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SEM > SEC Filings for SEM > Form 10-Q on 1-Nov-2012All Recent SEC Filings

Show all filings for SELECT MEDICAL HOLDINGS CORP

Form 10-Q for SELECT MEDICAL HOLDINGS CORP


1-Nov-2012

Quarterly Report


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 accompanying notes.

Forward-Looking Statements

This report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. Forward-looking statements include statements preceded by, followed by or that include the words "may," "could," "would," "should," "believe," "expect," "anticipate," "plan," "target," "estimate," "project," "intend" and similar expressions. These statements include, among others, statements regarding our expected business outlook, anticipated financial and operating results, our business strategy and means to implement our strategy, our objectives, the amount and timing of capital expenditures, the likelihood of our success in expanding our business, financing plans, budgets, working capital needs and sources of liquidity.

Forward-looking statements are only predictions and are not guarantees of performance. These statements are based on our management's beliefs and assumptions, which in turn are based on currently available information. Important assumptions relating to the forward-looking statements include, among others, assumptions regarding our services, the expansion of our services, competitive conditions and general economic conditions. These assumptions could prove inaccurate. Forward-looking statements also involve known and unknown risks and uncertainties, which could cause actual results to differ materially from those contained in any forward-looking statement. Many of these factors are beyond our ability to control or predict. Such factors include, but are not limited to, the following:

additional changes in government reimbursement for our services, including changes that will result from the expiration of the moratorium for long term acute care hospitals established by the Medicare, Medicaid, and SCHIP Extension Act of 2007, the American Recovery and Reinvestment Act, and the Patient Protection and Affordable Care Act may result in a reduction in net operating revenues, an increase in costs and a reduction in profitability;

the failure of our specialty hospitals to maintain their Medicare certifications 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;

a government investigation or assertion that we have violated applicable regulations may result in sanctions or reputational harm and increased costs;

acquisitions or joint ventures 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;


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the failure to maintain established relationships with the physicians in the areas we serve 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;

the effect of claims asserted against us could subject us to substantial uninsured liabilities; and

other factors discussed from time to time in our filings with the Securities and Exchange Commission (the "SEC"), including factors discussed under the heading "Risk Factors" for the year ended December 31, 2011 contained in our annual report on Form 10-K filed with the SEC on March 2, 2012.

Except as required by applicable law, including the securities laws of the United States and the rules and regulations of the SEC, we are under no obligation to publicly update or revise any forward-looking statements, whether as a result of any new information, future events or otherwise. You should not place undue reliance on our forward-looking statements. Although we believe that the expectations reflected in forward-looking statements are reasonable, we cannot guarantee future results or performance.

Investors should also be aware that while we do, from time to time, communicate with securities analysts, it is against our policy to disclose to securities analysts any material non-public information or other confidential commercial information. Accordingly, stockholders should not assume that we agree with any statement or report issued by any securities analyst irrespective of the content of the statement or report. Thus, to the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not the responsibility of the Company.

Overview

We believe that we are one of the largest operators of both specialty hospitals and outpatient rehabilitation clinics in the United States based on number of facilities. As of September 30, 2012, we operated 111 long term acute care hospitals and 12 acute medical rehabilitation hospitals in 28 states, and 965 outpatient rehabilitation clinics in 32 states and the District of Columbia. We also provide medical rehabilitation services on a contracted basis to nursing homes, hospitals, assisted living and senior care centers, schools and work sites. We began operations in 1997 under the leadership of our current management team. As of September 30, 2012, we had operations in 44 states and the District of Columbia.

We manage our Company through two business segments, our specialty hospital segment and our outpatient rehabilitation segment. We had net operating revenues of $2,207.9 million for the nine months ended September 30, 2012. Of this total, we earned approximately 74% of our net operating revenues from our specialty hospitals and approximately 26% from our outpatient rehabilitation business. Our specialty hospital segment consists of hospitals designed to serve the needs of long term stay acute patients and hospitals designed to serve patients that require intensive medical rehabilitation care. Patients are typically admitted to our specialty hospitals from general acute care hospitals. These patients have specialized needs, and serious and often complex medical conditions such as respiratory failure, neuromuscular disorders, traumatic brain and spinal cord injuries, strokes, non-healing wounds, cardiac disorders, renal disorders and cancer. Our outpatient


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rehabilitation segment consists of clinics and contract services that provide physical, occupational and speech rehabilitation services. Our outpatient rehabilitation patients are typically diagnosed with musculoskeletal impairments that restrict their ability to perform normal activities of daily living.

Significant 2012 Events

Refinancing

On August 13, 2012, Select, Holdings and the subsidiaries of Select named therein entered into an Extension Amendment to Select's senior secured credit facility with a group of lenders and JPMorgan Chase Bank, N.A. as administrative agent. Pursuant to the terms and conditions of the Extension Amendment, the lenders extended Series A Tranche B Term Loans in the aggregate principal amount of $275.0 million to Select at the same interest rate and with the same term as applies to other Tranche B Term Loan amounts borrowed by Select under the senior secured credit facility. On September 12, 2012, Select used the proceeds of the Series A Tranche B Term Loans (other than amounts used for fees and expenses) and cash on hand to redeem an aggregate of $275.0 million principal amount of Select's outstanding 7 5/8% senior subordinated notes due 2015 at a redemption price of 101.271% of the principal amount. Select recognized a loss on early retirement of debt of $6.1 million for the three and nine months ended September 30, 2012 in connection with the redemption of the senior subordinated notes, which included the write-off of unamortized deferred financing costs and call premiums.

Stock Repurchase Program

On February 22, 2012, the Company's board of directors authorized an increase of $100.0 million in the capacity of its common stock repurchase program from $150.0 million to $250.0 million. The program will remain in effect until March 31, 2013, unless extended by the board of directors. Stock repurchases under this program may be made in the open market or through privately negotiated transactions, and at times and in such amounts as the Company deems appropriate. The timing of purchases of stock will be based upon market conditions and other factors. The Company is funding this program with cash on hand or borrowings under its revolving credit facility. The Company did not repurchase any shares during the three months ended September 30, 2012. The Company repurchased 5,725,782 shares at a cost of $46.8 million, which includes transaction costs, during the nine months ended September 30, 2012. Since the inception of the program through September 30, 2012, the Company has repurchased 22,490,389 shares at a cost of $163.6 million, or $7.28 per share, which includes transaction costs.

Summary Financial Results

Three Months Ended September 30, 2012

For the three months ended September 30, 2012, our net operating revenues increased 2.8% to $713.7 million compared to $694.1 million for the three months ended September 30, 2011. Our specialty hospital revenues increased $10.3 million or 2.0% and our outpatient rehabilitation revenues increased $9.2 million or 5.3%. We had income from operations for the three months ended September 30, 2012 of $70.8 million compared to $68.1 million for the three months ended September 30, 2011. We had net income attributable to Holdings for the three months ended September 30, 2012 of $24.1 million compared to $25.6 million for the three months ended September 30, 2011. Our Adjusted EBITDA for the three months ended September 30, 2012 was $87.7 million compared to $86.5 million for the three months ended September 30, 2011. See the section entitled "Results of Operations" for a reconciliation of net income to Adjusted EBITDA. The increase in our income from operations and Adjusted EBITDA is principally due to increases in operating performance


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in our specialty hospital segment. We were able to increase our specialty hospital income from operations $3.4 million or 4.9% and our specialty hospital Adjusted EBITDA $2.1 million or 2.6% for the three months ended September 30, 2012 compared to the same quarter prior year. These increases principally occurred in our Regency hospitals, from management services fees and lower bad debt expense.

Net income attributable to Holdings decreased $1.5 million to $24.1 million for the three months ended September 30, 2012 compared to $25.6 million for the three months ended September 30, 2011. The decrease resulted primarily from the loss on early retirement of debt related to the redemption of $275.0 million of our senior subordinated notes completed September 12, 2012, offset in part by an increase in income from operations.

Nine Months Ended September 30, 2012

For the nine months ended September 30, 2012, our net operating revenues increased 5.8% to $2,207.9 million compared to $2,086.1 million for the nine months ended September 30, 2011. Our specialty hospital revenues increased $80.3 million or 5.1% and our outpatient rehabilitation revenues increased $41.5 million or 7.9%. We had income from operations for the nine months ended September 30, 2012 of $255.9 million compared to $236.7 million for the nine months ended September 30, 2011. We had net income attributable to Holdings for the nine months ended September 30, 2012 of $108.8 million compared to $71.0 million for the nine months ended September 30, 2011. Our Adjusted EBITDA for the nine months ended September 30, 2012 was $307.1 million compared to $292.2 million for the nine months ended September 30, 2011. See the section entitled "Results of Operations" for a reconciliation of net income to Adjusted EBITDA. The increases in our income from operations and Adjusted EBITDA are principally due to increases in the operating performance of our specialty hospital segment. We were able to increase our specialty hospital income from operations $15.8 million or 6.7% and our specialty hospital Adjusted EBITDA $12.8 million or 4.7% for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011. These increases principally occurred due to the performance of our Regency hospitals.

Net income attributable to Holdings increased $37.8 million to $108.8 million for the nine months ended September 30, 2012 compared to $71.0 million for the nine months ended September 30, 2011. The increase resulted primarily from an increase in our income from operations described above, increases in our equity in earnings of unconsolidated subsidiaries principally related to our Baylor JV and a reduction of interest expense. We also incurred losses on early retirement of debt related to the refinancing transactions completed June 1, 2011 that reduced our net income in the nine months ended September 30, 2011, and a debt redemption completed September 12, 2012 that reduced our net income in the nine months ended September 30, 2012.

Cash flow from operations provided $194.1 million of cash for the nine months ended September 30, 2012 for Holdings and $204.8 million of cash for the nine months ended September 30, 2012 for Select. The difference in cash flow from operations between Holdings and Select primarily relates to interest payments on Holdings' senior floating rate notes.


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Regulatory Changes

In the past few years, there have been significant regulatory changes that have affected our net operating revenues and, in some cases, caused us to change our operating models and strategies. The following is a discussion of recent regulatory changes that are affecting our results of operations in 2012 or may have an affect on our future results of operations. Our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission ("SEC") on March 2, 2012 contains a more detailed discussion of the regulations that affect our business in Part I - Business - Government Regulations, and the information below should be read in connection with that more detailed discussion.

Healthcare Reform Legislation

Federal agencies, including the Centers for Medicare & Medicaid Services ("CMS"), continue to implement provisions of the Patient Protection and Affordable Care Act ("PPACA"). The PPACA expands access to health insurance through subsidies, coverage mandates and other insurance market reforms. In addition, PPACA makes dramatic changes to the Medicare and Medicaid programs by adopting numerous initiatives addressing, among other things, reductions in healthcare spending, patient safety incentives and protections against fraud and abuse of federal healthcare programs. The PPACA adopts significant changes to the Medicare program that are particularly relevant to long term acute care hospitals ("LTCHs"), inpatient rehabilitation facilities ("IRFs") and outpatient rehabilitation services. As part of healthcare reform legislation, President Obama also signed the "Health Care and Education Affordability Reconciliation Act of 2010," which made some limited but important changes to the PPACA.

A number of states attorneys general and other parties filed legal challenges to the PPACA seeking to block its implementation on constitutional grounds. On June 28, 2012, the U.S. Supreme Court upheld the PPACA finding that the individual health insurance mandate does not violate the Constitution because it may be viewed as a permissible tax on individuals who do not obtain health insurance. The only provision of the law that the Court invalidated is a Medicaid provision that threatened states with the loss of existing Medicaid funding if they decline to comply with the PPACA's Medicaid coverage extension.

Federal and state agencies are expected to continue to implement provisions of the PPACA following the Court's decision. However, the 2012 presidential election and pending efforts in the U.S. Congress to repeal, amend or retract funding for various aspects of the PPACA create additional uncertainty about the ultimate impact of the PPACA. As a result, the full impact of the PPACA, and healthcare reform efforts in general, may not be known for several years.

We have included in our Annual Report on Form 10-K for the year ended December 31, 2011 a discussion of the principal PPACA provisions that affect our business, as well as regulatory initiatives adopted by CMS in response to particular provisions of the PPACA.

Budget Control Act of 2011

Beginning in January 2013, the Budget Control Act of 2011 will automatically reduce federal spending by approximately $1.2 trillion split evenly between domestic and defense spending. Payments to Medicare providers are subject to these automatic spending reductions, subject to a 2% cap. Unless further legislation is enacted, we believe this will generally result in a 2% reduction to Medicare payments, beginning on February 1, 2013.


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Medicare Payment of Long Term Acute Care Hospital Services

Medicare Payment of Long Term Acute Care Hospitals during Fiscal Year 2012

On August 18, 2011, CMS published the policies and payment rates for LTCH-PPS for fiscal year 2012 (affecting discharges and cost reporting periods beginning on or after October 1, 2011 through September 30, 2012). The standard federal rate for fiscal year 2012 was $40,222, an increase from the fiscal year 2011 standard federal rate of $39,600. The final rule established a fixed-loss amount for high cost outlier cases for fiscal year 2012 of $17,931, which was a decrease from the fixed-loss amount in the 2011 fiscal year of $18,785.

Medicare Payment of Long Term Acute Care Hospitals during Fiscal Year 2013

On August 1, 2012, CMS published the final rule updating the policies and payment rates for LTCH-PPS for fiscal year 2013 (affecting discharges and cost reporting periods beginning on or after October 1, 2012 through September 30, 2013). Two different standard federal rates apply during fiscal year 2013. The standard federal rate for discharges on or after October 1, 2012 through December 28, 2012 is set at $40,916, an increase from $40,222 applicable during fiscal year 2012. The standard federal rate for discharges on or after December 29, 2012 and the remainder of fiscal year 2013 is set at $40,398. The increase through December 28, 2012 is based on a market basket increase of 2.6% less a productivity adjustment of 0.7% and less an additional reduction of 0.1% mandated by the PPACA. The market basket increase for the period of December 29, 2012 through the remainder of fiscal 2013 is further reduced by a portion of the one-time budget neutrality adjustment, as discussed below. The fixed loss amount for high cost outlier cases is set at $15,408, a decrease from the fixed loss amount in the 2012 fiscal year of $17,931.

Very Short Stay Outlier Policy

CMS established a different 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 that particular MS-LTC-DRG, referred to as a short stay outlier, or "SSO." The SSO rule was further revised adding a category referred to as a "very short stay outlier" for discharges occurring after July 1, 2007. For cases with a length of stay that is equal to or less than one standard deviation from the geometric average length of stay for the same MS-DRG under IPPS, referred to as the so-called "IPPS comparable threshold," the rule lowers the LTCH payment to a rate based on the general acute care hospital IPPS per diem. SSO cases with covered lengths of stay that exceed the IPPS comparable threshold would continue to be paid under the SSO payment policy. The SCHIP Extension Act, as amended by the PPACA, prevented CMS from applying the very short-stay outlier policy before December 29, 2012. Under existing regulations Medicare payments for very short-stay cases will be generally lowered to a rate based on the general acute care hospital IPPS per diem beginning with discharges on or after December 29, 2012.

25 Percent Rule

The 25 Percent Rule is a downward payment adjustment that applies to Medicare patients discharged from LTCHs who were admitted from a co-located hospital or a non-co-located hospital and caused the LTCH to exceed the applicable percentage thresholds of discharged Medicare patients. The SCHIP Extension Act as amended by the American Recovery and Reinvestment Act, or "ARRA," and the PPACA limited the full application of the Medicare percentage threshold and, in some cases, postponed application of the percentage threshold until cost reporting periods beginning on or after July 1, 2012 or October 1, 2012.


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In the update to the Medicare policies and payment rates for fiscal year 2013, CMS adopted through regulations a one-year extension of relief granted by the SCHIP Extension Act from the full application of Medicare admission thresholds. As a result, full implementation of the Medicare admission thresholds will not go into effect until cost reporting periods beginning on or after October 1, 2013, except for certain LTCHs with cost reporting periods that begin between July 1, 2012 and September 30, 2012. Specifically, those freestanding facilities, grandfathered HIHs and grandfathered satellites with cost reporting periods beginning on or after July 1, 2012 and before October 1, 2012 were subject to a modified 25 Percent Rule for discharges occurring in a three month period between July 1, 2012 and September 30, 2012.

In the preamble to the proposed update to the Medicare policies and payment rates for fiscal year 2013, CMS indicated that "within the near future" it may recommend revisions to the payment policies addressing MedPAC's recommendations for the development of patient-level and facility-level criteria. CMS also indicated that these recommendations may render unnecessary the existing payment reductions for Medicare patients admitted from a general acute care hospital in excess of the applicable admission thresholds.

One-Time Budget Neutrality Adjustment

Congress required that the LTCH-PPS payment rates maintain budget neutrality during the first year of the prospective payment system with total expenditures that would have been made under the previous reasonable cost-based payment system. The LTCH-PPS regulations give CMS the ability to make a one-time adjustment to the standard federal rate to correct any "significant difference between actual payments and estimated payments for the first year" of LTCH-PPS. The SCHIP Extension Act, as amended by the PPACA, precluded CMS from implementing the one-time prospective adjustment to the LTCH standard federal rate before December 29, 2012.

In the update to the Medicare policies and payment rates for fiscal year 2013, CMS adopted a one-time budget neutrality adjustment that results in a permanent negative adjustment of 3.75% to the LTCH base rate. CMS is implementing the adjustment over a three-year period by applying a factor of 0.98734 to the standard federal rate in fiscal years 2013, 2014 and 2015, except that the adjustment would not apply to payments for discharges occurring on or after October 1, 2012 through December 28, 2012.

Medicare Market Basket Adjustments for Long Term Acute Care Hospitals

In the update to the Medicare policies and payment rates for fiscal year 2013, CMS adopted for the first time an LTCH-specific market basket based entirely on Medicare cost report data from LTCHs. The LTCH-specific market basket replaces the rehabilitation, psychiatric and long-term care hospital market basket previously used to determine the annual update to the LTCH-PPS.

Additionally, the PPACA instituted a market basket payment adjustment for LTCHs. For fiscal years 2012 and 2013, the reduction was 0.1%. For fiscal year 2014, the reduction is 0.3%. For fiscal years 2015 and 2016, the reduction is 0.2%. For fiscal years 2017 through fiscal year 2019, the reduction is 0.75%.


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Medicare Payment of Inpatient Rehabilitation Facility Services

Medicare Payment of Inpatient Rehabilitation Facilities during Fiscal Year 2012

On August 5, 2011, CMS published the policies and payment rates for IRF-PPS for fiscal year 2012 (affecting discharges and cost reporting periods beginning on or after October 1, 2011 through September 30, 2012). The standard payment conversion factor for discharges for fiscal year 2012 was $14,076, an increase from the fiscal year 2011 standard payment conversion factor of $13,860. CMS initially decreased the outlier threshold amount for fiscal year 2012 to $10,660 from $11,410 for fiscal year 2011. In a notice published September 26, 2011, CMS corrected its calculation of the outlier threshold amount for fiscal year 2012 to $10,713.

Medicare Payment of Inpatient Rehabilitation Facilities during Fiscal Year 2013

On July 30, 2012, CMS published the policies and payment rates for IRF-PPS for fiscal year 2013 (affecting discharges and cost reporting periods beginning on or after October 1, 2012 through September 30, 2013). The standard payment conversion factor for discharges for fiscal year 2013 is $14,343, an increase from the fiscal year 2012 standard payment conversion factor of $14,076. The standard payment conversion factor for fiscal year 2013 includes a market basket increase of 2.7% less a productivity adjustment of 0.7% and less a reduction of 0.1% mandated by the PPACA. The outlier threshold amount for fiscal year 2013 is set at $10,466, a decrease from the outlier threshold amount in the 2012 fiscal year of $10,713.

Medicare Market Basket Adjustments for Inpatient Rehabilitation Facilities

The PPACA instituted a market basket payment reduction adjustment for IRFs. For fiscal years 2012 and 2013, the reduction was 0.1%. For fiscal year 2014, the reduction is 0.3%. For fiscal years 2015 and 2016, the reduction is 0.2%. For fiscal years 2017 - 2019, the reduction is 0.75%.

Medicare Quality Reporting Program for LTCHs and IRFs

The PPACA requires that CMS establish new quality data reporting programs for LTCHs and IRFs by fiscal year 2014. CMS has adopted a quality data reporting program requiring LTCHs to submit data from three quality measures in order to . . .

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