		1,165		408		1,013			2,586

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	Successor
	Period from February 25 through September 30, 2005
	Specialty		Outpatient
	Hospitals		Rehabilitation		All Other			Total
	(in thousands)
Net revenue	$	828,606	$	291,019	$	3,123		$	1,122,748
Adjusted EBITDA		190,927		42,566		(27,495	)		205,998
Total assets		1,589,460		516,697		38,674			2,144,831
Capital expenditures		66,943		937		2,579			70,459

	Successor
	Nine Months Ended September 30, 2006
	Specialty		Outpatient
	Hospitals		Rehabilitation		All Other			Total
	(in thousands)
Net revenue	$	1,049,768	$	353,974	$	2,014		$	1,405,756
Adjusted EBITDA		218,203		48,920		(30,574	)		236,549
Total assets		1,773,586		254,865		102,610			2,131,061
Capital expenditures		107,001		3,827		1,304			112,132

13

A reconciliation of net income (loss) to Adjusted EBITDA is as follows:

	Successor					Predecessor			Successor
	Three			Three		Period from			Period from			Nine
	Months			Months		January 1			February 25			Months
	Ended			Ended		through			through			Ended
	September			September		February			September			September
	30, 2005			30, 2006		24, 2005			30, 2005			30, 2006
	(in thousands)
Net income (loss)	$	15,367		$	12,544		$(100,251	)	$	54,476		$	68,004
Income from discontinued operations, net of tax		(1,061	)		—		(522	)		(3,367	)		(10,018	)
Income tax expense (benefit)		9,800			8,717		(59,794	)		34,702			41,889
Minority interest		494			369		330			1,350			1,095
Interest expense, net		29,398			32,683		4,128			69,365			97,787
Other expense (income)		(247	)		—		(267	)		(658	)		—
Merger related charges		—			—		12,025			—			—
Loss on early retirement of debt		—			—		42,736			—			—
Depreciation and amortization		11,828			12,394		5,933			28,110			34,955
Stock compensation expense:
Included in general and administrative		1,366			888		115,025			7,438			2,663
Included in cost of services		58			58		27,188			129			174
Long-term incentive compensation (1)		14,453			—		—			14,453			—
Adjusted EBITDA	$	81,456		$	67,653		$   46,531		$	205,998		$	236,549

1) For the three months ended September 30, 2005 and for the period from February 25 through September 30, 2005, $14.5 million of long-term compensation expense was included in general administrative expense on the Company’s consolidated statement of operations.

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6. Discontinued Operations

          On December 23, 2005, the Company agreed to sell all of the issued and outstanding shares of its wholly-owned subsidiary, Canadian Back Institute Limited (“CBIL”), for approximately C$89.8 million (US$79.0 million). The sale was completed on March 1, 2006. CBIL operated 109 outpatient rehabilitation clinics in seven Canadian provinces. The Company operated all of its Canadian activity through CBIL. The purchase price is subject to adjustment based on the amount of net working capital and long term liabilities of CBIL and its subsidiaries on the closing date. CBIL’s assets and liabilities have been classified as held for sale at December 31, 2005 and its operating results have been classified as discontinued operations and cash flows have been included with continuing operations for the period from January 1, 2005 through February 24, 2005, the period from February 25, 2005 through September 30, 2005 and the three months ended September 30, 2005 and the nine months ended September 30, 2006. Previously, the operating results of this subsidiary were included in the Company’s outpatient rehabilitation segment.

	Successor		Predecessor		Successor
			Period from		Period from		For the Two
	Three Months		January 1		February 25		Months
	Ended		through		through		Ended
	September 30,		February 24,		September		February 28,
	2005		2005		30, 2005		2006 (1)
			(in thousands)
Net revenue	$	17,040	$	10,051	$	41,702	$	12,902
Income from discontinued operations before income tax expense		1,708		950		5,563		15,547
Income tax expense		647		428		2,196		5,529
Income from discontinued operations, net of tax	$	1,061	$	522	$	3,367	$	10,018

(1) The income from discontinued operations before income taxes includes a gain on sale of approximately $14.0 million.

7. Commitments and Contingencies

Litigation

          On August 24, 2004, Clifford C. Marsden and Ming Xu filed a purported class action complaint in the United States District Court for the Eastern District of Pennsylvania on behalf of the public stockholders of Select against Martin F. Jackson, Robert A. Ortenzio, Rocco A. Ortenzio, Patricia A. Rice and Select. In February 2005, the Court appointed James Shaver, Frank C. Bagatta and Capital Invest, die Kapitalanlagegesellschaft der Bank Austria Creditanstalt Gruppe GmbH as lead plaintiffs (“Lead Plaintiffs”).

          On April 19, 2005, Lead Plaintiffs filed an amended complaint, purportedly on behalf of a class of shareholders of Select, against Martin F. Jackson, Robert A. Ortenzio, Rocco A. Ortenzio, Patricia A. Rice, and Select as defendants. The amended complaint continues to allege, among other things, failure to disclose adverse information regarding a potential regulatory change affecting reimbursement for Select’s services applicable to long-term acute care hospitals operated as hospitals within hospitals, and the issuance of false and misleading statements about the financial outlook of Select. The amended complaint seeks, among other things, damages in an unspecified amount, interest and attorneys’ fees. The Company believes that the allegations in the amended complaint are without merit and intends to vigorously defend against this action. In April 2006, the Court granted in part and denied in part Select and the individual officers’ preliminary motion to dismiss the amended complaint. Select and the individual officers have answered the amended complaint and the case has

15

moved to the discovery and class certification phase. The Company does not believe this claim will have a material adverse effect on its financial position or results of operations. However, due to the uncertain nature of such litigation, the Company cannot predict the outcome of this matter.

          The Company is subject to legal proceedings and claims that arise in the ordinary course of its business, which include malpractice claims covered under insurance policies. In the Company’s opinion, the outcome of these actions will not have a material adverse effect on the financial position or results of operations of the Company.

          To cover claims arising out of the operations of the Company’s hospitals and outpatient rehabilitation facilities, the Company maintains professional malpractice liability insurance and general liability insurance. The Company also maintains umbrella liability insurance covering claims which, due to their nature or amount, are not covered by or not fully covered by the Company’s other insurance policies. These insurance policies also do not generally cover punitive damages and are subject to various deductibles and policy limits. Significant legal actions as well as the cost and possible lack of available insurance could subject the Company to substantial uninsured liabilities.

          Health care providers are often subject to lawsuits under the qui tam provisions of the federal False Claims Act. Qui tam lawsuits typically remain under seal (hence, usually unknown to the defendant) for some time while the government decides whether or not to intervene on behalf of a private qui tam plaintiff (known as a relator) and take the lead in the litigation. These lawsuits can involve significant monetary damages and penalties and award bounties to private plaintiffs who successfully bring the suits. A qui tam lawsuit against Select has been filed in the United States District Court for the District of Nevada, but because the action is still under seal, the Company does not know the details of the allegations or the relief sought. As is required by law, the federal government is conducting an investigation of matters alleged by this complaint. The Company has received subpoenas for patient records and other documents apparently related to the federal government’s investigation. The Company believes that this investigation involves the billing practices of certain of its subsidiaries that provide outpatient services to beneficiaries of Medicare and other federal health care programs. The three relators in this qui tam lawsuit are two former employees of the Company’s Las Vegas, Nevada subsidiary who were terminated by Select in 2001 and a former employee of the Company’s Florida subsidiary who the Company asked to resign. Select sued the former Las Vegas employees in state court in Nevada in 2001 for, among other things, return of misappropriated funds, and the Company’s lawsuit has recently been transferred to the federal court in Las Vegas. While the government has investigated but chosen not to intervene in two previous qui tam lawsuits filed against Select, the Company cannot provide assurance that the government will not intervene in the Nevada qui tam case or any other existing or future qui tam lawsuit against the Company. While litigation is inherently uncertain, the Company believes, based on its prior experiences with qui tam cases and the limited information currently available to the Company, that the Nevada qui tam action will not have a material adverse effect on the Company.

Other

          At September 30, 2006, the Company has outstanding commitments under construction contracts at six long-term acute care properties and one of its inpatient rehabilitation facilities totaling $27.2 million.

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

     You should read this discussion together with our unaudited consolidated financial statements and the accompanying notes.

Forward Looking Statements

     This discussion contains forward-looking statements relating to the financial condition, results of operations, plans, objectives, future performance and business of Select Medical Holdings Corporation. These statements include, without limitation, statements preceded by, followed by or that include the words “believes,” “expects,” “anticipates,” “estimates” or similar expressions. These forward-looking statements involve risks and uncertainties. Actual results may differ materially from those contemplated by the forward-looking statements due to factors including the following:

• compliance with the Medicare “hospital within a hospital” regulation changes will require increased capital expenditures and may have an adverse effect on our future net operating revenues and profitability;

• changes in government reimbursement for our services may have an adverse effect on our future net operating revenues and profitability, such as the regulations adopted by the Centers for Medicare & Medicaid Services, also known as CMS, on May 2, 2006;

• the failure of our long-term acute care hospitals to maintain their status as such may cause our net operating revenues and profitability to decline;

• the failure of our facilities operated as “hospitals within hospitals” to qualify as hospitals separate from their host hospitals may cause our net operating revenues and profitability to decline;

• implementation of modifications to the admissions policies for our inpatient rehabilitation facilities, as required to achieve compliance with Medicare guidelines, may result in a loss of patient volume at these hospitals and, as a result, may reduce our future net operating revenues and profitability;

• implementation of annual caps that limit the amounts that can be paid for outpatient therapy services rendered to any Medicare beneficiary may reduce our future net operating revenues and profitability;

• changes in applicable regulations or a government investigation or assertion that we have violated applicable regulations may result in increased costs or sanctions that reduce our net operating revenues and profitability;

• integration of recently acquired operations and future acquisitions may prove difficult or unsuccessful, use significant resources or expose us to unforeseen liabilities;

• private third-party payors for our services may undertake future cost containment initiatives that limit our future net operating revenues and profitability;

• the failure to maintain established relationships with the physicians in our markets could reduce our net operating revenues and profitability;

• shortages in qualified nurses or therapists could increase our operating costs significantly;

• competition may limit our ability to grow and result in a decrease in our net operating revenues and profitability;

• the loss of key members of our management team could significantly disrupt our operations; and

• the effect of claims asserted against us or lack of adequate available insurance could subject us to substantial uninsured liabilities.

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Overview

     We are a leading operator of specialty hospitals in the United States. We are also a leading operator of outpatient rehabilitation clinics in the United States. As of September 30, 2006, we operated 93 long-term acute care hospitals in 26 states, four acute medical rehabilitation hospitals which are certified by Medicare as inpatient rehabilitation facilities in New Jersey, and 605 outpatient rehabilitation clinics in 24 states and the District of Columbia. We also provide medical rehabilitation services on a contract basis at 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.

     We manage our company through two business segments, our specialty hospital segment and our outpatient rehabilitation segment. We had net operating revenues of $1,405.8 million for the nine months ended September 30, 2006. 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 in our long-term acute care hospitals typically suffer from serious and often complex medical conditions that require a high degree of care. Patients in our inpatient rehabilitation facilities typically suffer from debilitating injuries, including traumatic brain and spinal cord injuries, and require rehabilitation care in the form of physical and vocational rehabilitation services. Our outpatient rehabilitation business consists of clinics and contract services that provide physical, occupational and speech rehabilitation services. Our outpatient rehabilitation patients are typically diagnosed with musculoskeletal impairments that restrict their ability to perform normal activities of daily living.

Recent Trends and Events

     CBIL Sale

     On March 1, 2006, we sold our wholly-owned subsidiary, Canadian Back Institute Limited (“CBIL”), for approximately C$89.8 million in cash (US$79.0 million). As of December 31, 2005, CBIL operated 109 outpatient rehabilitation clinics in seven Canadian provinces. We conducted all of our Canadian operations through CBIL. The purchase price is subject to a post-closing adjustment based on the amount of net working capital and long term liabilities of CBIL and its subsidiaries on the closing date. The financial results of CBIL have been reclassified as discontinued operations for all periods presented in this report, and its assets and liabilities have been reclassified as held for sale on our December 31, 2005 balance sheet. We have recognized a gain on sale (net of tax) of $9.1 million in the first quarter ended March 31, 2006.

     Third Quarter Ended September 30, 2006

     For the three months ended September 30, 2006, our net operating revenues decreased 3.6% to $443.9 million compared to $460.7 million for the three months ended September 30, 2005. This decrease in net operating revenues was attributable to a decline in both our specialty hospital net operating revenues and our outpatient rehabilitation net operating revenues. The decline in our specialty hospital net operating revenues is primarily a result of a decrease in our Medicare net revenues due to LTACH regulatory changes that have reduced the payment rates and a decline in Medicare volume. The decline in our outpatient net operating revenues is due to a decline in the number of clinics we operate and the volume of visits occurring at the operating clinics. We realized income from operations for the three months ended September 30, 2006 of $54.3 million compared to $53.8 million for the three months ended September 30, 2005. Interest expense for the three

18

months ended September 30, 2006 was $33.0 million compared to $29.6 million for the three months ended September 30, 2005.

     For the nine months ended September 30, 2006, our net operating revenues increased 0.4% to $1,405.8 million compared to $1,400.5 million for the combined nine months ended September 30, 2005. This increase in net operating revenues was attributable to a 1.8% increase in our specialty hospital net operating revenues offset by a 2.9% decline in our outpatient rehabilitation net operating revenues that resulted from a decline in the number of clinics we operate and in the volume of visits occurring at the operating clinics. We had income from operations for the nine months ended September 30, 2006 of $198.8 million compared to $54.3 million for the combined nine months ended September 30, 2005. For the combined nine month period ended September 30, 2005, we incurred $149.8 million of stock compensation costs as a result of the Merger. Interest expense for the nine months ended September 30, 2006 was $98.5 million compared to $74.5 million for the combined nine months ended September 30, 2005. This increase resulted from the significant increase in Merger related debt that occurred on February 25, 2005.

     Our cash flow from operations provided $105.2 million of cash for the nine months ended September 30, 2006.

Regulatory Changes

     On May 2, 2006, CMS released its final annual payment rate updates for the 2007 LTCH-PPS rate year (affecting discharges and cost reporting periods beginning on or after July 1, 2006 and before July 1, 2007). The May 2006 final rule made several changes to LTCH-PPS payment methodologies and amounts which affect our long-term acute care hospitals.

     For discharges occurring on or after July 1, 2006, the rule changes the payment methodology for Medicare patients with a length of stay less than or equal to five-sixths of the geometric average length of stay for each LTC-DRG (referred to as “short-stay outlier” or “SSO” cases). Previously, payment for these patients was based on the lesser of (1) 120 percent of the cost of the case; (2) 120 percent of the LTC-DRG specific per diem amount multiplied by the patient’s length of stay; or (3) the full LTC-DRG payment. The final rule modifies the limitation in clause (1) above to reduce payment for SSO cases to 100 percent (rather than 120 percent) of the cost of the case. The final rule also adds a fourth limitation, capping payment for SSO cases at a per diem rate derived from blending 120 percent of the LTC-DRG specific per diem amount with a per diem rate based on the general acute care hospital inpatient prospective payment system (“IPPS”). Under this methodology, as a patient’s length of stay increases, the percentage of the per diem amount based upon the IPPS component will decrease and the percentage based on the LTC-DRG component will increase.

     In addition, for discharges occurring on or after July 1, 2006, the final rule provides for (i) a zero-percent update for the 2007 LTCH-PPS rate year to the LTCH-PPS standard federal rate used as a basis for LTCH-PPS payments; (ii) the elimination of the surgical case exception to the three-day or less interruption of stay policy, under which surgical exception Medicare reimburses a general acute care hospital directly for surgical services furnished to a long-term acute care hospital patient during a brief interruption of stay from the long-term acute care hospital, rather than requiring the long-term acute care hospital to bear responsibility for such surgical services; and (iii) increasing the costs that a long-term acute care hospital must bear before Medicare will make additional payments for a case under its high-cost outlier policy for the 2007 LTCH-PPS rate year.

CMS estimates that the changes in the May 2006 final rule will result in an approximately 3.7 percent decrease in LTCH Medicare payments-per-discharge as compared to the 2006 rate year, largely attributable to the revised SSO payment methodology. Based upon our historical Medicare patient volumes and revenues, we expect that

19

the May 2006 final rule will reduce Medicare revenues associated with SSO cases and high cost outlier cases to our long-term acute care hospitals by approximately $30.0 million on an annual basis. For the three months ended September 30, 2006, we estimate the reduction in Medicare payments for discharges occurring during this period related to the rule change approximated $7.2 million.

     Additionally, had CMS updated the LTCH-PPS standard federal rate by the 2007 estimated market basket index of 3.4 percent rather than applying the zero-percent update, we estimate that we would have received approximately $31.0 million in additional annual Medicare revenues, based on our historical Medicare patient volumes and revenues (such revenues would have been paid to our hospitals for discharges beginning on or after July 1, 2006).

     On August 11, 2004, CMS published final regulations applicable to long-term acute care hospitals that are operated as “hospitals within hospitals” or as “satellites” (collectively referred to as “HIHs”). HIHs are separate hospitals located in space leased from, and located in, general acute care hospitals, known as “host” hospitals. As of September 30, 2006, we operated 93 long-term acute care hospitals, 82 of which operated as HIHs. Effective for hospital cost reporting periods beginning on or after October 1, 2004, subject to certain exceptions, the final regulations provide lower rates of reimbursement to HIHs for those Medicare patients admitted from their hosts that are in excess of a specified percentage threshold. For HIHs opened after October 1, 2004, the Medicare admissions threshold has been established at 25%. For HIHs that meet specified criteria and were in existence as of October 1, 2004, including all of our existing HIHs, the Medicare admissions thresholds will be phased-in over a four-year period starting with hospital cost reporting periods beginning on or after October 1, 2004, as follows: (i) for discharges during the cost reporting period beginning on or after October 1, 2004 and before October 1, 2005, the Medicare admissions threshold is the Fiscal 2004 Percentage (as defined below) of Medicare discharges admitted from the host hospital; (ii) for discharges during the cost reporting period beginning on or after October 1, 2005 and before October 1, 2006, the Medicare admissions threshold is the lesser of the Fiscal 2004 Percentage of Medicare discharges admitted from the host hospital or 75%; (iii) for discharges during the cost reporting period beginning on or after October 1, 2006 and before October 1, 2007, the Medicare admissions threshold is the lesser of the Fiscal 2004 Percentage of Medicare discharges admitted from the host hospital or 50%; and (iv) for discharges during cost reporting periods beginning on or after October 1, 2007, the Medicare admissions threshold is 25%. As used above, “Fiscal 2004 Percentage” means, with respect to any HIH, the percentage of all Medicare patients discharged by such HIH during its cost reporting period beginning on or after October 1, 2003 and before October 1, 2004 who were admitted to such HIH from its host hospital, but in no event is the Fiscal 2004 Percentage less than 25%. We have developed a business plan and strategy in each of our markets to adapt to the HIH regulations and maintain our Company’s current business. Our transition plan includes managing admissions at existing HIHs, relocating certain HIHs to leased spaces in smaller host hospitals in the same markets, consolidating HIHs in certain of our markets, relocating certain of our facilities to alternative settings, building or buying free-standing facilities and closing some of our facilities. At this time we cannot predict with any certainty the impact on revenues or operating expenses at the hospitals being moved. If CMS implements certain additional regulatory changes that it has proposed and discussed and that would affect long-term acute care hospitals more generally, our plan would have to be further modified.

     During the three months and nine months ended September 30, 2006, we have recorded a liability of approximately $1.5 million and $2.5 million, respectively, related to estimated repayments to Medicare for host admissions exceeding a HIH hospital’s threshold. The liability has been recorded through a reduction in our net revenue. Because these rules are complex and are based on the volume of Medicare admissions from our host hospitals as a percent of our overall Medicare admissions, we cannot predict with any certainty the impact on our future net operating revenues of compliance with these regulations. Although, we expect the financial impact to increase as the thresholds decline during the phase-in of the regulations and the execution of our transition plan.

     The new HIH regulations established exceptions to the Medicare admissions thresholds with respect to patients who reach “outlier” status at the host hospital, HIHs located in “MSA-dominant hospitals” or HIHs located in rural areas.

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Development of New Specialty Hospitals and Clinics

     We expect to continue evaluating opportunities to develop new long-term acute care hospitals. Additionally, we are evaluating opportunities to develop free-standing inpatient rehabilitation facilities similar to the four inpatient rehabilitation facilities acquired through our September 2003 Kessler acquisition. We also intend to open new outpatient rehabilitation clinics in our current markets where we can benefit from existing referral relationships and brand awareness to produce incremental growth.

Operating Statistics

     The following table sets forth operating statistics for our specialty hospitals and our outpatient rehabilitation clinics for each of the periods presented. The data in the table reflect the changes in the number of specialty hospitals and outpatient rehabilitation clinics we operate that resulted from acquisitions, start-up activities, closures and consolidations. The operating statistics reflect data for the period of time these operations were managed by us.

	Three Months						Nine Months
	Ended						Ended
	September 30,						September 30,
	2005			2006			2005			2006
Specialty hospital data(1):
Number of hospitals — start of period		102			100			86			101
Number of hospital start-ups		—			1			—			3
Number of hospitals closed		(1	)		(3	)		(2	)		(4	)
Number of hospitals consolidated		—			(1	)		—			(3	)
Number of hospitals acquired		—			—			17			—
Number of hospitals — end of period		101			97			101			97
Available licensed beds		3,814			3,825			3,814			3,825
Admissions		9,725			9,485			30,056			30,122
Patient days		242,850			236,094			739,860			734,070
Average length of stay (days)		25			25			25			24
Net revenue per patient day(2)	$	1,385		$	1,361		$	1,371		$	1,401
Occupancy rate		69	%		66	%		70	%		69	%
Percent patient days — Medicare		75	%		72	%		76	%		73	%
Outpatient rehabilitation data (3):
Number of clinics owned — start of period		574			542			589			553
Number of clinic start-ups		2			2			17			7
Number of clinics closed/sold		(10	)		(7	)		(40	)		(23	)
Number of clinics owned — end of period		566			537			566			537
Number of clinics managed — end of period		55			68			55			68
Total number of clinics (all) — end of period		621			605			621			605
Number of visits		805,018			714,064			2,532,157			2,261,080
Net revenue per visit (4)	$	89		$	95		$	89		$	93

(1) Specialty hospitals consist of long-term acute care hospitals and inpatient rehabilitation facilities.

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(2)	Net revenue per patient day is calculated by dividing specialty hospital patient service revenues by the total number of patient days.
(3)	Clinic data has been restated to remove the clinics operated by CBIL, which is being reported as a discontinued operation. Occupational health clinics have been reclassified as managed clinics.
(4)	Net revenue per visit is calculated by dividing outpatient rehabilitation clinic revenue by the total number of visits. For purposes of this computation, outpatient rehabilitation clinic revenue does not include contract services revenue.

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Results of Operations

     On February 24, 2005, Select Medical Corporation (“Select”) consummated a Merger with a wholly-owned subsidiary of ours pursuant to which Select became our wholly-owned subsidiary. Although the Predecessor and Successor results are not comparable by definition due to the Merger and the resulting change in basis, for ease of comparison in the following discussion and to assist the reader in understanding our operating performance and trends, the financial data for the period after the Merger, February 25, 2005 through September 30, 2005 (Successor period), has been added to the financial data for the period from January 1, 2005 through February 24, 2005 (Predecessor period), to arrive at the combined nine months ended September 30, 2005. The combined data is referred to herein as the combined nine months ended September 30, 2005. As a result of the Merger, certain of our costs and expenses have been affected by increased interest expense, loss on early retirement of debt, merger related charges, a significant stock compensation charge allocated to cost of services and general and administrative expense and increases in depreciation and amortization due to the revaluation of our tangible and intangible assets. We believe this combined presentation is a reasonable means of presenting our operating results. The following table presents the combined consolidated statement of operations for the nine months ended September 30, 2005.

	Predecessor			Successor			Combined
				Period
	Period from			from			Nine
	January 1			February			Months
	through			25 through			Ended
	February			September			September
	24, 2005			30, 2005			30, 2005
	(in thousands)
Net operating revenues	$	277,736		$	1,122,748		$	1,400,484
Costs and expenses:
Cost of services		244,321			875,566			1,119,887
General and administrative		122,509			48,960			171,469
Bad debt expense		6,588			14,244			20,832
Depreciation and amortization		5,933			28,110			34,043
Total costs and expenses		379,351			966,880			1,346,231
Income (loss) from operations		(101,615	)		155,868			54,253
Other income and expense:
Loss on early retirement of debt		(42,736	)		—			(42,736	)
Merger related charges		(12,025	)		—			(12,025	)
Other income		267			658			925
Interest income		523			511			1,034
Interest expense		(4,651	)		(69,876	)		(74,527	)
Income (loss) from continuing operations before minority interests and income taxes		(160,237	)		87,161			(73,076	)
Minority interest in consolidated subsidiary companies		330			1,350			1,680
Income (loss) from continuing operations before income taxes		(160,567	)		85,811			(74,756	)
Income tax expense (benefit)		(59,794	)		34,702			(25,092	)
Income (loss) from continuing operations		(100,773	)		51,109			(49,664	)
Income from discontinued operations, net of tax		522			3,367			3,889
Net income (loss)	$	(100,251	)	$	54,476		$	(45,775	)

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     The following table outlines, for the periods indicated, selected operating data as a percentage of net operating revenues:

	Three Months						Nine Months
	Ended						Ended
	September 30,						September 30,
	2005			2006			2005 (1)			2006
Net operating revenues		100.0	%		100.0	%		100.0	%		100.0	%
Cost of services(2)		78.9			81.6			80.0			79.7
General and administrative		5.9			2.2			12.2			2.4
Bad debt expense		1.0			1.2			1.5			1.3
Depreciation and amortization		2.6			2.8			2.4			2.5
Income from operations		11.6			12.2			3.9			14.1
Loss on early retirement of debt		—			—			(3.1	)		—
Merger related charges		—			—			(0.9	)		—
Other income		0.1			—			0.1			—
Interest expense, net		(6.4	)		(7.3	)		(5.2	)		(6.9	)
Income (loss) from continuing operations before minority interests and income taxes		5.3			4.9			(5.2	)		7.2
Minority interests		0.1			0.1			0.1			0.1
Income (loss) from continuing operations before income taxes		5.2			4.8			(5.3	)		7.1
Income tax expense (benefit)		2.1			2.0			(1.8	)		3.0
Income (loss) from continuing operations		3.1			2.8			(3.5	)		4.1
Income from discontinued operations, net of tax		0.2			—			0.3			0.7
Net income (loss)		3.3	%		2.8	%		(3.2	)%		4.8	%

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     The following table summarizes selected financial data by business segment, for the periods indicated:

	Three Months Ended									Nine Months Ended
	September 30,									September 30,
	2005			2006			% Change			2005 (1)			2006			% Change
	(in thousands)									(in thousands)
Net operating revenues:
Specialty hospitals	$	341,835		$	329,324			(3.7	)%	$	1,031,387		$	1,049,768			1.8	%
Outpatient rehabilitation		118,263			114,043			(3.6	)		364,363			353,974			(2.9	)
Other		560			505			(9.8	)		4,734			2,014			(57.5	)
Total company	$	460,658		$	443,872			(3.6	)%	$	1,400,484		$	1,405,756			0.4	%
Income (loss) from operations:
Specialty hospitals	$	70,675		$	52,424			(25.8	)%	$	214,957		$	195,291			(9.1	)%
Outpatient rehabilitation		12,778			12,493			(2.2	)		44,980			39,161			(12.9	)
Other		(29,702	)		(10,604	)		64.3			(205,684	)		(35,695	)		82.6
Total company	$	53,751		$	54,313			1.0	%	$	54,253		$	198,757			266.4	%
Adjusted EBITDA:(3)
Specialty hospitals	$	77,571		$	60,812			(21.6	)%	$	235,311		$	218,203			(7.3	%)
Outpatient rehabilitation		15,302			15,737			2.8			52,414			48,920			(6.7	)
Other		(11,417	)		(8,896	)		22.1			(35,196	)		(30,574	)		13.1
Adjusted EBITDA margins:(3)
Specialty hospitals		22.7	%		18.5	%		(18.5	)%		22.8	%		20.8	%		(8.8	)%
Outpatient rehabilitation		12.9			13.8			7.0			14.4			13.8			(4.2	)
Other		N/M			N/M			N/M			N/M			N/M			N/M
Total assets:
Specialty hospitals	$	1,589,460		$	1,773,586					$	1,589,460		$	1,773,586
Outpatient rehabilitation		516,697			254,865						516,697			254,865
Other		38,674			102,610						38,674			102,610
Total company	$	2,144,831		$	2,131,061					$	2,144,831		$	2,131,061
Purchases of property and equipment, net:
Specialty hospitals	$	13,814		$	38,671					$	68,108		$	107,001
Outpatient rehabilitation		324			876						1,345			3,827
Other		113			771						3,592			1,304
Total company	$	14,251		$	40,318					$	73,045		$	112,132

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     The following table reconciles same hospitals information:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2005			2006			2005 (1)			2006
	(in thousands)						(in thousands)
Net operating revenue
Specialty hospitals net operating revenue	$	341,835		$	329,324		$	1,031,387		$	1,049,768
Less: Specialty hospitals in development or closed after 1/1/05		10,210			5,195			39,064			21,947
Specialty hospitals same store net operating revenue	$	331,625		$	324,129		$	992,323		$	1,027,821
Adjusted EBITDA(3)
Specialty hospitals Adjusted EBITDA(3)	$	77,571		$	60,812		$	235,311		$	218,203
Less: Specialty hospitals in development or closed after 1/1/05		903			(3,193	)		3,908			(5,671	)
Specialty hospitals same store Adjusted EBITDA(3)	$	76,668		$	64,005		$	231,403		$	223,874
All specialty hospitals Adjusted EBITDA margin(3)		22.7	%		18.5	%		22.8	%		20.8	%
Specialty hospitals same store Adjusted EBITDA margin(3)		23.1	%		19.7	%		23.3	%		21.8	%

N/M — Not Meaningful.

(1)	The financial data for the period after the Merger, February 25, 2005 through September 30, 2005 (Successor period), has been added to the financial data for the period from January 1, 2005 through February 24, 2005 (Predecessor period), to arrive at the combined nine months ended September 30, 2005.
(2)	Cost of services include salaries, wages and benefits, operating supplies, lease and rent expense and other operating costs.
(3)	We define Adjusted EBITDA as net income before interest, income taxes, depreciation and amortization, other income, income from discontinued operations, loss on early retirement of debt, merger related charges, stock compensation expense, long-term incentive compensation and minority interest. We believe that the presentation of Adjusted EBITDA is important to investors because 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. See footnote 5 to our interim unaudited consolidated financial statements for the period ended September 30, 2006 for a reconciliation of net income to Adjusted EBITDA as utilized by us in reporting our segment performance in accordance with SFAS No. 131.

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Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005

Net Operating Revenues

     Our net operating revenues decreased by 3.6% to $443.9 million for the three months ended September 30, 2006 compared to $460.7 million for the three months ended September 30, 2005.

     Specialty Hospitals.Our specialty hospital net operating revenues decreased 3.7% to $329.3 million for the three months ended September 30, 2006 compared to $341.8 million for the three months ended September 30, 2005. Net operating revenues for the specialty hospitals opened or acquired as of January 1, 2005 and operated by us throughout both periods decreased 2.3% to $324.1 million for the three months ended September 30, 2006 from $331.6 million for the three months ended September 30, 2005. This decrease resulted primarily from a decrease in our Medicare net revenues due to LTACH regulatory changes that have reduced the payment rates and a decline in Medicare volume. Our patient days for these same store hospitals decreased 1.3%. This decrease in patient days was due to a decline in the average length of stay in our long-term acute care hospitals from 27 days for the three months ended September 30, 2005 to 26 days for the three months ended September 30, 2006. Additionally, our occupancy percentage decreased to 67% for the three months ended September 30, 2006 compared to 69% for the three months ended September 30, 2005.

     Outpatient Rehabilitation.Our outpatient rehabilitation net operating revenues declined 3.6% to $114.0 million for the three months ended September 30, 2006 compared to $118.3 million for the three months ended September 30, 2005. The number of patient visits in our outpatient rehabilitation clinics declined 11.3% for the three months ended September 30, 2006 to 714,064 visits compared to 805,018 visits for the three months ended September 30, 2005. The decrease in net operating revenues and patient visits was principally related to a 5.1% decline in the number of clinics we own and a 6.5% decline in the volume of visits per clinic. We are continuing to experience declines in our patient visits in a number of markets as a result of physicians opening competing physical therapy practices. Net revenue per visit in our clinics was $95 for the three months ended September 30, 2006 compared to $89 for the three months ended September 30, 2005.

     Other.Our other revenues were $0.5 million for the three months ended September 30, 2006 compared to $0.6 million for the three months ended September 30, 2005. These revenues relate to revenue from other non-healthcare services.

Operating Expenses

     Our operating expenses decreased by 4.5% to $377.2 million for the three months ended September 30, 2006 compared to $395.1 million for the three months ended September 30, 2005. Our operating expenses include our cost of services, general and administrative expense and bad debt expense. As a percentage of our net operating revenues, our operating expenses were 85.0% for the three months ended September 30, 2006 compared to 85.8% for the three months ended September 30, 2005. Cost of services as a percentage of operating revenues was 81.6% for the three months ended September 30, 2006 compared to 78.9% for the three months ended September 30, 2005. These costs primarily reflect our labor expenses. Another component of cost of services is facility rent expense, which was $20.0 million for the three months ended September 30, 2006 compared to $20.2 million for the three months ended September 30, 2005. During the same time period, general and administrative expense declined in total, and as a percentage of net operating revenues. General and administrative expenses were 2.2% of net operating revenues for the three months ended September 30, 2006

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compared to 5.9% for the three months ended September 30, 2005. Our general and administrative expenses for the three months ended September 30, 2005 included $14.5 million paid under the terms of Holdings’ long-term incentive compensation plan. Our bad debt expense as a percentage of net operating revenues was 1.2% for the three months ended September 30, 2006 compared to 1.0% for the three months ended September 30, 2005.

Adjusted EBITDA

     Specialty Hospitals. Adjusted EBITDA decreased by 21.6% to $60.8 million for the three months ended September 30, 2006 compared to $77.6 million for the three months ended September 30, 2005. Our Adjusted EBITDA margins decreased to 18.5% for the three months ended September 30, 2006 from 22.7% for the three months ended September 30, 2005. The hospitals opened or acquired as of January 1, 2005 and operated by us throughout both periods had Adjusted EBITDA of $64.0 million for the three months ended September 30, 2006, a decrease of 16.5% over the Adjusted EBITDA of these hospitals for the three months ended September 30, 2005. Our Adjusted EBITDA margin in these same store hospitals decreased to 19.7% for the three months ended September 30, 2006 from 23.1% for the three months ended September 30, 2005. The decrease in our adjusted EBITDA is principally related to the reduction in our Medicare net operating revenues resulting from LTACH regulatory changes that have reduced our payment rates for Medicare cases.

     Outpatient Rehabilitation. Adjusted EBITDA increased by 2.8% to $15.7 million for the three months ended September 30, 2006 compared to $15.3 million for the three months ended September 30, 2005. Our Adjusted EBITDA margins increased to 13.8% for the three months ended September 30, 2006 from 12.9% for the three months ended September 30, 2005. The increase in Adjusted EBITDA was primarily the result of the increase in our net revenue per visit described under—“Net Operating Revenues -Outpatient Rehabilitation.”

     Other. The Adjusted EBITDA loss was $8.9 million for the three months ended September 30, 2006 compared to a loss of $11.4 million for the three months ended September 30, 2005. This reduction in the Adjusted EBITDA loss was primarily the result of the decline in our general and administrative expenses.

Income from Operations

     For the three months ended September 30, 2006 we had income from operations of $54.3 million compared to $53.8 million for the three months ended September 30, 2005. The increase in income from operations resulted from the Adjusted EBITDA changes described above and a reduction in general and administrative expense, offset by a small increase in depreciation and amortization expense. This increase in depreciation and amortization expense resulted primarily from increased depreciation expense associated with free-standing hospitals we have placed in service.

Interest Expense

     Interest expense was $33.0 million for the three months ended September 30, 2006 compared to $29.6 million for the three months ended September 30, 2005. The increase in interest expense is related to interest costs associated with the $175.0 million of senior floating rate notes issued in September 2005, offset by a reduction in interest expense resulting from lower outstanding debt balances under Select’s senior credit facility.

Minority Interests

     Minority interests in consolidated earnings was $0.4 million for the three months ended September 30, 2006 compared to $0.5 million for the three months ended September 30, 2005.

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Income Taxes

     We recorded income tax expense of $8.7 million for the three months ended September 30, 2006. The expense represented an effective tax rate of 41.0%. For the three months ended September 30, 2005 we recorded income tax expense of $9.8 million. This expense represented an effective tax rate of 40.7%.

Income from Discontinued Operations, Net of Tax

     On March 1, 2006, we sold our wholly-owned subsidiary CBIL. The operating results of CBIL have been reclassified and reported as discontinued operations.

Nine Months Ended September 30, 2006 Compared to Combined Nine Months Ended September 30, 2005

Net Operating Revenues

     Our net operating revenues increased by 0.4% to $1,405.8 million for the nine months ended September 30, 2006 compared to $1,400.5 million for the combined nine months ended September 30, 2005.

     Specialty Hospitals.Our specialty hospital net operating revenues increased 1.8% to $1,049.8 million for the nine months ended September 30, 2006 compared to $1,031.4 million for the combined nine months ended September 30, 2005. Net operating revenues for the specialty hospitals opened or acquired as of January 1, 2005 and operated by us throughout both periods increased 3.6% to $1,027.8 million for the nine months ended September 30, 2006 from $992.3 million for the combined nine months ended September 30, 2005. This increase resulted primarily from higher net revenue per patient day and an increase in patient days. Our patient days for these hospitals increased 1.0% for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005. Additionally, our occupancy percentage increased to 71% for the nine months ended September 30, 2006 compared to 70% for the combined nine months ended September 30, 2005. Although our net operating revenues and patient days increased for the comparable nine month period, our net operating revenues and patient days decreased for the three months ended September 30, 2006. See “Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005 – Net Operating Revenues – Specialty Hospitals” for a discussion of these declines.

     Outpatient Rehabilitation.Our outpatient rehabilitation net operating revenues declined 2.9% to $354.0 million for the nine months ended September 30, 2006 compared to $364.4 million for the combined nine months ended September 30, 2005. The number of patient visits in our outpatient rehabilitation clinics declined 10.7% for the nine months ended September 30, 2006 to 2,261,080 compared to 2,532,157 visits for the combined nine months ended September 30, 2005. The decrease in net operating revenues and patient visits was principally related to a 5.1% decline in the number of clinics we own and a 5.9% decline in the volume of visits per clinic. We are continuing to experience declines in our patient visits in a number of markets as a result of physicians opening competing physical therapy practices. Net revenue per visit in these clinics was $93 for the nine months ended September 30, 2006 compared to $89 for the combined nine months ended September 30, 2005.

     Other.Our other revenues were $2.0 million for the nine months ended September 30, 2006 compared to $4.7 million for the combined nine months ended September 30, 2005. The decline resulted from the sale of our home medical equipment and infusion/intravenous service business which we sold in May 2005.

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Operating Expenses

     Our operating expenses decreased by 10.7% to $1,172.0 million for the nine months ended September 30, 2006 compared to $1,312.2 million for the combined nine months ended September 30, 2005. Our operating expenses include our cost of services, general and administrative expense and bad debt expense. The decrease in operating expenses was principally related to the significant decline in stock compensation expense for the nine months ended September 30, 2006. In connection with the Merger, we granted restricted stock awards to certain key management employees. These awards generally vest over five years. Effective at the time of the Merger, we also granted stock options to certain other key employees that vest over five years. The fair value of restricted stock awards and stock options vesting during the nine months ended September 30, 2006 was $2.7 million and for the period from February 25, 2005 through September 30, 2005 was $7.4 million which were included in general and administrative expenses. Additionally, during the Predecessor period of January 1, 2005 through February 25, 2005, all of our then outstanding stock options were redeemed in accordance with the Merger agreement. This resulted in a charge of $142.2 million of which $115.0 million is included in general and administrative expense and $27.2 million is included in cost of services.

     As a percentage of our net operating revenues, our operating expenses were 83.4% for the nine months ended September 30, 2006 compared to 93.7% for the combined nine months ended September 30, 2005. Cost of services as a percentage of operating revenues was 79.7% for the nine months ended September 30, 2006 compared to 80.0% for the combined nine months ended September 30, 2005. These costs primarily reflect our labor expenses. This reduction resulted from a decline in our stock compensation costs offset by an increase in our direct labor costs in both our specialty hospitals and outpatient rehabilitation segments which principally occurred during the first quarter of 2006. This is primarily the result of inefficient nurse staffing ratios in our specialty hospitals and higher salaries for physical and occupational therapists in our outpatient clinics. Another component of cost of services is facility rent expense, which was $61.1 million for both the nine months ended September 30, 2006 and for the combined nine months ended September 30, 2005. During the same time period, general and administrative expense declined in total, and as a percentage of net operating revenues. General and administrative expenses were 2.4% of net operating revenues for the nine months ended September 30, 2006 compared to 12.2% for the combined nine months ended September 30, 2005. Our general and administrative expenses for the combined nine months ended September 30, 2005 included costs associated with the SemperCare Corporate office that were not eliminated until the second quarter of 2005 and stock compensation expense related to the Merger. Our bad debt expense as a percentage of net operating revenues was 1.3% for the nine months ended September 30, 2006 compared to 1.5% for the combined nine months ended September 30, 2005.

Adjusted EBITDA

     Specialty Hospitals. Adjusted EBITDA decreased by 7.3% to $218.2 million for the nine months ended September 30, 2006 compared to $235.3 million for the combined nine months ended September 30, 2005. Our Adjusted EBITDA margins declined to 20.8% for the nine months ended September 30, 2006 from 22.8% for the combined nine months ended September 30, 2005. The hospitals opened or acquired as of January 1, 2005 and operated by us throughout both periods had Adjusted EBITDA of $223.9 million, a decrease of 3.3% over the Adjusted EBITDA of these hospitals for the same period in 2005. This decrease in same hospital Adjusted EBITDA for the nine months ended September 30, 2006 resulted from the significant decline we experienced in same hospital Adjusted EBITDA for the three months ended September 30, 2006. See “Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005 – Adjusted EBITDA – Specialty Hospitals” for a discussion of this decline. As a result, our Adjusted EBITDA margin in these same store

30

hospitals declined to 21.8% for the nine months ended September 30, 2006 from 23.3% for the combined nine months ended September 30, 2005.

     Outpatient Rehabilitation. Adjusted EBITDA decreased by 6.7% to $48.9 million for the nine months ended September 30, 2006 compared to $52.4 million for the combined nine months ended September 30, 2005. Our Adjusted EBITDA margins declined to 13.8% for the nine months ended September 30, 2006 from 14.4% for the combined nine months ended September 30, 2005. The decline in Adjusted EBITDA was the result of the decline in clinic visit volumes described under—“Net Operating Revenues -Outpatient Rehabilitation” above. Additionally, we experienced increased labor costs for physical and occupational therapists in 2006.

     Other. The Adjusted EBITDA loss was $30.6 million for the nine months ended September 30, 2006 compared to a loss of $35.2 million for the combined nine months ended September 30, 2005. This reduction in the Adjusted EBITDA loss was primarily the result of the decline in our general and administrative expenses associated with the SemperCare Corporate office that was closed during the second quarter of 2005.

Income from Operations

     For the nine months ended September 30, 2006 we had income from operations of $198.8 million compared to income from operations of $54.3 million for the combined nine months ended September 30, 2005. The lower income from operations experienced for the combined nine months ended September 30, 2005 resulted from the significant stock compensation expense of $142.2 million related to the cancellation of all vested and unvested outstanding stock options in accordance with the terms of the Merger agreement in the Predecessor period of January 1, 2005 through February 24, 2005.

Loss on Early Retirement of Debt

     In connection with the Merger, Select commenced tender offers to acquire all of our then outstanding 9¹/2% senior subordinated notes due 2009 and all of our then outstanding 7¹/2% senior subordinated notes due 2013. Upon completion of the tender offers on February 24, 2005, all $175.0 million of the 7¹/2% senior subordinated notes were tendered and $169.3 million of the $175.0 million of 9¹/2% notes were tendered. The loss on early retirement of debt consists of the tender premium cost of $34.8 million and the remaining unamortized deferred financing costs of $7.9 million.

Merger Related Charges

     As a result of the Merger, we incurred costs in the Predecessor period of January 1, 2005 through February 24, 2005 directly related to the Merger. This included the cost of the investment advisor hired by the Special Committee of Select’s Board of Directors to evaluate the Merger, legal and accounting fees, costs associated with the Hart-Scott-Rodino filing related to the Merger, costs associated with purchasing a six year extended reporting period under our directors and officers liability insurance policy and other associated expenses.

Interest Expense

     Interest expense increased by $24.0 million to $98.5 million for the nine months ended September 30, 2006 from $74.5 million for the combined nine months ended September 30, 2005. The increase in interest expense is due to the higher debt levels outstanding in the Successor periods resulting from the Merger and the issuance of the $175.0 million senior floating rate notes in issued in September 2005.

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Minority Interests

     Minority interests in consolidated earnings was $1.1 million for the nine months ended September 30, 2006 compared to $1.7 million for the combined nine months ended September 30, 2005.

Income Taxes

     We recorded income tax expense of $41.9 million for the nine months ended September 30, 2006. The expense represented an effective tax rate of 41.9%. We recorded income tax benefit of $59.8 million for the Predecessor period of January 1, 2005 through February 24, 2005. The tax benefit represented an effective tax benefit rate of 37.2%. This effective tax benefit rate consisted of the statutory Federal rate of 35.0% and a state rate of 2.2%. Because of the differing state tax rules related to net operating losses, a portion of these state net operating losses were assigned valuation allowances. We recorded income tax expense of $34.7 million for the Successor period of February 25, 2005 through September 30, 2005. The expense represented an effective tax rate of 40.4%.

Income from Discontinued Operations, Net of Tax

     On March 1, 2006, we sold our wholly-owned subsidiary CBIL. The operating results of CBIL have been reclassified and reported as discontinued operations.

Liquidity and Capital Resources

     Operating activities provided $105.2 million of cash flow for the nine months ended September 30, 2006. Operating activities used $44.7 million of cash flow for the combined nine months ended September 30, 2005, which includes $186.0 million in cash expenses related to the Merger. Our days sales outstanding decreased to 51 days at September 30, 2006, from 52 days at December 31, 2005. The reduction in days sales outstanding is primarily related to the timing of the periodic interim payments we received from Medicare for the services provided at our specialty hospitals.

     Investing activities used $37.6 million of cash flow for the nine months ended September 30, 2006. Investing activities used $183.7 million of cash flow for the combined nine months ended September 30, 2005. The primary source of cash from investing activities in the nine months ended September 30, 2006 resulted from the sale of CBIL which generated cash proceeds of $76.8 million, which was offset by cash disbursements of $112.1 million related to building improvements and equipment purchases primarily associated with properties we acquired in 2005 and acquisition payments of $3.3 million which primarily relate to the repurchase of minority interests. The primary use of cash from investing activities for the combined nine months ended September 30, 2005 related to the acquisition of SemperCare, which used $105.1 million in cash. The remaining use of cash was related to purchases of property and equipment of $73.0 million and other acquisition related payments of $5.9 million.

     Financing activities utilized $98.4 million of cash flow for the nine months ended September 30, 2006. The cash usage resulted primarily from principal repayments on our credit facility of $84.4 million and repayment of bank overdrafts of $11.8 million. Financing activities used $10.1 million of cash for the combined nine months ended September 30, 2005. The Merger financing was the primary contributor of this cash flow. The excess

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proceeds from the Merger financing were used to pay Merger related costs, which included the cancellation and cash-out of outstanding stock options.

Capital Resources

     Net working capital was $36.8 million at September 30, 2006 compared to $77.6 million at December 31, 2005. This decrease in working capital was principally related to a reduction in cash and cash equivalents.

     At September 30, 2006, Select’s senior credit facility provides for senior secured financing consisting of a term loan facility that matures on February 24, 2012 and a revolving loan facility that will terminate on February 24, 2011. At September 30, 2006, Select had outstanding $576.3 million of indebtedness under its senior credit facility of which $5.0 million was borrowed under its revolving loan facility and $571.3 million was borrowed under the term loan facility, excluding $23.9 million of letters of credit. At September 30, 2006 Select had $271.1 million of additional borrowing capacity under its revolving loan facility. Borrowings under the revolving loan facility bear interest at a fluctuating rate of interest based upon financial covenant ratio tests. On June 13, 2005 Select entered into an interest rate swap transaction with an effective date of August 22, 2005. The swap is designated as a cash flow hedge of forecasted LIBOR based variable rate interest payment. The underlying variable rate debt is $200.0 million and the swap is for a period of five years.

     At September 30, 2006 Select also had outstanding $660.0 million in aggregate principal amount of 7 5/8% senior subordinated notes due 2015. 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.

     We also have outstanding $175.0 million of senior floating rate notes due 2015 and $150.0 million of 10% senior subordinated notes due 2015. These notes are general unsecured obligations and are not guaranteed by any of our subsidiaries. On September 19, 2005, Select entered into an interest rate swap transaction with an effective date of September 29, 2005. The swap is designated as a cash flow hedge of forecasted LIBOR based variable interest payments. The underlying variable rate debt is $175.0 million and the swap is for a period of four years. In the nine months ended September 30, 2006, Select remitted to us an aggregate of $32.5 million consisting of $15.0 million to fund the interest payment on our $150.0 million 10% senior subordinated notes and $17.1 million to fund the interest payment on our $175.0 million senior floating rate notes. The remainder of the funds remitted to us of $0.4 million were to pay costs associated with registering the $175.0 million senior floating rate notes. As of September 30, 2006, Select had remitted to us all the funds it was permitted to remit under the terms of its senior credit facility and senior subordinated notes. We expect in the future that Select will continue to remit to us the maximum amount that is permitted under the terms of its senior credit facility and senior subordinated notes, which includes amounts necessary to fund the interest payments on our 10% senior subordinated notes and our senior floating rate notes and other permitted payments.

     We believe internally generated cash flows and borrowings of revolving loans under Select’s senior credit facility will be sufficient to finance operations for at least the next twelve months.

     As a result of the HIH regulations enacted in 2004, we currently anticipate that we will need to relocate a significant number of our long-term acute care hospitals. Our transition plan includes managing admissions at existing HIHs, relocating certain HIHs to leased spaces in smaller host hospitals in the same markets, consolidating HIHs in certain of our markets, relocating certain of our facilities to alternative settings, building or buying free-standing facilities and closing some of our facilities. At this time we cannot predict with any certainty the impact on revenues or operating expenses at the hospitals being moved. These relocation efforts will require us to make additional capital expenditures above historic levels. We currently expect to spend

33

approximately $280.0 million on capital expenditures through 2009, including both our ongoing maintenance capital expenditures and the capital required for hospital relocations. At September 30, 2006, we have outstanding commitments under construction contracts at six long-term acute care properties and one of our inpatient rehabilitation facilities totaling $27.2 million.

     During the nine months ended September 30, 2006, we have relocated eight of our HIH hospitals into five free-standing buildings. Additionally we have opened two new hospitals in free-standing buildings and one new hospital as an HIH. We closed four HIH hospitals during 2006.

     We also continue to evaluate opportunities to develop new long-term acute care hospitals. Additionally, we are evaluating opportunities to develop free-standing inpatient rehabilitation facilities similar to the four inpatient rehabilitation facilities acquired through our September 2003 Kessler acquisition. We also intend to open new outpatient rehabilitation clinics in our current markets where we can benefit from existing referral relationships and brand awareness to produce incremental growth.

     We periodically investigate strategic acquisitions that could increase our market share in one or both of our business segments. We cannot predict the likelihood that any of these business acquisitions will be consummated nor can we predict the cost of this type of acquisition.

Inflation

     The healthcare industry is labor intensive. Wages and other expenses increase during periods of inflation and when labor shortages occur in the marketplace. In addition, suppliers pass along rising costs to us in the form of higher prices. We have implemented cost control measures, including our case and resource management program, to curtail increases in operating costs and expenses. We cannot predict our ability to cover or offset future cost increases.

     CMS did not update our LTACH-PPS standard federal rate for the 2007 estimated market basket index change. This annual market basket adjustment is CMS’ approach to adjusting Medicare payments to reflect inflationary effects on costs. This increase historically has occurred on July 1 of each year.

Recent Accounting Pronouncements

     In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides guidance on how to evaluate prior period financial statement misstatements for purposes of assessing their materiality in the current period. Correcting prior year financial statements for immaterial misstatements would not require amending previous filings; rather such corrections may be made in subsequent filings. The cumulative effect of initially applying SAB 108, if any, can be recorded as an adjustment to opening retained earnings. SAB 108 does not change the SEC staff’s previous positions regarding qualitative considerations in assessing the materiality of misstatements. SAB 108 is effective beginning in the fourth quarter of this fiscal year. We do not believe SAB 108 will have a material impact on our financial statements.

     In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. The changes to current practice resulting from the application of this Statement relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. We do not believe that the adoption of the provisions of SFAS No. 157 will materially impact our consolidated financial statements.

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     In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”). SFAS No. 158 requires the employer to recognize the overfunded or underfunded status of a single-employer defined benefit postretirement plan as an asset or liability in its balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. SFAS No. 158 also requires an employer to measure the funded status of a plan as of the date of its year-end balance sheet. SFAS No. 158 is effective for fiscal years ending after December 15, 2006. We believe that the adoption of SFAS No. 158 will have no impact on our consolidated financial statements.

     In July 2006, the Financial Accounting Standards Board (“FASB”) issued Financial Accounting Standards Board Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes.” FIN No. 48 is an interpretation of Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes.” FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in an enterprise’s tax return. This interpretation also provides guidance on the derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition of tax positions. The recognition threshold and measurement attribute is part of a two step tax position evaluation process prescribed in FIN No. 48. FIN No. 48 is effective after the beginning of an entity’s first fiscal year that begins after December 15, 2006. We are currently evaluating our uncertain tax positions as required under the accounting standard in order to implement the standard during the first quarter of 2007. We have not determined the impact, if any, to our consolidated financial statements.

     In March 2006, FASB issued SFAS No. 156 “Accounting for Servicing of Financial Assets an amendment of SFAS No. 140” (“SFAS No. 156”). SFAS No. 156 requires that all separately recognized servicing assets and servicing liabilities associated with a transfer of assets (e.g., a sale of receivables) be initially measured at fair value, if practicable. SFAS No. 156 permits, but does not require, the subsequent measurement of servicing assets and servicing liabilities at fair value and requires an entity that uses derivative instruments to mitigate the risks inherent in servicing assets and servicing liabilities to account for those derivative instruments at fair value. SFAS No. 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006 although early adoption is permitted. We have evaluated SFAS No. 156 and have determined that there is no impact to the consolidated financial statements.

     In February 2006, the Financial Accounting Standards Board issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and No. 140” (“SFAS No. 155”). SFAS No. 155 simplifies the accounting for certain hybrid financial instruments, eliminates the FASB’s interim guidance which provides that beneficial interests in securitized financial assets are not subject to the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and eliminates the restriction on the passive derivative instruments that a qualifying special-purpose entity may hold. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. We do not anticipate that the implementation of this standard will have a material impact on our financial position, results of operations or cash flows.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Quantitative and Qualitative Disclosures About Market Risk

     We are subject to interest rate risk in connection with our long-term indebtedness. Our principal interest rate exposure relates to the loans outstanding under Select’s senior credit facility and our senior floating rate notes. As of September 30, 2006, Select had $576.3 million in term loans outstanding under its senior credit facility which bear interest at variable rates. On June 13, 2005, Select entered into an interest rate swap transaction. The effective date of the swap transaction was August 22, 2005. The swap transaction was entered into to mitigate the risks of future variable

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rate interest payments. The notional amount of the interest rate swap is $200.0 million, the underlying variable rate debt is associated with the senior credit facility, and the swap is for a period of five years. Each eighth point change in interest rates on the variable rate portion of Select’s outstanding senior credit facility at September 30, 2006 would have an annualized effect on interest expense of $0.5 million.

     In conjunction with the issuance of the senior floating rate notes, Select entered into a swap transaction to mitigate the risks of future variable rate interest payments associated with this debt. The notional amount of the interest rate swap is $175.0 million and the swap is for a period of four years.

ITEM 4. CONTROLS AND PROCEDURES

          We carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934) as of the end of the period covered in this report. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective to provide reasonable assurance that material information required to be included in our periodic SEC reports is recorded, processed, summarized and reported within the time periods specified in the relevant SEC rules and forms.

          In addition, we reviewed our internal controls, and there have been no significant changes in our internal controls or in other factors that could significantly affect those controls subsequent to the date of their last evaluation.

PART II OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

          On August 24, 2004, Clifford C. Marsden and Ming Xu filed a purported class action complaint in the United States District Court for the Eastern District of Pennsylvania on behalf of the public stockholders of Select against Martin F. Jackson, Robert A. Ortenzio, Rocco A. Ortenzio, Patricia A. Rice and Select. In February 2005, the Court appointed James Shaver, Frank C. Bagatta and Capital Invest, die Kapitalanlagegesellschaft der Bank Austria Creditanstalt Gruppe GmbH as lead plaintiffs (“Lead Plaintiffs”).

          On April 19, 2005, Lead Plaintiffs filed an amended complaint, purportedly on behalf of a class of shareholders of Select, against Martin F. Jackson, Robert A. Ortenzio, Rocco A. Ortenzio, Patricia A. Rice, and Select as defendants. The amended complaint continues to allege, among other things, failure to disclose adverse information regarding a potential regulatory change affecting reimbursement for Select’s services applicable to long-term acute care hospitals operated as hospitals within hospitals, and the issuance of false and misleading statements about the financial outlook of Select. The amended complaint seeks, among other things, damages in an unspecified amount, interest and attorneys’ fees. The Company believes that the allegations in the amended complaint are without merit and intends to vigorously defend against this action. In April 2006, the Court granted in part and denied in part Select and the individual officers’ preliminary motion to dismiss the amended complaint. Select and the individual officers have answered the amended complaint and the case has moved to the discovery and class certification phase. The Company does not believe this claim will have a material adverse effect on its financial position or results of operations. However, due to the uncertain nature of such litigation, the Company cannot predict the outcome of this matter.

          The Company is subject to legal proceedings and claims that arise in the ordinary course of its business, which include malpractice claims covered under insurance policies. In the Company’s opinion, the outcome of

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these actions will not have a material adverse effect on the financial position or results of operations of the Company.

          To cover claims arising out of the operations of the Company’s hospitals and outpatient rehabilitation facilities, the Company maintains professional malpractice liability insurance and general liability insurance. The Company also maintains umbrella liability insurance covering claims which, due to their nature or amount, are not covered by or not fully covered by the Company’s other insurance policies. These insurance policies also do not generally cover punitive damages and are subject to various deductibles and policy limits. Significant legal actions as well as the cost and possible lack of available insurance could subject the Company to substantial uninsured liabilities.

          Health care providers are often subject to lawsuits under the qui tam provisions of the federal False Claims Act. Qui tam lawsuits typically remain under seal (hence, usually unknown to the defendant) for some time while the government decides whether or not to intervene on behalf of a private qui tam plaintiff (known as a relator) and take the lead in the litigation. These lawsuits can involve significant monetary damages and penalties and award bounties to private plaintiffs who successfully bring the suits. A qui tam lawsuit against Select has been filed in the United States District Court for the District of Nevada, but because the action is still under seal, the Company does not know the details of the allegations or the relief sought. As is required by law, the federal government is conducting an investigation of matters alleged by this complaint. The Company has received subpoenas for patient records and other documents apparently related to the federal government’s investigation. The Company believes that this investigation involves the billing practices of certain of its subsidiaries that provide outpatient services to beneficiaries of Medicare and other federal health care programs. The three relators in this qui tam lawsuit are two former employees of the Company’s Las Vegas, Nevada subsidiary who were terminated by Select in 2001 and a former employee of the Company’s Florida subsidiary who the Company asked to resign. Select sued the former Las Vegas employees in state court in Nevada in 2001 for, among other things, return of misappropriated funds, and the Company’s lawsuit has recently been transferred to the federal court in Las Vegas. While the government has investigated but chosen not to intervene in two previous qui tam lawsuits filed against Select, the Company cannot provide assurance that the government will not intervene in the Nevada qui tam case or any other existing or future qui tam lawsuit against the Company. While litigation is inherently uncertain, the Company believes, based on its prior experiences with qui tam cases and the limited information currently available to the Company, that the Nevada qui tam action will not have a material adverse effect on the Company.

ITEM 1A. RISK FACTORS.

          There have been no material changes from the Risk Factors we previously disclosed in our S-4, filed July 28, 2006.

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

          None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

          Not applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

          Not applicable.

ITEM 5. OTHER INFORMATION

     On August 25, 2006, Select Medical Corporation entered into a lease for approximately 47,864 square feet of office space in a new building yet to be constructed in Mechanicsburg, Pennsylvania (the “New Lease”) with Old Gettysburg Associates IV, L.P., a limited partnership owned by Rocco A. Ortenzio, Robert A. Ortenzio, John M. Ortenzio and Select Capital Commercial Properties, Inc., a Pennsylvania corporation whose principal offices are located in Mechanicsburg, Pennsylvania. Rocco A. Ortenzio, Robert A. Ortenzio, and John M. Ortenzio each own one-third of Select Capital Commercial Properties, Inc. Rocco A. Ortenzio is a director and the Executive Chairman of Holdings and Select. Robert A. Ortenzio is a director and the Chief Executive Officer of Holdings and Select. The New Lease is for a fifteen year initial term from the date of the issuance of the occupancy permit at an annual rental of $23.53 per rentable square foot. Select obtained an independent appraisal to support the amount of rent it will pay for this space. A copy of the New Lease is attached as Exhibit 10.1 to this report.

     On August 10, 2006, the Board of Directors of Select authorized Select to enter into the New Lease. Under the provisions of Select’s Code of Conduct, it is an actual or potential conflict of interest for an employee to own a significant financial interest in any third party that has an actual or potential business or other relationship with Select. Rocco A. Ortenzio and Robert A. Ortenzio are each officers and directors of Select, and are also partners in Old Gettysburg Associates IV, L.P. On August 10, 2006, in connection with authorizing Select to enter into the New Lease, the Board of Directors of Select approved the waiver of this provision of the Code of Conduct based on all the facts and circumstances surrounding the New Lease, including (a) the fact that the terms of the New Lease were negotiated at arm’s length, (b) that Select obtained an independent appraisal to support the amount of rent it will pay for this space, and (c) that the Board of Directors of Select did not otherwise find that the transaction would conflict or prevent either Mr. Rocco Ortenzio or Mr. Robert Ortenzio from faithfully performing his duties for Select.

     On November 10, 2006, the Board of Directors approved a lease for approximately 1,606 square feet of additional office space at 4718 Old Gettysburg Road in Mechanicsburg, Pennsylvania (the “Additional Lease”) with Old Gettysburg Associates II, a limited partnership owned by Rocco A. Ortenzio, Robert A. Ortenzio, John M. Ortenzio and Select Capital Commercial Properties, Inc. The Additional Lease will be for a five year term at an annual rental of $18.64 per rentable square foot. Select obtained an independent appraisal to support the amount of rent it will pay for this space. On November 10, 2006, in connection with authorizing Select to enter into the Additional Lease the Board of Directors of Select also approved a waiver of the relevant provision of the Code of Conduct in connection with the Additional Lease for the same reasons that applied in the case of the New Lease, which are discussed above.

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ITEM 6. EXHIBITS

          The exhibits to this report are listed in the Exhibit Index appearing on page 39 hereof.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

SELECT MEDICAL CORPORATION
By:	/s/ Martin F. Jackson     Martin F. Jackson
	Senior Vice President and Chief Financial Officer
	(Duly Authorized Officer)
By:	/s/ Scott A. Romberger     Scott A. Romberger
	Vice President, Chief Accounting Officer and Controller
	(Principal Accounting Officer)

Dated: November 13, 2006

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EXHIBIT INDEX

Exhibit	Description
10.1	Office Lease Agreement dated August 25, 2006 between Old Gettysburg Associates IV, L.P. and Select Medical Corporation.
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Senior Vice President and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Senior Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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