~~Table~~ Use ofthese ~~Contents~~links to rapidly review the document TABLE OF CONTENTS SELECT MEDICAL HOLDINGS CORPORATION AND SELECT MEDICAL CORPORATION INDEX TO FINANCIAL STATEMENTS

~~UNITED STATES~~Table ~~SECURITIES~~of ~~AND~~Contents ~~EXCHANGE COMMISSION~~

UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549

~~FORM~~ Form 10-K

(Mark One)


þ		ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the fiscal year ended December 31, 2014
OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the transition period from to

þCommission ~~Annual~~file ~~Report~~numbers: ~~Pursuant~~001-34465 toand ~~Section 13 or 15(d) of the Securities Exchange Act of 1934~~001-31441

~~For~~SELECT ~~the~~MEDICAL ~~Fiscal~~HOLDINGS ~~Year~~CORPORATION SELECT ~~Ended~~MEDICAL ~~December 31,~~CORPORATION (Exact ~~2005~~ name of Registrants as specified in their Charter)


Delaware Delaware (State or Other Jurisdiction of Incorporation or Organization)		20-1764048 23-2872718 (I.R.S. Employer Identification Number)
4714 Gettysburg Road, P.O. Box 2034 Mechanicsburg, PA (Address of Principal Executive Offices)		17055 (Zip Code)
(717) 972-1100 (Registrants' telephone number, including area code)

oSecurities ~~Transition~~registered ~~report~~ pursuant to Section ~~13 or 15~~ 12(db) of the ~~Securities Exchange~~ Act ~~of 1934~~:

For the Period From to .

Title of Each Class		Name of Each Exchange on Which Registered

Select Medical Holdings Corporation, Common Stock, $0.001 par value		New York Stock Exchange

~~SELECT~~Securities ~~MEDICAL~~registered ~~CORPORATION~~pursuant to Section 12(g) of the Act: NONE

~~(Exact~~ Indicate by ~~name~~check ofmark ~~Registrant~~if the registrants are well-known seasoned issuers, as ~~specified~~defined in ~~its~~Rule 405 ~~charter)~~of the Securities Act.

~~Delaware~~ Select Medical ~~(State~~Holdings Corporation Yes þ No o Select orMedical Corporation Yes o No þ ~~other jurisdiction of incorporation or organization) 23-2872718 (I.R.S. employer identification number)~~

~~4716~~ Indicate ~~Old~~by ~~Gettysburg~~check ~~Road P.O.~~mark ~~Box~~if ~~2034 Mechanicsburg,~~the ~~Pennsylvania~~registrants ~~17055 (Address~~are ofnot ~~principal~~required ~~executive~~to ~~offices~~file ~~and~~reports ~~zip~~pursuant ~~code~~to Section 13 or Section 15(d) of the Act. Yes o No þ

Indicate by check mark whether the registrants (~~717~~1) ~~972-1100~~have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (~~Registrant’s~~or ~~telephone~~for ~~number,~~such ~~including~~shorter ~~area~~period ~~code~~that the registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. Yes þ No o

~~Securities~~ Indicate ~~registered~~by check mark whether the registrants have submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to ~~Section~~Rule 12405 of Regulation S-T (b)§ 232.405 of this chapter) during the ~~Act:~~preceding ~~None~~twelve months (or for such shorter period that the registrants were required to submit and post such files). Yes þ No o

~~Securities~~ Indicate ~~registered~~by check mark if disclosure of delinquent filers pursuant to ~~Section~~Item 12405 of Regulation S-K (g)§ 229.405 of this chapter) is not contained herein, and will not be contained, to the ~~Act:~~best ~~None~~of registrants' knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark ifwhether the ~~Registrant~~registrant, Select Medical Holdings Corporation, is a ~~well~~large accelerated filer, an accelerated filer, a non-~~known~~accelerated ~~seasoned~~filer, or ~~issuer~~a ~~(as~~smaller ~~defined~~reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule ~~405~~ 12b-2 of the ~~Securities~~Exchange Act). ~~Yes~~(Check oone): ~~No þ~~

~~Indicate~~Large byaccelerated ~~check~~filer ~~mark~~þ ifAccelerated ~~the~~filer ~~Registrant~~o isNon-accelerated ~~not~~filer ~~required~~o to(Do ~~file~~not ~~reports~~check ~~pursuant~~if toa ~~Section 13~~smaller orreporting ~~15(d~~company) ofSmaller ~~the~~reporting ~~Act.~~company ~~Yes~~ o ~~No þ~~

Indicate by check mark whether the ~~Registrant~~registrant, ~~(1) has~~Select ~~filed~~Medical ~~all~~Corporation, ~~reports~~is ~~required~~a tolarge beaccelerated ~~filed by~~filer, ~~Section 13~~an oraccelerated ~~15(d)~~filer, ofa ~~the~~non-accelerated ~~Securities~~filer, ~~Exchange~~or ~~Act~~a ofsmaller ~~1934~~reporting ~~during~~company. See the ~~preceding~~definitions ~~12 months,~~of ~~and (2) has~~"large ~~been~~accelerated ~~subject~~filer," to"accelerated ~~such~~filer" ~~filing~~and ~~requirements~~"smaller ~~for~~reporting ~~the~~company" ~~past~~in 90Rule ~~days.~~12b-2 ~~Yes~~of þthe NoExchange o Act.(Check one):

~~Indicate~~Large byaccelerated ~~check~~filer ~~mark~~o ifAccelerated ~~disclosure~~filer ofo ~~delinquent filers pursuant to Item 405 of Regulation S~~Non-Kaccelerated isfiler ~~not~~þ ~~contained~~(Do ~~herein, and will~~ not becheck ~~contained,~~if toa ~~the~~smaller ~~best~~reporting ofcompany) ~~Registrant’s~~Smaller ~~knowledge,~~reporting ~~in definitive~~company ~~proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ~~ o

Indicate by check mark whether the ~~Registrant~~registrants isare ashell ~~large~~companies ~~accelerated filer, an accelerated filer, or a non-accelerated filer~~ (as defined in Rule 12b-2 of the ~~Exchange~~ Act). Yes o No þ

~~Large~~ The ~~accelerated~~aggregate ~~filer~~market ~~o Accelerated~~value ~~Filer~~of Holdings' voting stock held by non-affiliates at June 30, 2014 (the last business day of Holdings' most recently completed ~~o Non~~second fiscal quarter) was approximately $1,311,848,710, based on the closing price per share of common stock on that date of $15.60 as reported on the New York Stock Exchange. Shares of common stock known by the registrants to be beneficially owned by directors and officers of Holdings subject to the reporting and other requirements of Section 16 of the Securities Exchange Act of 1934 are not included in the computation. The registrants, however, have made no determination that such persons are "affiliates" within the meaning of Rule 12b-~~accelerated~~2 ~~filer~~under þthe Securities Exchange Act of 1934.

~~Indicate~~ The number byof ~~check~~shares ~~mark~~of ~~whether~~Holdings' ~~the~~Common ~~Registrant~~Stock, is$0.001 apar ~~shell~~value, ~~company~~outstanding (as ~~defined~~of ~~in Rule~~February ~~12b-2~~1, of2015 ~~the Exchange~~was ~~Act)~~131,228,508. ~~Yes o No þ~~

~~None~~ This Form 10-K ofis ~~the~~a ~~Registrant’s~~combined ~~common~~annual ~~stock~~report isbeing ~~held~~filed separately by ~~non~~two Registrants: Select Medical Holdings Corporation and Select Medical Corporation. Unless the context indicates otherwise, any reference in this report to "Holdings" refers to Select Medical Holdings Corporation and any reference to "Select" refers to Select Medical Corporation, the wholly-~~affiliates~~owned operating subsidiary of Holdings. References to the ~~Registrant~~"Company," "we," "us," and "our" refer collectively to Select Medical Holdings Corporation and Select Medical Corporation.

AsDocuments ~~of March~~Incorporated ~~17,~~by ~~2006, the Registrant’s parent had outstanding 205,508,342 shares of common stock.~~ Reference

~~SELECT~~ Listed ~~MEDICAL~~hereunder ~~CORPORATION ANNUAL~~are ~~REPORT~~the ONdocuments, ~~FORM~~any portions of which are incorporated by reference and the Parts of this Form 10-K ~~FOR~~ ~~THE~~into ~~YEAR~~which ~~ENDED~~such ~~DECEMBER~~portions ~~31, 2005~~are incorporated:

1.: The registrant's definitive proxy statement for use in connection with the 2015 Annual Meeting of Stockholders to be held on or about April 27, 2015 to be filed within 120 days after the registrant's fiscal year ended December 31, 2014, portions of which are incorporated by reference into Part III of this Form 10-K. Such definitive proxy statement, except for the parts therein which have been specifically incorporated by reference, should not be deemed "filed" for the purposes of this form 10-K.

~~INDEX~~Table of Contents

		Page
PART I			1
ITEM 1.	BUSINESS		2
ITEM 1A.	RISK FACTORS		20
ITEM 1B.	UNRESOLVED STAFF COMMENTS		28
ITEM 2.	PROPERTIES		28
ITEM 3.	LEGAL PROCEEDINGS		28
ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS		29
PART II			30
ITEM 5.	MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES		30
ITEM 6.	SELECTED FINANCIAL DATA		30
ITEM 7.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		32
ITEM 7A.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		54
ITEM 8.	FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA		54
ITEM 9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE		54
ITEM 9A.	CONTROLS AND PROCEDURES		54
ITEM 9B.	OTHER INFORMATION		55
PART III			55
ITEM 10.	DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT		55
ITEM 11.	EXECUTIVE COMPENSATION		59
ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS		64
ITEM 13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS		66
ITEM 14.	PRINCIPAL ACCOUNTING FEES AND SERVICES		69
PART IV			69
ITEM 15.	EXHIBITS, FINANCIAL STATEMENT SCHEDULES		69
Statement of Ratio of Earnings to Fixed Charges
Subsidiaries of Select Medical Corporation
Certification of President and Chief Executive Officer pursuant to Section 302
Certification of Senior Vice President and Chief Financial Officer pursuant to Section 302
Certification of President and Chief Executive Officer pursuant to Section 906
Certification of Senior Vice President and Chief Financial Officer pursuant to Section 906

SELECT MEDICAL HOLDINGS CORPORATION
SELECT MEDICAL CORPORATION
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2014

-i-

Item		Page

	PART I
	Forward-Looking Statements	1
1.	Business	2
1A.	Risk Factors	31
1B.	Unresolved Staff Comments	42
2.	Properties	42
3.	Legal Proceedings	43
4.	Mine Safety Disclosures	44
	PART II
5.	Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	45
6.	Selected Financial Data	46
7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	49
7A.	Quantitative and Qualitative Disclosures About Market Risk	80
8.	Financial Statements and Supplementary Data	80
9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	80
9A.	Controls and Procedures	80
9B.	Other Information	81
	PART III
10.	Directors, Executive Officers and Corporate Governance	82
11.	Executive Compensation	82
12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	82
13.	Certain Relationships, Related Transactions and Director Independence	83
14.	Principal Accountant Fees and Services	83
	PART IV
15.	Exhibits and Financial Statement Schedules	84
SIGNATURES		93

Table of Contents

PART I

Forward-Looking Statements

This ~~discussion~~annual report on Form 10-K contains forward-looking statements within the meaning of the ~~Private Securities~~federal ~~Litigation~~securities ~~Reform~~laws. Statements ~~Act~~that ofare ~~1995~~not ~~regarding~~historical facts, ~~among~~including ~~other~~statements ~~things,~~about our ~~financial~~beliefs ~~condition, results~~and ~~of operations~~expectations, ~~plans, objectives, future performance and business. All statements contained in this report other than historical information~~ are forward-looking statements. Forward-looking statements include, ~~but~~statements ~~are~~preceded ~~not limited to~~by, ~~statements~~followed by or that ~~represent~~include ~~our~~the ~~beliefs~~words ~~concerning~~"may," ~~future~~"could," ~~operations~~"would," ~~strategies~~"should," ~~financial results or other developments~~"believe," ~~and contain words and phrases such as “may~~"expect,”" ~~“expects~~"anticipate,”" ~~“believes~~"plan,”" ~~“anticipates~~"target,”" ~~“estimates~~"estimate,”" ~~“should~~"project,”" or"intend" and similar expressions. ~~Because~~ ~~these~~These ~~forward-looking~~ statements ~~are~~include, ~~based~~among onothers, ~~estimates~~statements ~~and~~regarding ~~assumptions that are subject to~~our ~~significant~~expected business outlook, ~~economic~~anticipated financial and ~~competitive~~operating ~~uncertainties~~results, ~~many~~our ofbusiness ~~which~~strategy ~~are~~and ~~beyond~~means ~~our~~to ~~control or~~implement ~~are~~our ~~subject~~strategy, toour ~~change~~objectives, ~~actual~~the ~~results~~amount ~~could~~and betiming ~~materially~~of ~~different.~~capital ~~Although~~expenditures, wethe likelihood ~~believe~~of ~~that~~ our ~~plans,~~success ~~intentions and expectations reflected~~ in orexpanding ~~suggested~~our ~~by these forward-looking statements are reasonable~~business, wefinancing ~~cannot assure you that we will achieve or realize these~~ plans, ~~intentions~~ orbudgets, ~~expectations.~~working ~~Forward-looking~~capital ~~statements~~needs ~~are~~and ~~inherently~~sources ~~subject~~of ~~to risks, uncertainties and assumptions~~liquidity. ~~Important factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to:~~

• Forward-looking statements ~~compliance~~are ~~with~~only ~~the~~predictions ~~Medicare~~and ~~“hospital~~are ~~within~~not aguarantees ~~hospital”~~of ~~regulation~~performance. ~~changes~~These ~~will~~statements ~~require~~are ~~increased~~based ~~capital expenditures and may have an adverse effect~~ on our ~~future~~management's ~~net~~beliefs ~~operating revenues~~ and ~~profitability;~~assumptions, •which ~~additional changes~~ in ~~government~~turn ~~reimbursement~~are ~~for~~based ~~our services may have an adverse effect~~ on currently ~~our~~available ~~future~~information. ~~net~~Important ~~operating~~assumptions ~~revenues~~relating ~~and~~to ~~profitability, such as~~ the ~~regulations~~forward-looking ~~proposed~~statements byinclude, ~~the~~among ~~Centers~~others, ~~for~~assumptions ~~Medicare~~regarding &our ~~Medicaid Services on January 27~~services, ~~2006; •~~ the ~~failure~~expansion of our ~~long-term~~services, ~~acute~~competitive conditions ~~care~~and ~~hospitals~~general toeconomic ~~maintain~~conditions. ~~their~~These ~~status~~assumptions ascould ~~such~~prove ~~may~~inaccurate. ~~cause~~Forward-looking ~~our~~statements ~~net~~also ~~operating~~involve ~~revenues~~known and ~~profitability~~unknown torisks ~~decline;~~and •uncertainties, ~~the~~which ~~failure~~could ofcause ~~our~~actual results ~~facilities operated as “hospitals within hospitals”~~ to ~~qualify~~differ asmaterially ~~hospitals separate~~ from ~~their~~those ~~host~~contained ~~hospitals~~in ~~may~~any ~~cause~~forward-looking ~~our~~statement. ~~net~~Many ~~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~~factors ~~and,~~are asbeyond ~~a result, may reduce~~ our ~~future~~ability ~~net operating revenues and profitability; • implementation of annual caps that limit the amounts that can be paid for outpatient therapy services rendered~~ to ~~any~~control ~~Medicare beneficiary may reduce our future net operating revenues and profitability; • changes in applicable regulations~~ or apredict. ~~government~~Such ~~investigation~~factors 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 unsuccessfulinclude, ~~use~~but ~~significant~~are ~~resources~~not orlimited ~~expose us~~ to, the ~~unforeseen liabilities;~~following:

•: changes in government reimbursement for our services due to the implementation of healthcare reform legislation, deficit reduction measures, and/or new payment policies (including, for example, the expiration of the moratorium limiting the full application of the 25 Percent Rule that would reduce our Medicare payments for those patients admitted to a long term acute care hospital from a referring hospital in excess of an applicable percentage admissions threshold) may result in a reduction in net operating revenues, an increase in costs and a reduction in profitability;
•: the impact of the Bipartisan Budget Act of 2013 (the "BBA of 2013"), which establishes new payment limits for Medicare patients who do not meet specified criteria, may result in a reduction in net operating revenues and profitability of our long term acute care hospitals;
•: 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;
•: 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;

~~Table of Contents~~1

•Table 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.Contents

•: 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" of this annual report on Form 10-K.

~~Consequently~~ Except as required by applicable law, ~~such~~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, ~~should~~whether beas ~~regarded~~a ~~solely~~result asof ~~our~~any ~~current~~new ~~plans~~information, ~~estimates~~ ~~and~~future ~~beliefs.~~events ~~For~~or aotherwise. ~~discussion~~You ofshould ~~those~~not ~~and~~place ~~other~~undue ~~factors~~reliance ~~affecting~~on our ~~business,~~forward-looking ~~see~~statements. ~~the~~Although we believe that ~~section~~the ~~captioned~~expectations ~~“Risk~~reflected ~~Factors”~~in ~~under~~forward-looking ~~Item IA~~statements ofare ~~this~~reasonable, ~~report~~we cannot guarantee future results or performance.

~~ITEM~~ Investors should 1also 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. ~~BUSINESS~~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.

~~Company~~ ~~Overview~~ Item 1. Business.

~~Select Medical Corporation (the “Company,” “Select,” “we” or “us”) is a leading operator of~~ ~~specialty hospitals and outpatient rehabilitation clinics in the United States. As of December 31,~~ ~~2005, we operated 97 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 717 outpatient rehabilitation clinics in 24 states, the District of Columbia and seven Canadian~~ ~~provinces. On March 1, 2006 we completed the sale of our Canadian business. See “Business —~~ Subsequent Event.” We also provide medical rehabilitation services on a contract basis at nursing homes, hospitals, assisted living and senior care centers, schools and worksites. We began operations in 1997 under the leadership of our current management team, including our co-founders, Rocco A. Ortenzio and Robert A. Ortenzio, both of whom have significant experience in the healthcare industry. Under this leadership, we have grown our business through internal development initiatives and strategic acquisitions. For the combined twelve months ended December 31, 2005, we had net operating revenues of $1,858.4 million. Overview

We ~~manage~~began ~~our~~operations ~~company~~in ~~through~~1997, ~~two~~and ~~business~~we ~~segments,~~believe ~~our~~that ~~specialty~~we ~~hospital~~are ~~segment~~one of the largest operators of both specialty hospitals and ~~our~~ outpatient rehabilitation ~~segment.~~clinics ~~For~~in the ~~combined~~United ~~twelve~~States ~~months~~based ~~ended~~on number of facilities. As of December 31, ~~2005~~2014, ~~approximately~~ ~~74%~~we ofoperated ~~our~~113 ~~net~~long ~~operating~~term ~~revenues~~acute ~~were~~care ~~from~~hospitals, ~~our~~or ~~specialty~~"LTCHs," ~~hospitals~~ and ~~approximately~~16 inpatient rehabilitation ~~26%~~facilities, ~~were~~or ~~from~~"IRFs," ~~our~~in 28 states, and 1,023 outpatient rehabilitation ~~business~~clinics in 31 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 worksites. As of December 31, 2014, we had operations in 41 states and the District of Columbia.

~~The~~ We manage ~~Merger~~our ~~Transactions~~company through two business segments, our specialty hospital segment and our outpatient rehabilitation segment. We had net operating revenues of $3,065.0 million for the year ended December 31, 2014. Of this total, we earned approximately 73% of our net operating revenues from our specialty hospital segment and approximately 27% from our outpatient rehabilitation segment. Our specialty hospital segment consists of hospitals designed to serve the needs of long term stay acute care patients and hospitals designed to serve patients who require intensive inpatient medical rehabilitation care. Our outpatient rehabilitation segment consists of clinics and contract therapy locations that provide physical, occupational and speech rehabilitation services. See "Management's Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations" for financial information for each of our segments for the past three fiscal years.

~~On February 24, 2005, EGL Acquisition Corp. was merged with and into Select, with Select~~ ~~continuing as the surviving corporation and a wholly-owned subsidiary of Select Medical Holdings~~ ~~Corporation (the “Merger”). Select Medical Holdings Corporation was formerly known as EGL Holding~~ ~~Company and is referred to as Holdings. Holdings and EGL Acquisition Corp. were Delaware~~ ~~corporations formed by Welsh, Carson, Anderson & Stowe IX, LP (“Welsh Carson”), for purposes of~~ ~~engaging in the Merger and the related transactions. The Merger was completed pursuant to an~~ ~~agreement~~Specialty ~~and plan of merger, dated as of October 17, 2004, among EGL Acquisition Corp., Holdings~~ Hospitals

- We 2are a leading operator of specialty hospitals in the United States. As of December 31, 2014, we operated 129 facilities throughout 28 states, including 113 LTCHs, 108 of which are currently certified by the federal Medicare program as LTCHs and five of which are currently in the demonstration period (each new LTCH must demonstrate for a 6-month period that it has an average length of stay of greater than 25 days), and 16 IRFs, all of which are currently certified by the federal Medicare program as IRFs. For the years ended December 31, 2012, December 31, 2013 and December 31, 2014, approximately 60%, 59% and 57%, respectively, of the net operating revenues of our specialty hospital segment came from Medicare reimbursement. As of December 31, 2014, we operated a total of 5,326 available licensed beds and employed approximately 21,500 people in our specialty hospital segment, consisting primarily of registered nurses, respiratory therapists, physical therapists, occupational therapists and speech therapists.

~~Table of Contents~~2

~~and~~Table ~~Select.~~of ~~The Merger and related transactions are collectively referred to in this report as the “Transactions.”~~ Contents

As We operate athe ~~result~~majority of ~~the Transactions,~~ our ~~assets~~LTCHs ~~and~~as ~~liabilities~~a ~~have~~hospital ~~been~~within ~~adjusted~~a ~~to their fair value as of February 25~~hospital, ~~2005.~~or ~~We have also experienced~~ an ~~increase~~"HIH." inAn ~~our~~LTCH ~~aggregate~~that ~~outstanding indebtedness~~operates as aan ~~result~~HIH ofleases ~~financing~~space ~~transactions~~from ~~associated~~a ~~with~~general ~~the~~acute ~~Transactions.~~care ~~Accordingly~~hospital, ~~our~~ ~~amortization~~or ~~expense~~"host hospital," and ~~interest~~operates ~~expense~~as ~~are~~a ~~higher~~separately inlicensed ~~periods~~hospital ~~following~~within the ~~Transactions.~~host ~~The excess~~hospital, ofor ~~the~~on ~~total purchase price over~~ the ~~fair~~same ~~value~~campus ofas ~~our tangible and identifiable intangible assets of $1.4 billion has been allocated to goodwill, which will be~~ the ~~subject~~host ~~of an annual impairment test~~hospital. In ~~determining the total economic consideration to use for financial accounting purposes~~contrast, wea ~~have~~free-standing ~~applied~~LTCH ~~guidance~~does ~~found~~not inoperate ~~Financial~~on ~~Accounting~~a ~~Standards~~host ~~Board~~hospital ~~Emerging~~campus. ~~Issues~~We ~~Task~~operated ~~Force~~113 ~~Issue~~LTCHs ~~No.~~at December ~~88-16~~31, ~~“Basis~~2014, inof ~~Leveraged~~which ~~Buyout~~112 ~~Transactions.”~~were ~~This~~owned ~~has~~and ~~resulted~~one inwas amanaged. ~~portion of~~Of the ~~equity~~112 ~~related~~LTCHs towe ~~our~~owned, ~~continuing~~83 ~~stockholders~~were tooperated beas ~~recorded~~HIHs ~~at the stockholder’s predecessor basis~~ and a29 ~~corresponding~~were ~~portion~~operated ofas ~~the~~free-standing ~~acquired assets to be recorded likewise~~hospitals.

~~Subsequent~~ Patients are ~~Event~~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. Given their complex medical needs, these patients generally require a longer length of stay than patients in a general acute care hospital and benefit from being treated in a specialty hospital that is designed to meet their unique medical needs. The average length of stay for patients in our specialty hospitals was 27 days in our LTCHs and 15 days in our IRFs, for the year ended December 31, 2014.

~~On March 1, 2006, we sold our wholly-owned subsidiary Canadian Back Institute Limited (“CBIL”)~~ Below 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~~table ~~adjustment~~that ~~based on~~shows the ~~amount~~distribution ofby ~~net~~medical ~~working~~condition ~~capital~~(based ~~and long term liabilities of CBIL and its subsidiaries~~ on ~~the closing~~primary ~~date.~~diagnosis) ~~The financial results~~ of ~~CBIL~~patients ~~have been reclassified as discontinued operations for all periods presented~~ in ~~this~~our ~~report,~~hospitals ~~and its assets and liabilities have been reclassified as held~~ for ~~sale~~the onyear ~~our~~ended December 31, ~~2005~~2014: ~~balance sheet.~~

Specialty Hospitals

Medical Condition

Respiratory disorders	34	%
Neuromuscular disorders	33	%
Cardiac disorders	10	%
Wound care	5	%
Infectious diseases	5	%
Other	13	%

Total	100	%

As We believe ofthat ~~December 31,~~our ~~2005,~~services weare ~~operated~~attractive ~~101~~to ~~specialty~~healthcare ~~hospitals.~~payors Ofwho ~~this~~are ~~total,~~seeking 97to ~~operated~~provide ~~as long-term~~the ~~acute~~most cost-effective care ~~hospitals~~to their enrollees. Additionally, ~~all~~we ofcontinually ~~which~~seek ~~were~~to ~~certified~~increase our admissions by ~~the~~demonstrating ~~federal~~our ~~Medicare~~quality ~~program~~of ~~as long-term~~care and by doing so expanding and improving our relationships with the physicians and general acute care hospitals. ~~The~~in ~~remaining~~the ~~four~~markets ~~specialty~~where ~~hospitals~~we ~~are~~operate. ~~certified~~We maintain bya strong focus on the ~~federal Medicare~~provision ~~program~~of ashigh-quality ~~inpatient~~medical ~~rehabilitation~~care within our facilities. ~~For~~and ~~the~~believe ~~fiscal~~that ~~year~~this ~~ended~~operational ~~December 31, 2005,~~focus ~~approximately~~is ~~73%~~in ofpart ~~the~~reflected ~~net~~by ~~operating~~the ~~revenues~~accreditation of our specialty ~~hospital~~hospitals by ~~segment~~The ~~came~~Joint ~~from~~Commission, the ~~Medicare~~American ~~reimbursement~~Osteopathic Association ("AOA") and the Commission on Accreditation of Rehabilitation Facilities ("CARF"). As of December 31, ~~2005~~2014, all of the 129 specialty hospitals we operated awere accredited ~~total~~by one or more of 3these accrediting organizations. The Joint Commission,~~829~~ ~~available~~the ~~licensed beds~~AOA and ~~employed~~CARF ~~approximately~~are 12independent,~~000~~ ~~people~~not-for-profit inorganizations ~~our~~that ~~specialty~~establish ~~hospital~~standards ~~segment,~~related ~~with~~to the ~~majority~~operation and ~~being~~management ~~registered~~of orhealthcare ~~licensed~~facilities. ~~nurses,~~Each ~~respiratory~~of ~~therapists,~~our ~~physical~~accredited ~~therapists,~~facilities ~~occupational therapists~~must ~~and~~regularly ~~speech~~demonstrate ~~therapists~~to a survey team conformance to the applicable standards.

~~Patients~~ When a ~~are~~patient ~~admitted~~is referred to ~~our~~one ~~specialty~~of ~~hospitals~~our ~~from general acute care~~ hospitals. ~~These patients~~by ~~have~~a ~~specialized needs~~physician, ~~and~~case ~~serious and often complex medical conditions such as respiratory failure~~manager, ~~neuromuscular~~discharge ~~disorders~~planner, ~~traumatic~~health ~~brain~~maintenance ~~and~~organization ~~spinal~~or ~~cord~~insurance ~~injuries~~company, ~~stroke, cardiac~~we ~~disorders,~~perform ~~non-healing wounds, renal disorders and cancer. These patients generally require~~ a ~~longer~~clinical ~~length~~ assessment of ~~stay~~the ~~than~~patient ~~patients~~to indetermine aif ~~general~~the ~~acute~~patient ~~care~~meets ~~hospital~~our ~~and~~criteria ~~benefit~~for ~~from being treated in a specialty hospital that is designed to meet their unique medical needs~~admission. ~~Below~~Based ison ~~a table that shows~~ the ~~distribution~~determinations byreached ~~medical~~in ~~condition~~this ~~(based~~clinical onassessment, ~~primary~~an ~~diagnosis)~~admission ofdecision ~~patients~~is ~~in our~~made. ~~hospitals for the year ended December 31, 2005:~~

	Distribution
Medical Condition	of Patients
Respiratory disorder		33.0	%
Neuromuscular disorder		31.9
Cardiac disorder		11.1
Wound care		8.1
Other		15.9
Total		100.0	%

Upon admission, an interdisciplinary team reviews a new patient's condition. The interdisciplinary team is comprised of a number of clinicians and may include any or all of the following: an attending physician; a specialty nurse; a physical, occupational or speech therapist; a respiratory therapist; a dietician; a pharmacist; and a case manager. Upon completion of an initial evaluation by each member of the treatment team, an individualized treatment plan is established and implemented. The case manager

- 3 -

Table of Contents

~~We believe that we provide our services on a more cost-effective basis than a typical~~coordinates ~~general~~all ~~acute~~aspects ~~care hospital because we provide a much narrower range~~ of ~~services.~~the Wepatient's ~~believe~~hospital ~~that our~~stay ~~services~~and ~~are~~serves ~~therefore~~as ~~attractive~~a toliaison ~~healthcare~~with ~~payors who are seeking to provide~~ the ~~most cost-effective~~insurance ~~level~~carrier's ofcase ~~care~~management tostaff ~~their~~when ~~enrollees~~appropriate. ~~Additionally,~~The wecase ~~continually~~manager ~~seek~~communicates toprogress, ~~increase our~~resource ~~admissions~~utilization, ~~by expanding~~ and ~~improving~~treatment ~~our~~goals ~~relationships~~between ~~with~~ the ~~physicians~~patient, ~~and~~the ~~general~~treatment ~~acute~~team ~~care hospitals~~and ~~that~~the ~~refer patients to our facilities~~payor.

~~When~~ Each of aour ~~patient~~specialty hospitals has an interdisciplinary medical staff that is ~~referred~~comprised toof ~~one~~physicians that have completed the privileging and credentialing process required by that specialty hospital, and have been approved by the governing board of that specialty hospital. Physicians on the medical staff of our specialty hospitals byare agenerally ~~physician,~~not ~~case~~directly ~~manager,~~employed ~~discharge~~by our ~~planner,~~specialty ~~health~~hospitals ~~maintenance~~but ~~organization~~instead have staff privileges at one or ~~insurance~~more ~~company~~hospitals. At each of our specialty hospitals, attending physicians conduct rounds on their patients on a ~~clinical~~regular ~~liaison~~basis ~~along~~and consulting physicians provide consulting services based on the medical needs of our patients. Our specialty hospitals also have on-call arrangements with physicians to ensure that a physician is ~~Select~~available ~~case~~to ~~manager~~care ~~makes~~for anour ~~assessment~~patients at all times. We staff our specialty hospitals with the number of physicians and other medical practitioners that we believe is appropriate to ~~determine~~address the ~~care~~varying needs ~~required~~of our patients. ~~Based~~When ondetermining the ~~determinations~~appropriate composition of the medical staff of a specialty hospital, we consider (1) the size of the specialty hospital, (2) services ~~reached~~provided inby ~~this~~the ~~clinical~~specialty ~~assessment~~hospital, (3) if applicable, the size and capabilities of the medical staff of the general acute care hospital that hosts the HIH, and (4) if applicable, the proximity of an ~~admission~~acute ~~decision~~care ishospital ~~made~~to the free-standing specialty hospital. The medical staff of each of our specialty hospitals meets the applicable requirements set forth by Medicare, the hospital's ~~attending~~applicable ~~physician~~accrediting organizations, and the state in which that specialty hospital is located.

~~Upon~~ Each of ~~admission,~~our anspecialty ~~interdisciplinary~~hospitals ~~team~~has ~~reviews~~an aonsite ~~new~~management ~~patient’s condition. The interdisciplinary~~ team ~~comprises~~consisting of a ~~number~~chief ofexecutive ~~clinicians~~officer, ~~and~~a ~~may~~chief ~~include~~nursing ~~any~~officer orand ~~all~~a director of ~~the following:~~business andevelopment. ~~attending~~These ~~physician;~~teams amanage local ~~specialty~~strategy ~~nurse;~~and aday-to-day ~~physical~~operations, ~~occupational~~including oroversight ~~speech~~of ~~therapist; a~~clinical ~~respiratory~~care ~~therapist;~~and atreatment. ~~dietician;~~They aalso ~~pharmacist;~~assume ~~and~~primary aresponsibility ~~case~~for ~~manager.~~developing ~~Upon~~relationships ~~completion~~with ofthe ~~an initial~~general ~~evaluation~~acute bycare ~~each~~providers and ~~member~~clinicians ofin the ~~treatment~~local ~~team,~~areas anwe ~~individualized~~serve ~~treatment~~that ~~plan~~refer ~~is established~~patients ~~and~~to ~~implemented.~~our ~~The~~specialty ~~case~~hospitals. ~~manager~~We ~~coordinates~~provide ~~all~~our ~~aspects~~hospitals ofwith ~~the~~centralized ~~patient’s~~accounting, ~~hospital stay~~treasury, ~~and~~payroll, ~~serves~~legal, asoperational asupport, ~~liaison~~human resources, ~~with~~compliance, ~~the~~management ~~insurance~~information ~~carrier’s~~systems ~~case~~and ~~management~~billing ~~staff~~and ~~when~~collection ~~appropriate~~services. The ~~case~~centralization ~~manager~~of ~~communicates~~these ~~progress,~~services ~~resource~~improves ~~utilization,~~efficiency and ~~treatment~~permits ~~goals~~hospital ~~between~~staff ~~the patient,~~to ~~the~~focus ~~treatment~~their ~~team~~time ~~and~~on patient ~~the payor~~care.

~~Each of our specialty hospitals has an onsite management team consisting of a chief executive~~ For ~~officer,~~ a ~~director~~description of ~~clinical~~government ~~services~~regulations and aMedicare ~~director~~payments ofmade ~~provider relations. These teams manage local strategy and day-~~to~~-day~~ ~~operations, including oversight of clinical care and treatment. They also assume primary responsibility for developing relationships with the general acute care providers and clinicians in~~ our ~~markets that refer patients to our~~ specialty hospitals. Wesee ~~provide our~~" — ~~hospitals~~Government ~~with~~Regulations" ~~centralized~~and ~~accounting,~~"Management's ~~payroll,~~Discussion ~~legal, reimbursement, human resources,~~and ~~compliance,~~Analysis ~~management~~of ~~information~~Financial ~~systems,~~Condition ~~billing~~ and ~~collecting~~Results ~~services. The centralization~~ of ~~these~~ ~~services~~Operations — ~~improves~~Regulatory ~~efficiency and permits hospital staff to spend more time on patient care~~Changes. "

~~We operate most of our long-term acute care hospitals using a “hospital within a hospital” or~~ ~~“HIH” model. A long-term acute care hospital that operates as a hospital within a hospital leases~~ ~~space from a general acute care “host” hospital and operates as a separately-licensed hospital~~ ~~within the host hospital in contrast to a long-term acute care hospital that owns or operates a~~ ~~free-standing facility. Of the 97 long-term acute care hospitals we operated as of December 31,~~ ~~2005, 93 were operated as hospitals within hospitals and four were operated as free-standing~~ ~~facilities.~~Specialty AsHospital a result of the HIH regulatory changes discussed in further detail below, we have developed a plan that includes, among other things, relocating certain of our facilities to alternative settings, building or buying additional free-standing facilities and closing a small number of facilities. If the Centers for Medicare & Medicaid Services, also known as 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. Strategy

~~Recent~~ The ~~Long-Term~~key ~~Acute~~elements ~~Care~~of ~~Hospital~~our ~~Regulatory~~specialty ~~Developments~~ hospital strategy are to:

~~On August 11,~~ Focus ~~2004,~~on ~~CMS~~Specialized ~~published final~~Inpatient ~~regulations~~Services. We ~~applicable~~serve tohighly ~~long-term~~ acute ~~care~~patients ~~hospitals~~and ~~that~~patients ~~are~~with ~~operated~~debilitating asinjuries ~~“hospitals~~and rehabilitation ~~within~~needs ~~hospitals”~~that orcannot be asadequately ~~“satellites”~~cared ~~(collectively~~for ~~referred to as “HIHs”). HIHs are separate hospitals located~~ in ~~space~~a ~~leased~~less ~~from,~~medically ~~and~~intensive ~~located in~~environment, ~~general~~such ~~acute~~as ~~care~~a ~~hospitals,~~skilled ~~known~~nursing ~~as “host” hospitals~~facility. ~~Effective for hospital cost reporting periods beginning on or after October 1~~Generally, ~~2004,~~ ~~subject~~patients toin ~~certain~~our ~~exceptions,~~specialty ~~the~~hospitals ~~final~~require ~~regulations~~longer ~~provide~~stays ~~lower~~and ~~rates~~can ofbenefit ~~reimbursement~~from tomore ~~HIHs~~specialized ~~for~~clinical ~~those~~care ~~Medicare~~than patients ~~admitted~~treated ~~from their hosts that are~~ in ~~excess~~general ofacute acare ~~specified percentage threshold~~hospitals. ~~For~~Our ~~HIHs~~patients' ~~opened~~average ~~after~~length ~~October 1,~~of ~~2004,~~stay ~~the Medicare admissions threshold has been established at 25%. For HIHs that meet specified criteria and were~~ in ~~existence~~our asspecialty ofhospitals ~~October 1,~~was ~~2004,~~24 days ~~including~~for ~~all of our existing HIHs,~~ the ~~Medicare~~year ~~admissions thresholds will be phased-in~~ended ~~over~~December 31, a2014. ~~four-year period starting with~~

Provide High-Quality 4Care -and Service. We believe that our specialty hospitals serve a critical role in comprehensive healthcare delivery. Through our specialized treatment programs and staffing models, we treat patients with acute, complex and specialized medical needs who are typically referred to us by general acute care hospitals. Our specialized treatment programs focus on specific patient needs and medical conditions such as ventilator weaning programs, wound care protocols and rehabilitation programs for brain trauma and spinal cord injuries. Our responsive staffing models ensure that patients have the appropriate clinical resources over the course of their stay. We maintain quality assurance programs to support and monitor quality of care standards and to meet regulatory requirements and maintain Medicare certifications. We believe that we are recognized for providing quality care and service, as evidenced by our specialty hospitals' accreditations by The Joint Commission, the AOA and CARF. As of December 31,

~~Table of Contents~~4

~~hospital~~Table 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 was 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. The new HIH regulations also 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. Contents

~~As of December 31~~2014, ~~2005, we operated 97 long-term acute care hospitals, 93 of which operated~~ asall ~~HIHs. In order to minimize the more significant impact~~ of the ~~HIH~~129 ~~regulations~~specialty inhospitals ~~2006 and future years,~~ we ~~have~~operated ~~developed~~were aaccredited ~~business~~by ~~plan~~either ~~and~~The ~~strategy~~Joint inCommission ~~each~~or ~~of our markets to adapt to~~ the ~~HIH regulations and maintain our company’s current business~~AOA. ~~Our~~Some ~~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,~~IRFs ~~relocating~~had ~~certain~~also ofreceived ~~our facilities~~accreditation tofrom ~~alternative~~CARF. ~~settings,~~See ~~building or buying free-standing facilities and closing a small~~" — ~~number~~Government ofRegulations — ~~facilities~~Licensure — Accreditation." We ~~currently~~also ~~anticipate~~believe ~~that~~ we ~~will~~develop ~~need~~brand toloyalty ~~relocate~~in ~~approximately~~the ~~50%~~local ~~of our~~areas ~~long-term~~we ~~acute~~serve ~~care~~by ~~hospitals~~demonstrating ~~over~~our ~~the~~quality ~~next five years, including certain~~ of ~~the hospitals acquired in the SemperCare acquisition~~care.

~~All Medicare payments to our long-term acute care hospitals are made in accordance with a new~~ Our ~~prospective~~treatment ~~payment system specifically applicable to long-term acute care hospitals~~programs, ~~referred to as “LTCH-PPS”. Under LTCH-PPS, a long-term acute care hospital is paid a predetermined fixed amount depending upon the long-term care diagnosis-related group, or “LTC-DRG,” to~~ which ~~each patient~~are iscontinuously ~~assigned.~~reassessed LTCH-PPS includes special payment policies that adjust the payments for some patients based on a variety of factors. On January 27, 2006, the Centers for Medicare & Medicaid Services (known as “CMS”) published its proposed annual payment rate updates for the 2007 LTCH-PPS rate year (affecting cost reporting periods beginning on or after July 1, 2006 and ~~before July 1~~updated, ~~2007).~~ ~~The~~benefit ~~January 2006 proposed rule includes the following proposed changes to LTCH-PPS payment methodologies: (i) addition of a new payment methodology for Medicare~~ patients ~~with~~because athey ~~length~~give ~~of stay~~our ~~less~~clinicians ~~than~~access ~~or equal~~ to ~~5/6ths of~~ the ~~geometric~~best ~~average~~practices ~~length~~and ofprotocols ~~stay for each LTC-DRG (referred to as “short-stay outlier” or “SSO” cases), so~~ that ~~payment~~we ~~for~~have afound ~~significant portion of~~to ~~SSO cases will~~ be ~~reduced~~most toeffective anin ~~amount~~treating ~~comparable~~various ~~with~~conditions ~~that~~such ~~paid under the general acute care hospital reimbursement methodology; (ii) a zero-percent update to the LTCH-PPS standard federal rate used~~ as arespiratory ~~basis~~failure, ~~for LTCH~~non-~~PPS~~healing ~~payments;~~wounds, ~~(iii) sunset~~brain ofand ~~the~~spinal ~~surgical~~cord ~~case~~injuries, ~~exception~~strokes toand ~~the three-day~~neuromuscular ordisorders. ~~less~~In ~~interruption of stay policy~~addition, ~~under~~we ~~which~~combine ~~Medicare~~or ~~reimburses a general acute care~~modify ~~hospital~~these ~~directly~~programs ~~for surgical services furnished~~ to aprovide ~~long-term acute care hospital patient during~~ a ~~brief~~treatment ~~interruption~~plan oftailored ~~stay from the long-term acute care hospital, rather than requiring the long-term acute care hospital~~ to ~~bear~~meet ~~responsibility~~our ~~for~~patients' ~~such~~unique ~~surgical services; and (iv) 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~~needs. ~~CMS~~We ~~estimates that~~measure the ~~changes~~outcomes itand issuccesses ~~proposing~~of ~~for~~our ~~the~~patients' ~~2007~~recovery ~~LTCH-PPS rate year will result~~ in anorder ~~approximately 11 percent decrease in Medicare payments~~ to ~~long-term~~provide ~~acute~~the ~~care~~best ~~hospitals~~possible ~~as compared to the 2006~~patient ~~rate~~care ~~year. Consistent with its standard process for adopting regulations, CMS has solicited~~ and ~~will~~ ~~consider comments on the January 2006 proposed rule before it publishes a final update for the 2007 LTCH-PPS rate year~~service. ~~As a result, CMS may elect not to adopt certain of its proposals or the agency may adopt the proposals with modifications. If, however, the January 2006 proposals are~~

- The quality 5of -the patient care we provide is continually monitored using several measures, including clinical outcomes data and analyses and patient satisfaction surveys. Quality measures from our hospitals are collected at our corporate offices and used to create monthly, quarterly and annual reports. In order to benchmark ourselves against other hospitals, we collect our clinical and patient satisfaction information and compare it to national standards and the results of other healthcare organizations. We report to the states in which our hospitals are located certain quality measures that are required to be reported under state laws. We also report to the Centers for Medicare & Medicaid Services, or "CMS", the quality data required to be reported by specialty hospitals. See " — Government Regulations — Other Medicare Regulations — Medicare Quality Reporting."

~~Table~~ Reduce ofOperating ~~Contents~~Costs. We continually seek to improve operating efficiency and reduce costs at our hospitals by standardizing operations and centralizing key administrative functions. These initiatives include:

•: centralizing administrative functions such as accounting, treasury, payroll, legal, operational support, human resources, compliance and billing and collection;
•: standardizing management information systems to aid in accounting, billing, collections and data capture and analysis; and
•: centralizing sourcing and contracting to receive discounted prices for pharmaceuticals, medical supplies and other commodities used in our operations.

~~adopted~~ Increase ~~without~~Commercial ~~modification,~~Volume. We ~~these~~have ~~changes~~focused inon ~~LTCH-PPS~~continued ~~reimbursement~~expansion ~~policy~~of ~~will~~our ~~reduce~~relationships ~~our~~with ~~net~~commercial ~~operating~~insurers ~~revenues~~to ~~and~~increase ~~will~~our ~~adversely~~volume of ~~affect~~patients with commercial insurance in our ~~financial~~specialty ~~performance~~hospitals. We believe that commercial payors seek to contract with our hospitals because we offer patients high-quality, cost-effective care at more attractive rates than general acute care hospitals. We also offer commercial enrollees customized treatment programs not typically offered in general acute care hospitals.

~~See~~ Develop ~~“Business~~Specialty —Hospitals. Since ~~Government~~our ~~Regulations”~~inception in 1997 we have internally developed 71 specialty hospitals. The BBA of 2013 reinstated the moratorium on the establishment and ~~“Management’s~~classification ~~Discussion~~of new LTCHs, LTCH satellite facilities and ~~Analysis~~LTCH beds in existing LTCHs or satellite facilities beginning January 1, 2015 through September 30, 2017. The Protecting Access to Medicare Act of ~~Financial~~2014 (the "PAMA") advanced the commencement date of the new moratorium from January 1, 2015 to April 1, 2014. The PAMA ~~Condition~~includes exceptions to the moratorium that are applicable to the establishment and ~~Results~~classification of ~~Operations~~new —LTCHs ~~Regulatory~~or ~~Changes~~LTCH satellites facilities currently under development.” The new moratorium will not apply to LTCHs or LTCH satellites facilities that: (1) began their qualifying period to become an LTCH on or before April 1, 2014; (2) had a binding written agreement as of April 1, 2014 with an unrelated party for construction, renovation, or lease for an LTCH and have expended, before April 1, 2014, at least 10% of the estimated cost of the project (or, if less, $2,500,000); or (3) had obtained a certificate of need on or before April 1, 2014. The new moratorium provides no exceptions for increases in the number of certified beds in existing LTCHs and LTCH satellites. Further, in accordance with the requirements of guidance issued on October 10, 2014 by the Survey and Certification Group at CMS's

~~Outpatient Rehabilitation~~ 5

AsTable of December 31, 2005, we operated 717 clinics throughout 24 states, the District of Columbia and seven Canadian provinces. On March 1, 2006, we completed the sale of our Canadian business. See “Business — Subsequent Event.” As a result of the sale, our total clinic count was reduced by 109 clinics. Typically, each of our clinics is located in a medical complex or retail location. As of December 31, 2005, our outpatient rehabilitation segment employed approximately 8,300 people. Contents

~~In our clinics and through our contractual relationships~~Central Office, weany ~~provide~~LTCH ~~physical, occupational and speech rehabilitation programs and services. We also provide certain specialized programs such as hand therapy or sports performance enhancement~~ that ~~treat~~establishes ~~sports~~a ~~and~~new ~~work related injuries~~satellite, ~~musculoskeletal~~ ~~disorders,~~based ~~chronic~~upon ormeeting ~~acute~~the ~~pain~~criteria ~~and~~for ~~orthopedic~~an ~~conditions.~~exception ~~The typical patient in one of our clinics suffers from musculoskeletal impairments that restrict his or her ability~~ to ~~perform~~ ~~normal~~the ~~activities of daily living. These impairments are often associated with accidents~~moratorium, ~~sports~~ ~~injuries,~~must ~~strokes,~~reduce ~~heart~~beds ~~attacks~~elsewhere ~~and~~in ~~other~~the ~~medical~~LTCH ~~conditions.~~in ~~Our~~order ~~rehabilitation programs and services are designed~~ to ~~help~~operate ~~these~~beds ~~patients~~in ~~minimize physical and cognitive impairments and~~the ~~maximize~~new ~~functional~~satellite ~~ability~~location. WeIn ~~also design services to prevent short-term disabilities from becoming chronic conditions. Our rehabilitation services are provided by our professionals including licensed physical therapists~~addition, ~~occupational~~we ~~therapists,~~may ~~speech-language~~consider ~~pathologists~~international ~~and respiratory~~development ~~therapists~~opportunities.

~~Outpatient~~ Pursue ~~rehabilitation~~Joint ~~patients~~Ventures ~~are~~with ~~generally~~Large ~~referred~~Health orCare ~~directed~~Systems. By toleveraging ~~our~~the ~~clinics~~experience byof ~~a physician,~~our ~~employer~~senior ormanagement ~~health~~and ~~insurer~~development ~~who~~team, ~~believes~~we believe that awe are ~~patient,~~well ~~employee~~positioned orto ~~member~~expand ~~can~~our ~~benefit from~~portfolio ~~the~~of ~~level~~joint ofventured ~~therapy~~operations. When we ~~provide~~identify injoint anventure ~~outpatient~~opportunities, ~~setting.~~our Wedevelopment ~~believe~~team ~~that~~conducts ~~our~~an ~~services~~extensive ~~are attractive~~review toof ~~healthcare~~the ~~payors~~area's ~~who~~referral patterns ~~are~~and ~~seeking~~commercial insurance rates to ~~provide~~determine the ~~most~~general ~~cost-effective~~reimbursement ~~level~~trends ofand ~~care~~payor ~~to their enrollees~~mix. InOnce ~~addition~~discussions tocommence ~~providing~~with ~~therapy~~a inhealth ~~our~~care ~~outpatient clinics~~system, we ~~provide~~refine ~~medical rehabilitation~~the ~~management~~specific ~~services~~needs onof a ~~contract~~joint venture, ~~basis~~which atcould ~~nursing~~include ~~homes,~~working ~~hospitals~~capital, ~~schools, assisted~~the ~~living~~construction ~~and~~of ~~senior~~new ~~care~~space ~~centers~~or the leasing and ~~worksites~~renovation of existing space. InA ~~our~~joint ~~outpatient~~venture ~~rehabilitation~~typically ~~segment,~~consists of us and the health care system ~~approximately~~contributing ~~88%~~certain ofpost ~~our~~acute ~~net~~care ~~operating~~businesses ~~revenues~~into ~~come~~a ~~from~~newly ~~commercial~~formed ~~payors,~~entity. ~~including~~We ~~healthcare insurers,~~typically ~~managed~~function ~~care~~as ~~organizations~~the manager and ~~workers’~~hold ~~compensation~~either ~~programs,~~a ~~and~~majority ~~contract~~or ~~management services~~minority ownership interest. ~~The~~We ~~balance~~believe ofwe ~~our~~improve ~~reimbursement~~the joint isventure ~~derived~~by ~~from~~bringing ~~Medicare~~clinical expertise, adding clinical programs that attract commercial payors, and ~~other~~implementing ~~government~~our ~~sponsored~~ standardized resource management programs., which may increase the financial performance of the joint venture.

~~Other~~ Pursue ~~Services~~Opportunistic Acquisitions. In addition to our development and joint venture initiatives, we may grow our network of specialty hospitals through opportunistic acquisitions. When we acquire a hospital or a group of hospitals, a team of our professionals is responsible for formulating and executing an integration plan. We seek to improve financial performance at such facilities by adding clinical programs that attract commercial payors, centralizing administrative functions and implementing our standardized resource management programs.

~~Other services (which accounted for less than 1% of our net operating revenues in the combined~~ ~~twelve months ended December 31, 2005) include home medical equipment, orthotics, prosthetics,~~ ~~oxygen and ventilator systems, infusion/intravenous and certain non-healthcare services.~~ Outpatient Rehabilitation

~~Specialty~~ We ~~Hospital~~believe ~~Strategy~~that we are the largest operator of outpatient rehabilitation clinics in the United States based on number of facilities, with 1,023 facilities throughout 31 states and the District of Columbia as of December 31, 2014. Typically, each of our clinics is located in a medical complex or retail location. We also provide medical rehabilitative services to residents and patients of nursing homes, hospitals, schools, assisted living and senior care centers and worksites. As of December 31, 2014, we provided rehabilitative services to approximately 409 contracted locations in 27 states and the District of Columbia. Our outpatient rehabilitation segment employed approximately 9,000 people as of December 31, 2014.

~~Provide~~ In our ~~high~~clinics ~~quality~~and ~~care~~through our contractual relationships, we provide physical, occupational and ~~service~~speech rehabilitation programs and services. We ~~believe~~also ~~that~~provide ~~our~~certain ~~patients~~specialized ~~benefit~~programs such ~~from~~as ~~our experience~~functional inprograms ~~addressing~~for ~~complex~~work ~~medical~~related injuries, hand therapy and ~~rehabilitation~~athletic ~~needs~~training services. ToThe ~~effectively~~typical ~~address~~patient ~~the nature~~in one of our ~~patients’~~clinics ~~medical~~suffers ~~conditions,~~from wemusculoskeletal ~~have~~impairments ~~developed~~that ~~specialized~~restrict ~~treatment programs~~his ~~focused~~or ~~solely~~her onability ~~their~~to ~~needs~~perform normal activities of daily living. WeThese ~~have~~impairments ~~also~~are ~~implemented~~often ~~specific~~associated ~~staffing~~with ~~models~~accidents, ~~that~~sports injuries, work related injuries or post-operative orthopedic and other medical conditions. Our rehabilitation programs and services are designed to ~~ensure~~help ~~that~~these patients ~~have~~minimize ~~access~~physical toand ~~the~~cognitive ~~necessary~~impairments and ~~level~~maximize offunctional ~~clinical attention~~ability. We ~~believe~~also ~~that by~~provide ~~focusing~~services ondesigned ~~quality~~to ~~care~~prevent ~~and~~short ~~service~~term wedisabilities ~~develop~~from ~~brand~~becoming ~~loyalty~~chronic inconditions. ~~our~~Our ~~markets~~rehabilitation ~~allowing~~services usare ~~to retain~~provided ~~patients~~by ~~and strengthen~~ our ~~relationships~~professionals including ~~with~~licensed ~~physicians,~~physical ~~employers~~therapists, occupational therapists and ~~health~~speech-language ~~insurers~~pathologists.

Outpatient rehabilitation patients are generally referred or directed to our clinics by a physician, employer or health insurer who believes that a patient, employee or member can benefit from the level of therapy we provide in an outpatient setting. We believe that our services are attractive to healthcare payors who are seeking to provide a high-quality 6and cost-effective care to their enrollees.

~~Table~~ In our outpatient rehabilitation segment, approximately 90% of ~~Contents~~our net operating revenues come from commercial payors, including healthcare insurers, managed care organizations and workers' compensation programs, contract management services and private pay sources. The balance of our reimbursement is derived from Medicare and other government sponsored programs.

Our treatment and staffing programs benefit patients because they give our clinicians access to the regimens that we have found to be most effective in treating various conditions such as respiratory failure, non-healing wounds, brain and spinal cord injuries, strokes and neuromuscular disorders. In addition, we combine or modify these programs to provide a treatment plan tailored to meet a patient’s unique needs. 6

~~The~~Table ~~quality~~ of the patient care we provide is continually monitored using several measures, including patient, payor and physician satisfaction, as well as clinical outcomes. Quality measures are collected monthly and reported quarterly and annually. In order to benchmark ourselves against other healthcare organizations, we have contracted with outside vendors to collect our clinical and patient satisfaction information and compare it to other healthcare organizations. The information collected is reported back to each hospital, to the corporate office, and directly to the Joint Commission on Accreditation of Healthcare Organizations, commonly known as JCAHO. As of December 31, 2005, JCAHO had accredited all but one of our hospitals. This hospital has not yet undergone a JCAHO survey. Each of our four inpatient rehabilitation facilities has also received accreditation from the Commission on Accreditation of Rehabilitation Facilities. See “— Government Regulations — Licensure — Accreditation.” Contents

~~Maintain operational and financial results under revised Medicare regulations. As~~ For a ~~result~~description of ~~the~~ ~~regulatory~~government ~~changes~~regulations ~~published~~and byMedicare ~~CMS~~payments onmade ~~August 11,~~to ~~2004, much of~~ our ~~effort~~outpatient inrehabilitation ~~the~~services ~~near-term will~~see be" — ~~focused~~Government onRegulations" ~~implementing~~and ~~strategic initiatives at our existing hospitals. These initiatives~~"Management's ~~will~~Discussion ~~include~~and ~~managing~~Analysis ~~admissions at existing HIHs, relocating certain HIHs to leased spaces in smaller host hospitals in the same markets, relocating certain~~ of ~~our~~Financial ~~facilities~~Condition ~~to alternative settings~~ and ~~building~~Results ~~or buying free-standing facilities. We believe that there is sufficient time during the phase-in period to meet the requirements~~ of ~~the~~Operations — ~~new~~Regulatory ~~HIH regulations while maintaining our existing business~~Changes." If CMS implements certain additional regulatory changes that it has proposed and discussed and that would affect long-term acute care hospitals more generally, we may be required to further modify our strategic initiatives.

~~Reduce operating costs. We continually seek to improve operating efficiency and reduce costs~~ ~~at our hospitals by standardizing operations and centralizing key administrative functions. These~~ ~~initiatives include:~~ Outpatient Rehabilitation Strategy

• The ~~optimizing~~key ~~staffing~~elements ~~based on our occupancy and the clinical needs~~ of our ~~patients;~~outpatient •rehabilitation ~~centralizing~~strategy ~~administrative~~are ~~functions such as accounting, finance, payroll, legal, reimbursement, compliance, human resources and billing and collection; • standardizing management information systems~~ to: ~~aid in financial reporting as well as billing and collecting; and • participating in group purchasing arrangements to receive discounted prices for pharmaceuticals and medical supplies.~~

~~Increase~~ Provide ~~higher~~High-Quality ~~margin~~Care ~~commercial~~and ~~volume~~Service. We ~~typically~~are ~~receive~~focused ~~higher~~on ~~reimbursement~~providing ~~rates from commercial insurers than we do from the federal Medicare program. As~~ a ~~result,~~high welevel ~~work~~of toservice ~~expand relationships with insurers~~ to ~~increase~~our ~~commercial~~patients ~~patient~~throughout ~~volume.~~their Weentire course ~~believe that commercial~~of ~~payors~~treatment. ~~seek~~To tomeasure ~~contract~~satisfaction with our ~~hospitals~~service ~~because~~ we ~~offer~~have ~~patients~~developed ~~high~~surveys ~~quality~~for both patients and ~~cost-effective~~ ~~care~~physicians. ~~Although~~Our clinics utilize the ~~level~~feedback offrom ~~care~~these wesurveys ~~provide~~to iscontinuously ~~complex~~refine and ~~staff intensive, we~~improve ~~typically~~service ~~have~~levels. ~~lower~~We ~~relative~~believe ~~operating~~that ~~expenses~~by ~~than~~focusing aon ~~general~~quality ~~acute~~ care ~~hospital~~and ~~because~~offering ~~we provide~~ a ~~much~~high ~~narrower~~level ~~range~~ of ~~patient~~customer ~~services~~service atwe ~~our~~develop ~~hospitals.~~brand Asloyalty ain ~~result~~the oflocal ~~our~~areas ~~lower relative~~we ~~costs,~~serve. weThis ~~offer~~high ~~more~~quality ~~attractive~~of ~~rates~~care toand ~~commercial~~service allows ~~payors.~~us Weto ~~also~~strengthen ~~offer~~our ~~commercial enrollees~~relationships ~~customized~~with ~~treatment~~referring ~~programs~~physicians, ~~not~~employers ~~typically~~and ~~offered~~health ininsurers ~~general~~and ~~acute~~drive ~~care~~additional ~~hospitals~~patient volume.

- Increase 7Market -Share. We strive to establish a leading presence within the local areas we serve. To increase our presence, we seek to expand our services and programs and to open new clinics in our existing markets. This allows us to realize economies of scale, heightened brand loyalty and workforce continuity. We are focused on increasing our workers' compensation and commercial/managed care payor mix.

~~Table~~ Expand Rehabilitation Programs and Services. Through our local clinical directors of ~~Contents~~operations and clinic managers within their service areas, we assess the healthcare needs of the areas we serve. Based on these assessments, we implement additional programs and services specifically targeted to meet demand in the local community. In designing these programs we benefit from the knowledge we gain through our national network of clinics. This knowledge is used to design programs that optimize treatment methods and measure changes in health status, clinical outcomes and patient satisfaction.

~~Develop~~ Optimize ~~new~~the ~~specialty~~Profitability ~~hospitals.~~of our Payor Contracts. We ~~expect~~review topayor ~~continue~~contracts ~~evaluating~~up ~~opportunities~~for torenewal ~~develop~~and potential new payor contracts to ~~long-term~~optimize ~~acute~~our profitability. ~~care~~Before ~~hospitals~~we enter into a new contract with a commercial payor, ~~primarily~~we inevaluate ~~settings~~it ~~where~~with the ~~new~~aid ~~HIH~~of ~~regulations~~our ~~would~~contract ~~have little~~management orsystem. noWe ~~impact~~assess potential profitability by evaluating past and projected patient volume, ~~for~~clinic ~~example~~capacity, inand ~~free-standing~~expense ~~buildings~~trends. ~~Additionally,~~We wecreate ~~are~~a ~~evaluating opportunities~~retention tostrategy ~~develop~~for ~~free-standing~~the ~~inpatient~~top ~~rehabilitation~~performing ~~facilities~~contracts ~~similar~~and toa ~~the~~renegotiation ~~four~~strategy for contracts that do not meet our defined ~~inpatient~~criteria. ~~rehabilitation~~We ~~facilities~~believe ~~acquired~~that ~~through~~our national footprint and our ~~September 2003~~strong ~~Kessler~~reputation ~~acquisition~~enable us to negotiate favorable outpatient contracts with commercial insurers.

Maintain Strong Employee Relations. We ~~have~~believe athat ~~dedicated~~the ~~development~~relationships ~~team~~between ~~with~~our ~~significant~~employees ~~market~~and ~~experience.~~the ~~When~~referral wesources ~~target~~in atheir communities ~~new~~are ~~market,~~critical ~~the~~to ~~development~~our ~~team~~success. ~~conducts~~Our anreferral ~~extensive~~sources, ~~review~~such ofas ~~local~~physicians ~~market~~and ~~referral~~healthcare ~~patterns~~case ~~and commercial~~managers, ~~insurance~~send their patients to ~~determine~~our ~~the~~clinics ~~general~~based ~~reimbursement~~on ~~trends~~three ~~and~~factors: ~~payor~~the ~~mix.~~quality ~~Ultimately~~of our care, ~~when~~ the service we provide ~~determine~~and atheir ~~location~~familiarity orwith ~~sign~~our atherapists. ~~lease~~We ~~for~~seek to retain and motivate our ~~planned~~therapists ~~space~~by implementing a performance- based bonus program, ~~the~~a ~~project~~defined iscareer ~~transitioned~~path with the ability to ~~our~~be ~~start-up~~promoted ~~team~~from within, ~~which~~timely iscommunication ~~experienced~~on incompany ~~preparing~~developments aand ~~specialty~~internal ~~hospital~~training ~~for opening~~programs. ~~The~~We ~~start-up team~~also ~~oversees~~focus ~~facility~~on ~~improvements,~~empowering ~~equipment~~our ~~purchases,~~employees ~~licensure~~by ~~procedures,~~giving ~~and~~them ~~the~~a ~~recruitment~~ high degree of aautonomy ~~full-time~~in ~~management~~determining local ~~team~~area strategy. ~~After~~We ~~the~~seek ~~facility~~to isidentify ~~opened,~~therapists ~~responsibility~~who ~~for~~are ~~its~~potential business leaders. This management ~~is transitioned~~approach toreflects ~~this~~the ~~new~~unique ~~management~~nature ~~team~~of each local area in which we operate and the importance of encouraging our ~~corporate~~employees ~~operations~~to ~~group~~assume responsibility for their clinic's performance.

Pursue ~~opportunistic~~Opportunistic ~~acquisitions~~Acquisitions. We ~~In addition to our development initiatives, we~~ may grow our network of ~~specialty~~outpatient ~~hospitals~~rehabilitation facilities through opportunistic acquisitions~~, such as our SemperCare acquisition, which we completed on January 1, 2005~~. We ~~adhere~~believe ~~to selective criteria in~~ our ~~acquisition~~ ~~analysis~~size and ~~have~~centralized ~~historically~~infrastructure ~~been~~allow ~~able~~us to ~~obtain~~take ~~assets~~advantage ~~for what we believe are attractive valuations. When we acquire a hospital or a group~~ of ~~hospitals,~~operational aefficiencies ~~team of our professionals is responsible for formulating~~ and ~~executing an integration plan. We have generally been able to~~ increase margins at acquired facilities ~~by adding clinical programs that attract commercial payors, centralizing administrative functions and implementing our standardized staffing models and resource management programs~~. From our inception in 1997 through December 31, 2005, we have acquired and integrated 58 hospitals. All of these hospitals now share our centralized billing and standardized management information systems. All of our acquired hospitals participate in our centralized purchasing program.

~~Outpatient Rehabilitation Strategy~~ 7

~~Provide~~Table ~~high quality care and service. We are focused on providing a high level~~ of ~~service~~Contents to our patients throughout their entire course of treatment. To measure satisfaction with our service we have developed surveys for both patients and physicians. Our clinics utilize the feedback from these surveys to continuously refine and improve service levels. We believe that by focusing on quality care and offering a high level of customer service we develop brand loyalty in our markets. This loyalty allows us to retain patients and strengthen our relationships with the physicians, employers, and health insurers in our markets who refer or direct additional patients to us.

~~Increase market share. Our goal is to be a leading provider of outpatient rehabilitation~~ ~~services in our local markets. Having a strong market share in our local markets allows us to~~ ~~benefit from heightened brand awareness, economies of scale and increased leverage when negotiating~~ ~~payor contracts. To increase our market share, we seek to expand our services and programs and to~~ ~~continue to provide high quality care and strong customer service in order to generate loyalty with~~ ~~patients and referral sources.~~ Other

~~Expand~~ Other ~~rehabilitation~~activities ~~programs~~include ~~and services. We assess the healthcare needs of~~ our ~~markets~~corporate ~~and implement~~services ~~programs~~ and ~~services~~certain ~~targeted~~other tominority ~~meet~~investments ~~the~~in ~~demands~~other ofhealthcare ~~the~~related ~~local community~~businesses. ~~In designing~~These ~~these~~include ~~programs~~investments wein ~~benefit~~companies ~~from~~that ~~the~~provide ~~knowledge~~specialized wetechnology, ~~gain~~services ~~through our national network of clinics. This knowledge is used~~ to ~~design~~healthcare ~~programs~~entities ~~that optimize treatment methods~~ and ~~measure~~providers ~~changes~~of incomplementary ~~health status, clinical outcomes and patient satisfaction~~services.

~~Optimize the profitability of our payor contracts. Before we enter into a new contract with a~~ ~~commercial payor, we evaluate it with the aid of our contract management system. We assess~~ ~~potential profitability by evaluating past and projected patient volume, clinic capacity, and~~ ~~expense trends. Each contract we enter into is continually re-evaluated to determine how it is~~ ~~affecting~~ Our ~~our~~Competitive ~~profitability. We~~ Strengths

- We 8believe -that the success of our business model is based on a number of competitive strengths, including our position as a leading operator in each of our business segments, proven financial performance and strong cash flow, significant scale, experience in completing and integrating acquisitions, ability to capitalize on consolidation opportunities and an experienced management team.

~~Table~~ Leading Operator in Distinct but Complementary Lines of ~~Contents~~Business. We believe that we are a leading operator in each of our principal business segments, based on number of facilities in the United States. Our leadership position and reputation as a high-quality, cost-effective healthcare provider in each of our business segments allows us to attract patients and employees, aids us in our marketing efforts to payors and referral sources and helps us negotiate payor contracts. In our specialty hospital segment, we operated 113 LTCHs in 28 states and 16 IRFs in eight states at December 31, 2014. We derived approximately 73% of net operating revenues from our specialty hospital segment, for the year ended December 31, 2014. In our outpatient rehabilitation segment, we operated 1,023 outpatient rehabilitation clinics in 31 states and the District of Columbia at December 31, 2014. We derived approximately 27% of net operating revenues from our outpatient rehabilitation segment, for the year ended December 31, 2014. With these leading positions in the areas we serve, we believe that we are well-positioned to benefit from the rising demand for medical services due to an aging population in the United States, which will drive growth across our business lines.

~~create~~ Proven aFinancial ~~retention~~Performance ~~strategy~~and ~~for~~Strong ~~each~~Cash Flow. We have established a track record of improving the ~~top~~financial ~~performing~~performance ~~contracts~~of ~~and~~our facilities adue ~~renegotiation~~to ~~strategy~~our ~~for~~disciplined ~~contracts~~approach ~~that~~to dorevenue ~~not~~growth, ~~meet~~expense management and an intense focus on free cash flow generation. This includes regular review of specific financial metrics of our ~~defined~~business ~~criteria~~to determine trends in our revenue generation, expenses, billing and cash collection. Based on the ongoing analysis of such trends, we make adjustments to our operations to optimize our financial performance and cash flow.

~~Maintain~~ Significant ~~strong employee relations~~Scale. By Webuilding ~~believe~~significant ~~that~~scale ~~the relationships between our employees and the referral sources~~ in ~~their~~each ~~communities~~of ~~are critical to~~ our ~~success.~~business ~~Our referral sources~~segments, ~~such~~ ~~as physicians and healthcare case managers, send their patients to our clinics based on three factors: the quality of our care, the service~~ we ~~provide~~have ~~and~~been ~~their~~able ~~familiarity with our therapists. We seek~~ to ~~retain~~leverage ~~and motivate~~ our ~~therapists~~operating bycosts implementing a performance-based bonus program, a defined career path with the ability to be promoted from within, timely communication on company developments, and internal training programs. We also focus on empowering our employees by ~~giving~~ ~~them a high degree of autonomy in determining local market strategy. This management approach~~centralizing ~~reflects~~administrative ~~the~~functions ~~unique~~at ~~nature of each market in which we operate and the importance of encouraging~~ our ~~employees~~ tocorporate ~~assume responsibility for their clinic’s performance~~office.

~~Sources~~ Experience ofin ~~Net~~Successfully ~~Operating~~Completing ~~Revenues~~and Integrating Acquisitions. From our inception in 1997 through 2014, we completed seven significant acquisitions for approximately $1,104.8 million in aggregate consideration. We believe that we have improved the operating performance of these facilities over time by applying our standard operating practices and by realizing efficiencies from our centralized operations and management.

~~The~~ Experience ~~following~~in ~~table~~Partnering ~~presents~~with Large Health Care Systems. Over the ~~approximate~~past ~~percentages~~several byyears ~~source~~we ofhave ~~net~~partnered ~~operating~~with ~~revenue~~large regional health care ~~received~~systems ~~for~~to provide ~~healthcare~~post acute care services. We believe that we provide operating expertise through our experience in operating specialty hospitals and outpatient rehabilitation services to these ventures and have improved and expanded the level of post acute care services provided ~~for~~in these communities, as well as the ~~periods~~financial ~~indicated:~~ performance of these operations.

	Fiscal Year Ended
	December 31,
Net Operating Revenues by Payor Source (1)	2003			2004			2005 (2)
Medicare		47.8	%		49.8	%		56.4
Commercial insurance (3)		44.9			42.3			37.2
Private and other (4)		5.7			5.7			4.3
Medicaid		1.6			2.2			2.1
Total		100.0	%		100.0	%		100.0	%

Well-Positioned to Capitalize on Consolidation Opportunities. We believe that we are well-positioned to capitalize on consolidation opportunities within each of our business segments and selectively augment our internal growth. We believe that each of our business segments is fragmented, with many of the nation's LTCHs, IRFs and outpatient rehabilitation facilities being operated by independent operators lacking national or broad regional scope. With our geographically diversified portfolio of facilities in the

(1)		This table excludes the net operating revenues of our Canadian operations which have been reclassified and reported as a discontinued operation. See “Business — Subsequent Event.”
(2)		The net operating revenues for the period after the Merger, February 25, 2005 through December 31, 2005 (Successor period), has been added to the net operating revenues for the period from January 1, 2005 through February 24, 2005 (Predecessor period), to arrive at the combined fiscal year ended December 31, 2005.
(3)		Includes commercial healthcare insurance carriers, health maintenance organizations, preferred provider organizations, workers’ compensation and managed care programs.
(4)		Includes self payors, contract management services and non-patient related payments. Self pay revenues represent less than 1% of total net operating revenues.

~~Government~~Table ~~Sources~~ of Contents

~~Medicare~~United States, iswe abelieve ~~federal~~that ~~program~~our ~~that~~footprint provides ~~medical~~us ~~insurance benefits to persons age 65 and over, some disabled persons, and persons~~ with ~~end-stage renal disease. Medicaid is~~ a ~~federal~~wide-~~state funded~~ranging ~~program,~~perspective ~~administered~~on bymultiple ~~the~~potential ~~states,~~acquisition ~~which provides medical benefits to individuals who are unable to afford healthcare~~opportunities. All of our hospitals are currently certified as Medicare providers. Our outpatient rehabilitation clinics regularly receive Medicare payments for their services. Additionally, our specialty hospitals participate in fifteen state Medicaid programs. Amounts received under the Medicare and Medicaid programs are generally less than the customary charges for the services provided. In recent years, there have been significant changes made to the Medicare and Medicaid programs. Since more than half of our revenues come from patients under the Medicare program, our ability to operate our business successfully in the future will depend in large measure on our ability to adapt to changes in

Experienced and Proven Management Team. Prior to co-founding 9our company with our current Executive Chairman and Co-Founder, our Vice Chairman and Co-Founder founded and operated three other healthcare companies focused on inpatient and outpatient rehabilitation services. In addition, our senior management team has extensive experience in the healthcare industry. Our President and Chief Executive Officer has more than two decades of management experience in the healthcare industry. Many of our other executives, such as our Chief Operating Officer, our Chief Financial Officer, our General Counsel, our Chief Human Resources Officer and our Chief Accounting Officer, have each served at our company for more than 15 years. In recent years, we have reorganized our operations to expand executive talent and ensure management continuity.

~~Table~~ Sources of ~~Contents~~Net Operating Revenues

The following table presents the ~~Medicare~~approximate ~~program.~~percentages ~~See~~by ~~“Business~~source —of ~~Government~~net ~~Regulations~~operating —revenue ~~Overview~~received offor ~~U.S.~~healthcare ~~and~~services ~~State~~we ~~Government~~provided ~~Reimbursements.”~~ for the periods indicated:

Non-Government Sources

	Year Ended December 31,

Net Operating Revenues by Payor Source	2012			2013			2014
Medicare		46.9	%		45.9	%		44.5	%
Commercial insurance⁽¹⁾		41.9	%		41.7	%		42.7	%
Private and other⁽²⁾		7.7	%		8.6	%		8.8	%
Medicaid		3.5	%		3.8	%		4.0	%

Total		100.0	%		100.0	%		100.0	%

~~Although in recent years an increasing percentage of our net operating revenues were generated~~ ~~from~~ ~~the Medicare program, a significant amount of our net operating revenues continue to come from~~ ~~private~~(1)Includes commercial ~~payor~~healthcare ~~sources. These sources include~~ insurance ~~companies~~carriers, ~~workers’ compensation programs,~~ health maintenance organizations, preferred provider organizations, other managed care companies, and employers, as well as by patients directly. Patients are generally not responsible for any difference between customary charges for our services and amounts paid by Medicare and Medicaid programs, insurance companies, workers’' compensation ~~companies, health maintenance organizations, preferred provider organizations,~~ and ~~other~~ managed care ~~companies~~programs. (2)Includes self-payors, ~~but~~contract ~~are~~management ~~responsible for~~ services ~~not covered by these programs or plans, as well as for deductibles~~ and conon-~~insurance obligations~~patient ofrelated ~~their coverage~~payments. ~~The amount of these deductibles and co~~Self-~~insurance~~pay ~~obligations~~revenues ~~has increased~~represent inless ~~recent years. Collection of amounts due from individuals is typically more difficult~~ than ~~collection~~1% of ~~amounts~~total ~~due~~net ~~from government or business payors. To further reduce their~~operating ~~healthcare~~revenues ~~costs, most insurance companies, health maintenance organizations, preferred provider organizations, and other managed care companies have negotiated discounted fee structures or fixed amounts~~ for ~~hospital~~all ~~services performed, rather than paying healthcare providers the amounts billed~~periods. ~~Our results of operations may be negatively affected if these organizations are successful~~ in ~~negotiating further discounts.~~

~~Employees~~ Government Sources

Medicare is a federal program that provides medical insurance benefits to persons age 65 and over, some disabled persons, and persons with end-stage renal disease. Medicaid is a federal-state funded program, administered by the states, which provides medical benefits to individuals who are unable to afford healthcare. As of December 31, ~~2005~~2014, we ~~employed~~operated ~~approximately~~129 20specialty hospitals,~~900~~ ~~people~~126 ~~throughout~~of ~~the~~which ~~United~~were ~~States~~ certified as Medicare providers and ~~Canada.~~three Aof ~~total~~which were in the process of ~~approximately~~obtaining 13their certification. Our outpatient rehabilitation clinics regularly receive Medicare payments for their services. Additionally,~~900~~ many of our ~~employees~~specialty ~~are~~hospitals ~~full~~participate ~~time~~in ~~and~~state Medicaid programs. Amounts received under the ~~remaining~~Medicare ~~approximately~~and ~~7,000~~Medicaid programs are ~~part~~generally ~~time~~less ~~employees~~than the customary charges for the services provided. ~~Outpatient,~~In ~~contract~~recent ~~therapy~~years ~~and~~there ~~physical rehabilitation~~have ~~and~~been ~~occupational~~significant ~~health~~changes ~~employees~~made ~~totaled~~to ~~approximately~~the ~~8,300~~Medicare and ~~inpatient~~Medicaid programs. Since a ~~employees~~significant ~~totaled~~portion ~~approximately~~of 12our revenues come from patients under the Medicare program,~~000.~~ ~~The~~our ~~remaining~~ability ~~approximately~~to ~~600~~operate ~~employees~~our ~~were~~business successfully in ~~corporate~~the future will depend in large measure on our ability to adapt ~~management,~~to ~~administration~~changes in the Medicare program. See "— Government Regulations — Overview of U.S. and ~~other~~State ~~services~~Government Reimbursements. "

~~Competition~~ 9

WeTable ~~compete on the basis~~ of pricing, the quality of the patient services we provide and the results that we achieve for our patients. The primary competitive factors in the long-term acute care and inpatient rehabilitation businesses include quality of services, charges for services and responsiveness to the needs of patients, families, payors and physicians. Other companies operate long-term acute care hospitals and inpatient rehabilitation facilities that compete with our hospitals, including large operators of similar facilities, such as Kindred Healthcare Inc. and HealthSouth Corporation. The competitive position of any hospital is also affected by the ability of its management to negotiate contracts with purchasers of group healthcare services, including private employers, managed care companies, preferred provider organizations and health maintenance organizations. Such organizations attempt to obtain discounts from established hospital charges. The importance of obtaining contracts with preferred provider organizations, health maintenance organizations and other organizations which finance healthcare, and its effect on a hospital’s competitive position, vary from market to market, depending on the number and market strength of such organizations. Contents

~~Our~~ ~~outpatient~~Non-Government rehabilitation clinics face competition principally from locally owned and managed outpatient rehabilitation clinics in the communities they serve. Many of these clinics have longer operating histories and greater name recognition in these communities than our clinics, and they may have stronger relations with physicians in these communities on whom we rely for patient referrals. In addition, HealthSouth Corporation, which operates more outpatient rehabilitation clinics in the United States than we do, competes with us in a number of our markets. Sources

Our non-government 10sources of net operating revenue include insurance companies, workers' compensation programs, health maintenance organizations, preferred provider organizations, other managed care companies and employers, as well as by patients directly. Patients are generally not responsible for any difference between customary charges for our services and amounts paid by Medicare and Medicaid programs, insurance companies, workers' compensation companies, health maintenance organizations, preferred provider organizations and other managed care companies, but are responsible for services not covered by these programs or plans, as well as for deductibles and co-insurance obligations of their coverage. The amount of these deductibles and co-insurance obligations has increased in recent years. Collection of amounts due from individuals is typically more difficult than collection of amounts due from government or commercial payors.

~~Table of Contents~~ Employees

~~Government~~ As ~~Regulations~~of December 31, 2014, we employed approximately 31,400 people throughout the United States. Approximately 21,400 of our employees are full time and the remaining approximately 10,000 are part-time employees. Specialty hospital employees totaled approximately 21,500 and outpatient, contract therapy and physical rehabilitation and occupational health employees totaled approximately 9,000. The remaining approximately 900 employees were in corporate management, administration and other support services primarily residing at our Mechanicsburg, Pennsylvania headquarters.

~~General~~ Competition

~~The~~ We ~~healthcare~~compete ~~industry~~on isthe ~~required~~basis toof ~~comply~~the ~~with~~quality ~~many~~of ~~laws~~the ~~and~~patient ~~regulations~~services atwe provide, the ~~federal, state~~results that we achieve for our patients and ~~local~~the ~~government~~prices we ~~levels~~charge for our services. ~~These~~The ~~laws~~primary ~~and~~competitive ~~regulations~~factors ~~require~~in ~~that~~the ~~hospitals~~specialty ~~and~~hospital ~~outpatient rehabilitation~~business ~~clinics~~include ~~meet~~quality ~~various~~of ~~requirements~~services, ~~including~~charges ~~those~~for ~~relating~~services and responsiveness to the ~~adequacy~~needs of ~~medical~~ ~~care~~patients, ~~equipment~~families, payors ~~personnel,~~and ~~operating~~physicians. ~~policies~~Other ~~and~~companies ~~procedures,~~operate ~~maintenance~~specialty ofhospitals ~~adequate records,~~that ~~compliance~~compete with ~~building~~our ~~codes~~hospitals, ~~and~~including ~~environmental~~large ~~protection~~operators ~~and~~of ~~healthcare~~similar ~~fraud~~facilities, such as Kindred Healthcare Inc. and ~~abuse.~~HealthSouth ~~These~~Corporation ~~laws~~and rehabilitation units and ~~regulations~~stepdown ~~are~~units ~~extremely~~operated ~~complex~~by ~~and,~~acute incare ~~many~~hospitals ~~instances,~~in the ~~industry~~markets ~~does not~~we ~~have~~serve. ~~the~~The ~~benefit~~competitive position of ~~significant~~any ~~regulatory~~hospital oris ~~judicial~~also ~~interpretation.~~affected Ifby wethe ~~fail~~ability of its management to ~~comply~~ negotiate contracts with ~~applicable~~purchasers ~~laws~~of ~~and~~group ~~regulations~~healthcare services, weincluding ~~could~~private ~~suffer~~employers, ~~civil~~managed orcare ~~criminal penalties~~companies, ~~including~~preferred ~~the~~provider organizations and health maintenance ~~loss~~organizations. ofSuch ~~our~~organizations ~~licenses~~attempt to ~~operate~~obtain ~~and~~discounts ~~our~~from ~~ability~~established tohospital ~~participate~~charges. inThe ~~the~~importance ~~Medicare~~of obtaining contracts with preferred provider organizations, ~~Medicaid~~health maintenance organizations and other ~~federal~~ ~~and~~organizations ~~state~~which finance healthcare, ~~programs~~and its effect on a hospital's competitive position, vary from area to area, depending on the number and strength of such organizations.

~~Licensure~~ Our outpatient rehabilitation clinics face competition principally from locally owned and managed outpatient rehabilitation clinics in the communities they serve and from selected national providers such as Physiotherapy Associates and U.S. Physical Therapy in selected local areas. Some of these clinics have longer operating histories and greater name recognition in these communities than our clinics, and they may have stronger relations with physicians in these communities on whom we rely for patient referrals.

~~Facility licensure. Our healthcare facilities are subject to state and local licensing~~ ~~regulations ranging from the adequacy of medical care to compliance with building codes and~~ ~~environmental protection laws. In order to assure continued compliance with these various~~ ~~regulations, governmental and other authorities periodically inspect~~ ~~our facilities. Some states still require us to get approval under certificate of need regulations when we~~ ~~create, acquire or expand our facilities or services.~~ Government Regulations

~~Professional~~ licensure and corporate practice. Healthcare professionals at our hospitals and outpatient rehabilitation clinics are required to be individually licensed or certified under applicable state law. We take steps to ensure that our employees and agents possess all necessary licenses and certifications. In some states, business corporations such as ours are restricted from practicing therapy through the direct employment of therapists. In those states, in order to comply with the restrictions imposed, we either contract to obtain therapy services from an entity permitted to employ therapists, or we manage the physical therapy practice owned by licensed therapists through which the therapy services are provided. General

~~Certification.~~ The Inhealthcare ~~order~~industry is required to ~~participate~~comply inwith ~~the~~many ~~Medicare~~complex ~~program~~laws and ~~receive~~regulations ~~Medicare reimbursement~~at the federal, ~~each~~state ~~facility~~and ~~must~~local ~~comply~~government ~~with~~levels. These ~~the~~laws ~~applicable~~and regulations ofrequire ~~the~~that ~~United~~hospitals ~~States Department~~and ofoutpatient ~~Health~~rehabilitation ~~and~~clinics ~~Human~~meet ~~Services~~various ~~relating to~~requirements, ~~among~~including ~~other~~those ~~things,~~relating to the ~~type~~adequacy of ~~facility~~medical care, ~~its~~ equipment, ~~its~~ personnel, operating policies and ~~its~~procedures, ~~standards~~maintenance of ~~medical~~adequate ~~care~~records, assafeguarding ~~well~~protected ashealth information, compliance with ~~all applicable~~building ~~state~~codes and ~~local~~environmental ~~laws~~protection and ~~regulations~~healthcare fraud and abuse. ~~All~~These oflaws ~~our~~and ~~specialty~~regulations ~~hospitals~~are ~~participate~~extremely incomplex ~~the Medicare~~and, ~~program.~~in Inmany ~~addition~~instances, wethe ~~provide~~industry ~~the~~does ~~majority~~not ofhave ~~our~~the ~~outpatient~~benefit ~~rehabilitation~~of ~~services through~~significant ~~clinics~~regulatory ~~certified~~or byjudicial ~~Medicare~~interpretation. asIf ~~rehabilitation~~we ~~agencies~~fail orto ~~“rehab~~comply ~~agencies.”~~

Accreditation. Our hospitals receive accreditation from the Joint Commission on Accreditation of Healthcare Organizations, a nationwide commission which establishes standards relating to the physical plant, administration, quality of patient care and operation of medical staffs of hospitals. As of December 31, 2005, JCAHO had accredited all but one of our hospitals. This hospital has not yet undergone a JCAHO survey. Each of our four inpatient rehabilitation facilities has also received accreditation from the Commission on Accreditation of Rehabilitation Facilities, an independent, not-for-profit organization which reviews and grants accreditation for rehabilitation facilities that meet established standards for service and quality. 10

~~Overview~~Table of ~~U.S. and State Government Reimbursements~~ Contents

-with applicable 11laws -and regulations, we could suffer civil or criminal penalties, including the loss of our licenses to operate and our ability to participate in the Medicare, Medicaid and other federal and state healthcare programs.

~~Table~~ ofFacility ~~Contents~~Licensure

~~Medicare.~~ Our ~~The~~healthcare ~~Medicare~~facilities ~~program~~are ~~reimburses~~subject ~~healthcare~~to ~~providers~~state ~~for~~and ~~services~~local ~~furnished~~licensing regulations ranging from the adequacy of medical care to compliance ~~Medicare~~with ~~beneficiaries,~~building ~~which~~codes ~~are~~and ~~generally~~environmental ~~persons~~protection ~~age~~laws. 65In ~~and~~order ~~older,~~to ~~those~~assure ~~who~~continued ~~are~~compliance ~~chronically disabled~~with these various regulations, governmental and ~~those~~other ~~suffering~~authorities ~~from~~periodically ~~end~~inspect ~~stage~~our ~~renal~~facilities, not ~~disease.~~only ~~The~~at ~~program~~scheduled isintervals ~~governed~~but byalso ~~the~~in ~~Social Security~~response ~~Act~~to ofcomplaints ~~1965~~from patients and isothers. ~~administered~~While ~~primarily~~our byfacilities ~~the~~intend ~~Department~~to ofcomply ~~Health~~with existing licensing and ~~Human~~Medicare ~~Services~~ certification requirements and accreditation ~~the~~standards, ~~Centers~~there ~~for~~can ~~Medicare~~be &no ~~Medicaid~~assurance ~~Services~~that regulatory authorities will determine that all applicable requirements are fully met at any given time. ~~For~~A determination by an applicable regulatory authority that a facility is not in compliance with these requirements could lead to the ~~fiscals~~imposition ~~years~~of ~~ended~~corrective ~~December 31~~action, ~~2004~~assessment of fines and ~~December 31~~penalties, ~~2005~~or loss of licensure, weMedicare ~~received~~certification ~~approximately~~or ~~50%~~accreditation. ~~and~~These ~~56%,~~consequences ~~respectively,~~could ofhave ~~our~~an ~~revenue~~adverse ~~from Medicare~~effect on our company.

~~The~~ Some states ~~Medicare~~still ~~program~~require ~~reimburses~~us ~~various~~to ~~types~~get ofapproval ~~providers,~~under ~~including~~certificate ~~long-term~~of ~~acute~~need ~~care hospitals,~~regulations ~~inpatient~~when ~~rehabilitation~~we ~~facilities and outpatient rehabilitation providers~~create, ~~using different~~acquire ~~payment~~or ~~methodologies.~~expand ~~The~~our ~~Medicare reimbursement systems for long-term acute care hospitals, inpatient rehabilitation~~ facilities ~~and~~or ~~outpatient rehabilitation providers~~services, ~~as described~~or ~~below,~~alter ~~are different than~~ the ~~system~~ownership ~~applicable~~of ~~to general acute care hospitals. For~~such ~~general acute care hospitals~~facilities, ~~Medicare~~whether ~~inpatient~~directly ~~costs~~or are reimbursed under a prospective payment system under which a hospital receives a fixed payment amount per discharge (adjusted for area wage differences) using diagnosis related groups, commonly referred to as DRGsindirectly. The ~~general~~certificate ~~acute~~of ~~care hospital~~need ~~DRG~~regulations ~~payment~~vary ~~rate~~from isstate ~~based~~to ~~upon~~state, ~~the~~and ~~national~~are ~~average~~subject ~~cost~~to ofchange ~~treating~~and anew ~~Medicare patient’s condition in that type of facility~~interpretation. ~~Although~~If ~~the~~we ~~average~~fail ~~length~~to ofshow ~~stay~~public ~~varies~~need ~~for~~and ~~each DRG, the~~obtain ~~average~~approval ~~stay of all Medicare patients~~ in athese ~~general~~states ~~acute care hospital is approximately six days. Thus, the prospective payment system~~ for ~~general~~our ~~acute~~new ~~care~~facilities ~~hospitals~~or ~~creates~~changes ~~an economic incentive for those hospitals~~ to discharge medically complex Medicare patients as soon as clinically possible. Effective October 1, 2005, CMS expanded its post-acute care transfer policy under which general acute care hospitals are paid on a per diem basis rather than the ~~full~~ownership ~~DRG~~structure ~~rate~~of ifexisting ~~a patient is discharged early to certain post-acute care settings~~facilities, ~~including~~we ~~long-term~~may ~~acute~~be ~~care~~subject ~~hospitals. The expansion of this policy~~ to ~~patients~~civil inor aeven ~~greater~~criminal ~~number~~penalties, oflose ~~DRGs~~our ~~could~~facility ~~cause~~license ~~general~~or ~~acute care hospitals to~~become ~~delay~~ineligible ~~discharging~~for ~~those patients to our long-term acute care hospitals~~reimbursement.

~~Long-term~~ ~~acute~~Professional ~~care~~Licensure hospital Medicare reimbursement. The Medicare payment system for long-term acute care hospitals has been changed to a new prospective payment system specifically applicable to long-term acute care hospitals, which is referred to as LTCH-PPS. LTCH-PPS was established by final regulations published on August 30, 2002 by CMS, and ~~applies~~Corporate to long-term care hospitals for their cost reporting periods beginning on or after October 1, 2002. Ultimately, when LTCH-PPS is fully implemented, each patient discharged from a long-term acute care hospital will be assigned to a distinct long-term care diagnosis-related group, which is referred to as an LTC-DRG, and a long-term acute care hospital will generally be paid a predetermined fixed amount applicable to the assigned LTC-DRG (adjusted for area wage differences). The payment amount for each LTC-DRG is intended to reflect the average cost of treating a Medicare patient assigned to that LTC-DRG in a long-term acute care hospital. LTCH-PPS also includes special payment policies that adjust the payments for some patients based on the patient’s length of stay, the facility’s costs, whether the patient was discharged and readmitted and other factors. As required by Congress, LTC-DRG payment rates have been set to maintain budget neutrality with total expenditures that would have been made under the previous reasonable cost-based payment system. Practice

~~The~~ Healthcare ~~LTCH-PPS~~professionals ~~regulations~~at ~~also~~our ~~refined~~hospitals ~~the~~and ~~criteria~~outpatient ~~that~~rehabilitation ~~must~~clinics are required to be ~~met~~individually inlicensed ~~order~~or ~~for~~certified under aapplicable ~~hospital~~state law. We take steps to ensure that our employees and agents possess all necessary licenses and certifications. Some states prohibit the "corporate practice of medicine" so that bebusiness ~~certified~~corporations such as aours ~~long-term~~are ~~acute~~restricted ~~care~~from ~~hospital~~practicing medicine through the direct employment of physicians and therapists. ~~For~~The ~~cost~~laws ~~reporting~~relating ~~periods~~to ~~beginning~~corporate onpractice orvary ~~after~~from state to state ~~October 1,~~and ~~2002,~~are anot ~~long-term~~fully ~~acute~~developed ~~care~~in ~~hospital~~each ~~must~~state in which we have anfacilities. ~~average~~We ~~inpatient~~believe ~~length~~that each of ~~stay~~our ~~for~~facilities complies with any current corporate practice prohibition of the state in which it is ~~Medicare~~located. ~~patients~~For ~~(including~~example, ~~both~~in ~~Medicare~~those ~~covered~~states that apply the corporate practice prohibition, we either contract to obtain physician and ~~non-covered~~therapist ~~days)~~services offrom ~~greater~~an ~~than~~entity ~~25 days.~~permitted to employ them or we manage ~~Previously~~the medical or therapy practice owned by licensed clinicians through which the clinical services are provided. However, ~~average~~future ~~lengths~~interpretations of ~~stay~~the ~~were~~corporate ~~measured~~practice prohibition, enactment of new legislation or adoption of new regulations could cause us to have to restructure our business operations or close our facilities in a particular state. If new legislation, regulations or interpretations establish that our facilities do not comply with ~~respect~~state corporate practice prohibition, we could be subject to ~~all~~civil, ~~patients~~and perhaps criminal, penalties. Any such restructuring or penalties could have a material adverse effect on our business.

~~Prior~~ to becoming subject to LTCH-PPS, a long-term acute care hospital is paid on the basis of Medicare reasonable costs per case, subject to limits. Under this cost-based reimbursement system, costs accepted for reimbursement depend on a number of factors, including necessity, reasonableness, related party principles and relatedness to patient care. Qualifying costs under Medicare’s cost reimbursement system typically include all operating costs and also capital costs that include interest expense, depreciation, amortization, and rental expense. Certification

- In 12order -to participate in the Medicare program and receive Medicare reimbursement, each facility must comply with the applicable regulations of the United States Department of Health and Human Services relating to, among other things, the type of facility, its equipment, its personnel and its standards of medical care, as well as compliance with all applicable state and local laws and regulations. As of December 31, 2014, 126 of the 129 specialty hospitals we operated were certified as Medicare providers and three were in the process of obtaining their certification. In addition, we provide the majority of our outpatient rehabilitation services through clinics certified by Medicare as rehabilitation agencies or "rehab agencies."

~~Table of Contents~~11

~~Prior~~Table to qualifying under the payment system applicable to long-term acute care hospitals, a new long-term acute care hospital initially receives payments under the general acute care hospital DRG-based reimbursement system. The long-term acute care hospital must continue to be paid under this system for a minimum of ~~six months while meeting certain Medicare long-term acute care hospital requirements, the most significant requirement being an average Medicare length of stay of more than 25 days.~~ Contents

~~LTCH-PPS~~ is being phased-in over a five-year transition period, during which a long-term care hospital’s payment for each Medicare patient will be a blended amount consisting of set percentages of the LTC-DRG payment rate and the hospital’s reasonable cost-based reimbursement. The LTC-DRG payment rate is 20% for a hospital’s cost reporting period beginning on or after October 1, 2002, and will increase by 20% for each cost reporting period thereafter until the hospital’s cost reporting period beginning on or after October 1, 2006, when the hospital will be paid solely on the basis of LTC-DRG payment rates. A long-term acute care hospital may elect to be paid solely on the basis of LTC-DRG payment rates (and not be subject to the transition period) at the start of any of its cost reporting periods during the transition period. Accreditation

Our specialty hospitals receive accreditation from The Joint Commission, the AOA, CARF and/or other healthcare accrediting organizations. As of December 31, ~~2005~~2014, all 97 of ~~our~~the ~~eligible~~129 ~~long-term~~specialty ~~acute care~~ hospitals ~~have implemented~~we ~~LTCH-PPS.~~operated Wewere ~~have~~accredited ~~elected~~by toeither beThe ~~paid~~Joint ~~solely~~Commission onor the ~~basis~~AOA. In addition, some of ~~LTC-DRG~~our ~~payments~~IRFs ~~for~~have ~~all~~also 97applied offor ~~these~~and ~~hospitals~~received accreditation from CARF.

On ~~January 27,~~Overview 2006, the Centers for Medicare & Medicaid Services (known as “CMS”) published its proposed annual payment rate updates for the 2007 LTCH-PPS rate year (affecting cost reporting periods beginning on or after July 1, 2006 and before July 1, 2007). The January 2006 proposed rule includes the following proposed changes to LTCH-PPS payment methodologies: (i) addition of a new payment methodology for Medicare patients with a length of stay less than or equal to 5/6ths of the geometric average length of stay for each LTC-DRG (referred to as “short-stay outlier” or “SSO” cases), so that payment for a significant portion of SSO cases will be reduced to an amount comparable with that paid under the general acute care hospital reimbursement methodology; (ii) a zero-percent update to the LTCH-PPS standard federal rate used as a basis for LTCH-PPS payments; (iii) sunset of the surgical case exception to the three-day or less interruption of stay policy, under which 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 (iv) 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 policyU. CMS estimates that the changes it is proposing for the 2007 LTCH-PPS rate year will result in an approximately 11 percent decrease in Medicare payments to long-term acute care hospitals as compared to the 2006 rate yearS. ~~Consistent with its standard process for adopting regulations, CMS has solicited~~ and ~~will~~State ~~consider~~Government comments on the January 2006 proposed rule before it publishes a final update for the 2007 LTCH-PPS rate year. As a result, CMS may elect not to adopt certain of its proposals or the agency may adopt the proposals with modifications. If, however, the January 2006 proposals are adopted without modification, these changes in LTCH-PPS reimbursement policy will reduce our net operating revenues and will adversely affect our financial performance. Reimbursements

~~Regulatory~~ changes. 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. 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~~Program ~~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 General

- The 13Medicare -program reimburses healthcare providers for services furnished to Medicare beneficiaries, which are generally persons age 65 and older, those who are chronically disabled, and those suffering from end stage renal disease. The program is governed by the Social Security Act of 1965 and is administered primarily by the Department of Health and Human Services and CMS. Net operating revenues generated directly from the Medicare program represented approximately 47% of our consolidated net operating revenues for the year ended December 31, 2012, 46% for the year ended December 31, 2013, and 45% for the year ended December 31, 2014.

~~Table~~ The Medicare program reimburses various types of ~~Contents~~providers, including LTCHs, IRFs and outpatient rehabilitation providers, using different payment methodologies. The Medicare reimbursement systems specific to LTCHs, IRFs and outpatient rehabilitation providers, as described below, are different than the system applicable to general acute care hospitals. If any of our hospitals fail to comply with requirements for payment under Medicare reimbursement systems for LTCHs or IRFs, as applicable, that hospital will be paid under the system applicable to general acute care hospitals. For general acute care hospitals, Medicare payments for inpatient care are made under the inpatient prospective payment system, or "IPPS," under which a hospital receives a fixed payment amount per discharge (adjusted for area wage differences) using Medicare severity diagnosis-related groups, or "MS-DRGs." The general acute care hospital MS-DRG payment rate is based upon the national average cost of treating a Medicare patient's condition, based on severity levels of illness, in that type of facility. Although the average length of stay varies for each MS-DRG, the average stay of all Medicare patients in a general acute care hospital is substantially less than the average length of stay in LTCHs and IRFs. Thus, the prospective payment system for general acute care hospitals creates an economic incentive for those hospitals to discharge medically complex Medicare patients to a post-acute care setting as soon as clinically possible. Effective October 1, 2005, CMS expanded its post-acute care transfer policy under which general acute care hospitals are paid on a per diem basis rather than the full MS-DRG rate if a patient is discharged early to certain post-acute care settings, including LTCHs and IRFs. When a patient is discharged from selected MS-DRGs to, among other providers, an LTCH or IRF, the general acute care hospital may be reimbursed below the full MS-DRG payment if the patient's length of stay is less than the geometric mean length of stay for the MS-DRG.

- inLong ~~over~~Term aAcute ~~four-year~~Care ~~period~~Hospital 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 was 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. The new HIH regulations also 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. Reimbursement

As The ofMedicare ~~December 31,~~payment ~~2005,~~system wefor ~~operated~~LTCHs 97is ~~long-term~~based ~~acute~~on ~~care~~a ~~hospitals,~~prospective 93payment ofsystem ~~which~~specifically ~~operated as~~applicable ~~HIHs~~to LTCHs. InThe ~~order~~long toterm ~~minimize~~care hospital ~~the~~prospective ~~more~~payment ~~significant~~system, ~~impact~~or of"LTCH-PPS," ~~the~~was ~~HIH~~established ~~regulations~~by inCMS ~~2006~~final ~~and future~~regulations ~~years,~~published weon ~~have~~August 30, ~~developed~~2002, aand ~~business~~applies ~~plan~~to ~~and~~LTCHs ~~strategy~~for incost ~~each~~reporting ofperiods ~~our~~beginning ~~markets~~on toor ~~adapt~~after October 1, to2002. ~~the HIH~~The ~~regulations~~policies and ~~maintain~~payment ~~our~~rates ~~company’s~~under ~~current~~LTCH-PPS ~~business.~~are ~~Our~~subject ~~transition~~to ~~plan~~annual ~~includes~~updates ~~managing admissions~~and atrevisions. ~~existing~~Under ~~HIHs~~LTCH-PPS, ~~relocating~~each ~~certain~~patient ~~HIHs~~discharged tofrom ~~leased~~an ~~spaces~~LTCH inis ~~smaller~~assigned ~~host~~to ~~hospitals~~a indistinct ~~the~~"MS-LTC-DRG," ~~same~~which ~~markets,~~is ~~consolidating~~a ~~HIHs~~Medicare inseverity ~~certain~~diagnosis-related ofgroup ~~our~~for ~~markets~~LTCHs, ~~relocating~~and ~~certain~~an ofLTCH ~~our facilities~~is generally paid a pre-determined fixed amount applicable to ~~alternative~~the ~~settings~~assigned MS-LTC-DRG (adjusted for area wage differences), ~~building~~subject orto ~~buying~~exceptions ~~free-standing~~for ~~facilities~~short stay and ~~closing~~high acost ~~small number~~outlier ofpatients ~~facilities~~(described below). WeCMS ~~currently~~assigns ~~anticipate~~relative ~~that~~weights weto ~~will~~each ~~need~~MS-LTC-DRG to ~~relocate~~reflect ~~approximately~~their ~~50%~~relative use of medical care ~~our~~resources. ~~long~~The payment amount for each MS-~~term~~LTC-DRG ~~acute~~is ~~care~~intended ~~hospitals~~to ~~over~~reflect the ~~next~~average ~~five~~cost ~~years,~~of ~~including~~treating ~~certain~~a ofMedicare ~~the~~patient ~~hospitals acquired~~assigned into ~~the~~that ~~SemperCare~~MS-LTC-DRG ~~acquisition~~in an LTCH.

On January 27, 2006, CMS published its proposed annual payment rate updates for the 2007 LTCH-PPS rate year (affecting cost reporting periods beginning on or after July 1, 2006 and before July 1, 2007). In the January 2006 proposed rule, CMS announced that it is studying whether payment adjustments similar to those adopted with respect to HIHs in 2004 should also be adopted with respect to free-standing long-term acute care hospitals. Such adjustments could include limiting payments to free-standing long-term acute care hospitals to the extent that greater than 25% of a facility’s admissions come from a single general acute care hospital. 12

InTable the January 2006 proposed rule, CMS also discussed the contract it has awarded to Research Triangle Institute, International, or RTI, to examine recommendations made by the Medicare Payment Advisory Commission, or MedPAC, concerning how long-term acute care hospitals are defined and differentiated from other types of Medicare providers. MedPAC is an independent federal body that advises Congress on issues affecting the Medicare program. In its June 2004 ‘‘Report to Congress,’’ MedPAC recommended the adoption by CMS of new facility staffing and services criteria and patient clinical characteristics and treatment requirements for long-term acute care hospitals in order to ensure that only appropriate patients are admitted to these facilities. CMS indicated that it expects RTI’s final report to be submitted to the agency in late Spring 2006. While acknowledging that RTI’s findings are expected to have a substantial impact on future Medicare policy for long-term acute care hospitals, CMS stated its belief that many of the specific payment adjustment features of LTCH-PPS presently in place may still be necessary and appropriate even with the development of patient- and facility-level criteria for long-term acute care hospitals. Contents

~~Inpatient~~ ~~rehabilitation~~Standard ~~facility~~Federal Medicare reimbursement. Our acute medical rehabilitation hospitals are certified as inpatient rehabilitation facilities by the Medicare program, and are subject to a prospective payment system for services provided to each discharged Medicare beneficiary. Prior to January 1, 2002, inpatient rehabilitation facilities were paid on the basis of Medicare reasonable costs Rate

Payment under the LTCH-PPS 14is dependent on determining the patient classification, that is, the assignment of the case to a particular MS-LTC-DRG, the weight of the MS-LTC-DRG and the standard federal payment rate. There is a single standard federal rate that encompasses both the inpatient operating costs, which includes a labor and non-labor component, and capital-related costs that CMS updates on an annual basis. LTCH-PPS also includes special payment policies that adjust the payments for some patients based on the patient's length of stay, the facility's costs, whether the patient was discharged and readmitted and other factors.

~~Table~~ ofPatient ~~Contents~~Criteria

~~per~~ The ~~case,~~BBA ~~subject~~of to2013, ~~limits~~enacted ~~under TEFRA. For cost reporting periods beginning on or after January~~December 126, ~~2002~~2013, ~~inpatient~~establishes ~~rehabilitation facilities are paid under a~~ new ~~prospective~~ payment ~~system~~ ~~specifically~~limits ~~applicable~~for toMedicare ~~this~~patients ~~provider~~who ~~type,~~do ~~which~~not ismeet ~~referred to as “IRF-PPS~~specified criteria.” ~~Under the IRF-PPS~~Specifically, ~~each~~for ~~patient~~Medicare patients discharged ~~from~~in ancost ~~inpatient~~reporting ~~rehabilitation~~periods ~~facility~~beginning ison ~~assigned~~or toafter ~~a case-mix~~October 1, ~~group~~2015, orLTCHs ~~“IRF-CMG”~~will ~~containing~~be ~~patients~~reimbursed ~~with~~under ~~similar~~LTCH-PPS ~~clinical~~only ~~problems~~if, ~~that~~immediately ~~are expected to~~preceding ~~require~~the ~~similar~~patient's ~~amounts~~LTCH ofadmission, ~~resources.~~the Anpatient ~~inpatient~~was ~~rehabilitation~~discharged ~~facility~~from ~~is generally paid~~ a ~~predetermined~~ ~~fixed~~general ~~amount~~acute ~~applicable~~care tohospital ~~the~~paid ~~assigned~~under ~~IRF-CMG~~IPPS ~~(subject~~and tothe ~~applicable~~patient's ~~case adjustments~~stay ~~related~~included toat ~~length~~least ofthree ~~stay~~days ~~and~~in ~~facility~~an ~~level~~intensive ~~adjustments~~care ~~for~~unit ~~location~~(ICU) ~~and low income~~or ~~patients).~~coronary ~~The~~care ~~payment~~unit ~~amount~~(CCU) ~~for~~or ~~each~~the ~~IRF-CMG~~patient is ~~intended~~assigned to ~~reflect the average cost of treating a Medicare patient’s condition in~~ an ~~inpatient rehabilitation facility relative to patients with conditions described by other IRF~~MS-~~CMGs. The IRF~~LTC-~~PPS~~DRG ~~also includes special payment policies that adjust the payments~~ for ~~some~~cases ~~patients~~receiving ~~based~~at onleast ~~the~~96 hours ~~patient’s length~~ of ~~stay,~~ventilator ~~the~~services ~~facility’s~~in ~~costs, whether~~ the ~~patient was discharged and readmitted and other factors~~LTCH. AsIn ~~required by Congress~~addition, ~~IRF-CMG~~ ~~payments rates have been set~~ to ~~maintain~~be ~~budget~~paid ~~neutrality~~under ~~with~~LTCH-PPS ~~total expenditures that~~the ~~would~~patient's ~~have~~discharge ~~been~~from ~~made under~~ the ~~previous~~LTCH ~~reasonable~~may ~~cost~~not ~~based~~include ~~system.~~a ~~The~~principal ~~IRF-PPS~~diagnosis ~~was~~relating ~~phased-in over~~to apsychiatric ~~transition~~or ~~period~~rehabilitation ~~in 2002~~services. For ~~cost~~any ~~reporting~~Medicare ~~periods~~patient ~~beginning~~who ondoes ornot ~~after~~meet ~~January 1,~~the ~~2002 and~~new ~~before October 1~~criteria, ~~2002,~~the anLTCH ~~inpatient~~will be ~~rehabilitation~~paid ~~facility’s~~a ~~payment~~lower ~~for~~"site-neutral" ~~each~~payment ~~Medicare patient~~rate, ~~was~~which awill ~~blended~~be ~~amount~~the ~~consisting~~lower of ~~662/3%~~(1) the ofIPPS ~~the~~comparable ~~IRF~~per-~~PPS~~diem payment rate ~~and 331/3%~~capped ofat the ~~hospital’s~~MS-DRG ~~reasonable~~including ~~cost~~any ~~based~~outlier ~~reimbursement.~~payments, ~~For cost reporting periods beginning on~~ or ~~after October~~ (2) 1,100 percent ~~2002, inpatient rehabilitation facilities are paid solely on the basis~~ of the ~~IRF-PPS~~estimated ~~payment~~costs ~~rate~~for services.

~~Although~~ The BBA ~~the~~of ~~IRF-PPS~~2013 ~~regulations~~provides ~~did~~for ~~not~~a ~~change~~transition to the ~~criteria~~site-neutral ~~that~~payment ~~must~~rate befor ~~met~~those inpatients ~~order~~not ~~for~~paid ~~a hospital~~under toLTCH-PPS. beDuring ~~certified~~the astransition anperiod ~~inpatient~~(cost ~~rehabilitation~~reporting ~~facility,~~periods ~~CMS~~beginning ~~adopted~~on or aafter ~~separate~~October 1, ~~final~~2015 ~~rule on~~through ~~May~~September 730, ~~2004~~2017), ~~that~~a ~~made~~blended ~~significant~~rate ~~changes~~will tobe ~~those~~paid for Medicare patients not meeting the new criteria. The ~~new~~blended ~~inpatient~~rate ~~rehabilitation~~will comprise half the site-neutral ~~facility~~payment ~~certification~~rate ~~criteria~~and ~~became~~half ~~effective~~the ~~for~~LTCH-PPS payment rate. For discharges in cost reporting periods beginning on or after ~~July~~ October 1, ~~2004.~~2017, only the site-neutral payment rate will apply for Medicare patients not meeting the new criteria.

~~Under~~ In addition, ~~the~~for ~~historic~~cost ~~IRF~~reporting ~~certification~~periods ~~criteria~~beginning ~~that~~on ~~had~~or ~~been~~after inOctober 1, ~~effect since 1983~~2019, inqualifying ~~order~~discharges ~~to qualify~~from as an ~~IRF,~~LTCH awill ~~hospital~~continue ~~was required~~ to ~~satisfy~~be ~~certain~~paid ~~operational~~at ~~criteria~~the ~~as well as demonstrate that, during its most recent 12~~LTCH-~~month~~PPS ~~cost~~payment ~~reporting period~~rate, itunless ~~served an inpatient~~the ~~population~~number of ~~whom~~discharges ~~at least 75% required intensive rehabilitation services~~ for ~~one~~which orpayment ~~more~~is ofmade ~~ten conditions~~under ~~specified~~the insite-neutral ~~regulation~~payment ~~(referred~~rate tois asgreater ~~the~~than ~~“75~~50% ~~test”).~~of Inthe ~~2002,~~total ~~CMS~~number ~~became~~of ~~aware~~discharges ~~that its~~from ~~various contractors were using inconsistent methods to assess compliance with~~ the ~~75%~~LTCH. ~~test~~If ~~and that~~ the ~~percentage~~number of ~~inpatient~~discharges ~~rehabilitation~~for ~~facilities~~which inpayment ~~compliance~~is made ~~with~~under the ~~75%~~site-neutral ~~test~~payment ~~might~~rate ~~be low.~~is Ingreater ~~response,~~than ~~in June 2002~~50%, ~~CMS~~then ~~suspended~~beginning ~~enforcement~~in of the ~~75%~~next ~~test~~cost ~~and,~~reporting onperiod ~~September 9, 2003,~~all ~~proposed~~discharges ~~modifications~~from to the ~~regulatory~~LTCH ~~standards~~will ~~for~~be ~~certification~~reimbursed asat anthe ~~inpatient rehabilitation~~site-neutral ~~facility~~payment rate. InThe ~~addition,~~BBA of ~~during~~2013 ~~2003,~~requires ~~several~~ CMS ~~contractors,~~to ~~including~~establish ~~the contractor~~a ~~overseeing~~process ~~our~~for ~~inpatient~~an ~~rehabilitation~~LTCH ~~facilities,~~subject ~~promulgated~~to ~~draft local medical review policies that would change~~ the ~~guidelines~~site-neutral ~~used~~payment rate to ~~determine~~re-qualify ~~the medical necessity~~ for ~~inpatient~~ ~~rehabilitation~~payment ~~care~~under LTCH-PPS.

~~Notwithstanding~~ ~~concerns~~Short ~~stated~~Stay byOutlier the industry and Congress in late 2003 and early 2004 about the adverse impact that CMS’s proposed changes and renewed enforcement efforts might have on access to inpatient rehabilitation facility services, and notwithstanding Congressional requests that CMS delay implementation of or changes to the 75% test for additional study of clinically appropriate certification criteria, CMS adopted four major changes to the 75% test in its May 7, 2004 final rule. First, CMS temporarily lowered the 75% compliance threshold, as follows: (i) 50% for cost reporting periods beginning on or after July 1, 2004 and before July 1, 2005; (ii) 60% for cost reporting periods beginning on or after July 1, 2005 and before July 1, 2006; (iii) 65% for cost reporting periods beginning on or after July 1, 2006 and before July 1, 2007; and (iv) 75% for cost reporting periods beginning on or after July 1, 2007. Second, CMS modified and expanded from 10 to 13 the medical conditions used to determine whether a hospital qualifies as an inpatient rehabilitation facility. Third, the agency finalized the conditions under which comorbidities can be used to verify compliance with the 75% test. Fourth, CMS changed the timeframe used to determine compliance with the 75% test from “the most recent 12-month cost reporting period” to “the most recent, consecutive, and appropriate 12-month period,” with the result that a determination of non-compliance with the applicable compliance threshold will affect Policy

CMS established a different payment methodology for Medicare patients with a length of stay less than or equal to five-sixths 15of the geometric average length of stay for that particular MS-LTC-DRG, referred to as a short stay outlier, or "SSO." SSO cases are paid based on the lesser of (1) 100% of the average cost of the case, (2) 120% of the MS-LTC-DRG specific per diem amount multiplied by the patient's length of stay, (3) the full MS-LTC-DRG payment, or (4) a per diem rate derived from blending 120% of the MS-LTC-DRG specific per diem amount with a per diem rate based on the general acute care hospital IPPS.

~~Table~~ The SSO rule also has a category referred to as a "very short stay outlier", which applies to cases with a length of ~~Contents~~stay that is less than the average length of stay plus one standard deviation for the same MS-DRG under IPPS, referred to as the so-called "IPPS comparable threshold." The LTCH payment for very short stay outlier cases is equivalent to the general acute care hospital IPPS per diem rate. The Medicare, Medicaid, and SCHIP Extension Act of 2007, or the "SCHIP Extension Act," as amended by

~~the facility’s certification for its cost reporting period that begins immediately after the 12-month review period.~~ 13

~~Congress~~Table ~~temporarily suspended CMS enforcement~~ of the 75% test under the Consolidated Appropriations Act, 2005, enacted on December 8, 2004. The Act requires the Secretary of Health and Human Services to respond within 60 days to a study by the Government Accountability Office, or GAO, on the standards for defining inpatient rehabilitation services before the Secretary may use funds appropriated under the Act to redesignate as a general acute care hospital any hospital that was certified as an inpatient rehabilitation facility on or before June 30, 2004 as a result of the hospital’s failure to meet the 75% test. The GAO issued its study on April 22, 2005, and recommended that CMS, based on further research, refine the 75% test to describe more thoroughly the subgroups of patients within the qualifying conditions that are appropriate for care in an inpatient rehabilitation facility. The Secretary issued a formal response to the GAO study on June 24, 2005, in which it concluded that the revised inpatient rehabilitation facility certification standards, including the 75% test, were not inconsistent with the recommendations in the GAO report. In light of this determination, the Secretary announced that CMS would immediately begin enforcement of the revised certification standards. Contents

~~Subsequently, under~~ the American ~~Deficit~~Recovery ~~Reduction~~and ~~Act~~Reinvestment ~~of 2005~~Act, ~~enacted~~or onthe ~~February 8~~"ARRA," ~~2006,~~and ~~Congress extended~~ the ~~phase-in~~Patient ~~period~~Protection ~~for~~and ~~the~~Affordable ~~75%~~Care ~~test~~Act, byor ~~maintaining~~ the ~~compliance~~"ACA," ~~threshold~~prevented atCMS ~~60% (rather~~from ~~than~~applying ~~increasing~~the itvery toshort ~~65%)~~stay outlier policy during the period ~~12-month~~from ~~period~~December 29, ~~beginning~~2007 onthrough ~~July~~December 128, ~~2006~~2012. The ~~compliance~~ ~~threshold~~very ~~then~~short ~~increases~~stay tooutlier ~~65%~~policy ~~for~~again ~~cost~~became ~~reporting~~applicable ~~periods beginning on or after July 1, 2007 and again~~ to ~~75%~~discharges ~~for~~occurring ~~cost reporting periods beginning~~ on or after ~~July~~December 129, ~~2008~~2012. During the years while the new standard is being phased-in, it will be necessary for us to reassess and change our inpatient admissions standards. Such changes may include more restrictive admissions policies. Stricter admissions standards may result in reduced patient volumes at our inpatient rehabilitation facilities, which, in turn, may result in lower net operating revenue and net income for these operations.

~~Outpatient~~ ~~rehabilitation~~High ~~services~~Cost Medicare reimbursement. We provide the majority of our outpatient rehabilitation services in our rehabilitation clinics. Through our contract services agreements, we also provide outpatient rehabilitation services in schools, physician directed clinics, worksites, assisted living centers, hospitals and skilled nursing facilities. Outliers

~~Most~~ Some ofcases ~~our~~are ~~outpatient~~extraordinarily ~~rehabilitation~~costly, ~~services~~producing ~~are~~losses ~~provided~~that inmay ~~rehabilitation~~be ~~agencies~~too ~~and~~large for hospitals to offset. Cases with unusually high costs, ~~through~~referred ~~our~~to ~~inpatient~~as ~~rehabilitation~~"high ~~facilities~~cost outliers," receive a payment adjustment to reflect the additional resources utilized. CMS provides an additional payment if the estimated costs for the patient exceed the adjusted MS-LTC-DRG payment plus a fixed-loss amount that is established in the annual payment rate update.

~~Prior~~ toInterrupted January 1, 1999, outpatient therapy services, including physical therapy, occupational therapy, and speech-language pathology, were reimbursed on the basis of the lower of 90% of reasonable costs or actual charges. Beginning on January 1, 1999, the Balanced Budget Act of 1997 (the “BBA”) required that outpatient therapy services be reimbursed on a fee schedule, subject to annual limits. Outpatient therapy providers receive a fixed fee for each procedure performed, which is adjusted by the geographical area in which the facility is located. stays

~~The~~ An ~~BBA~~interrupted ~~also~~stay ~~imposed~~is ~~annual~~defined ~~per~~as ~~Medicare~~a ~~beneficiary~~case ~~caps~~in ~~beginning~~which ~~January 1,~~an ~~1999~~LTCH ~~that limited~~patient, ~~Medicare~~upon ~~coverage to $1~~discharge,~~500~~ ~~for~~is ~~outpatient~~admitted ~~rehabilitation~~to ~~services~~a ~~(including~~general ~~both~~acute ~~physical therapy~~care ~~and speech-language pathology services) and $1~~hospital,~~500~~ ~~for~~IRF ~~outpatient occupational health~~or ~~services,~~skilled ~~including~~nursing ~~deductible~~facility/swing-bed and ~~coinsurance~~then ~~amounts.~~returns ~~The caps were~~ to bethe ~~increased~~same ~~beginning~~LTCH ~~in 2002~~within ~~by application of an inflation index. Subsequent legislation imposed~~ a ~~moratorium~~specified onperiod ~~the application~~ of ~~these limits for the years 2000, 2001 and 2002~~time. ~~With~~If the ~~expiration~~length of ~~the moratorium,~~stay ~~CMS~~at ~~implemented~~ the ~~caps~~receiving ~~beginning~~provider onis ~~September 1,~~equal ~~2003.~~to ~~The~~or ~~Medicare~~less ~~Prescription Drug,~~than ~~Improvement and Modernization Act re-imposed~~ the ~~moratorium~~applicable ~~on the application of the therapy~~fixed ~~caps~~period ~~from the date~~ of ~~enactment (December 8~~time, ~~2003)~~it ~~through~~is ~~December 31,~~considered ~~2005. Congress allowed the therapy caps~~ to gobe ~~back~~an ~~into~~interrupted ~~effect~~stay oncase ~~January 1,~~and ~~2006.~~the ~~The~~case ~~inflation~~is ~~adjusted~~treated ~~caps~~as ~~are~~a ~~$1,740~~single ~~in 2006.~~discharge Asfor ~~directed by Congress in~~ the ~~Deficit~~purposes ~~Reduction Act~~ of ~~2005,~~payment ~~CMS~~to isthe ~~implementing an exceptions process for therapy expenses incurred in 2006~~LTCH. ~~Under this process, a Medicare enrollee may request an exception from the~~

- 16Freestanding, - HIH and Satellite LTCHs

~~Table~~ LTCHs may be organized and operated as freestanding facilities or as HIHs. As its name suggests, a freestanding LTCH is not located on the campus of ~~Contents~~another hospital. For such purpose, "campus" means the physical area immediately adjacent to a hospital's main buildings, other areas and structures that are not strictly contiguous to a hospital's main buildings but are located within 250 yards of its main buildings, and any other areas determined, on an individual case basis by the applicable CMS regional office, to be part of a hospital's campus. Conversely, an HIH is an LTCH that is located on the campus of another hospital. An LTCH, whether freestanding or an HIH, that uses the same Medicare provider number of an affiliated "primary site" LTCH is known as a "satellite." Under Medicare policy, a satellite LTCH must be located within 35 miles of its primary site LTCH and be administered by such primary site LTCH. A primary site LTCH may have more than one satellite LTCH. CMS sometimes refers to a satellite LTCH that is freestanding as a "remote location."

~~therapy~~ ~~caps~~Facility ifCertification the provision of therapy services is deemed to be medically necessary. Therapy cap exceptions will be available automatically for certain conditions and on a case-by-case basis upon submission of documentation of medical necessity. Criteria

~~Historically,~~ The ~~outpatient~~LTCH-PPS ~~rehabilitation~~regulations ~~services~~define ~~have~~the ~~been~~criteria ~~subject~~that tomust ~~scrutiny~~be bymet ~~the~~in ~~Medicare program~~order for, ~~among~~a ~~other~~hospital ~~things,~~to ~~medical~~be ~~necessity~~certified ~~for~~as ~~services,~~an ~~appropriate~~LTCH. ~~documentation~~To be eligible for ~~services~~payment under the LTCH-PPS, ~~supervision~~a ofhospital ~~therapy~~must ~~aides~~be ~~and~~primarily ~~students~~engaged ~~and~~in ~~billing~~providing ~~for~~inpatient ~~group~~services ~~therapy.~~to ~~CMS~~Medicare ~~has~~beneficiaries ~~issued guidance~~with tomedically ~~clarify~~complex conditions that ~~services~~require ~~performed~~a long hospital stay. In addition, by adefinition, ~~student~~LTCHs ~~are~~must ~~not~~meet ~~reimbursed~~certain ~~even~~facility ifcriteria, ~~provided~~including ~~under “line~~(1) instituting ofa ~~sight”~~review ~~supervision~~process ofthat ~~the~~screens ~~therapist.~~patients ~~Likewise,~~for ~~CMS~~appropriateness ~~has~~of ~~reiterated~~an ~~that~~admission ~~Medicare~~and ~~does~~validates ~~not~~the ~~pay~~patient ~~for~~criteria ~~services~~within ~~provided~~48 hours byof ~~aides~~each ~~regardless~~patient's ofadmission, ~~the~~evaluates ~~level~~regularly their patients for continuation of ~~supervision.~~care ~~CMS~~and ~~also~~assesses ~~has~~the ~~issued~~available discharge options, (2) having active ~~instructions~~physician involvement with patient care that ~~outpatient~~includes ~~physical~~a physician available on-site daily and ~~occupational~~additional ~~therapy~~consulting ~~services~~physicians ~~provided~~on ~~simultaneously~~call, ~~to two~~and or(3) having ~~more~~an ~~individuals~~interdisciplinary byteam aof ~~practitioner~~healthcare professionals ~~should~~to beprepare ~~billed~~and ascarry ~~group~~out ~~therapy~~an ~~services~~individualized treatment plan for each patient.

~~Payment~~ An LTCH ~~for~~must ~~rehabilitation~~have ~~services~~an ~~furnished~~average toinpatient ~~patients~~length of ~~skilled~~stay ~~nursing~~for ~~facilities~~Medicare ~~has been~~patients ~~affected~~(including byboth ~~the~~Medicare ~~establishment~~covered ofand anon-covered days and Medicare ~~prospective~~Advantage ~~payment~~Days) ~~system~~of ~~and~~greater ~~consolidated~~than ~~billing~~25 days. ~~requirement~~LTCHs ~~for~~that ~~skilled~~fail ~~nursing~~to ~~facilities.~~exceed ~~The~~an ~~resulting~~average ~~pressure~~length onof ~~skilled~~stay ~~nursing facilities~~of to25 days ~~reduce~~during ~~their~~any ~~costs~~cost byreporting ~~negotiating~~period ~~lower~~may ~~payments~~be topaid ~~therapy~~under ~~providers,~~the ~~such~~general asacute ~~our~~care hospital IPPS if not corrected within ~~contract~~established ~~therapy~~timeframes. ~~services~~CMS, ~~and~~through ~~the~~its ~~inability~~contractors, determines whether an LTCH has maintained an average length of ~~the~~stay ~~therapy~~of ~~providers~~greater tothan ~~bill~~25 days ~~the~~during ~~Medicare~~each ~~program~~annual cost reporting period. Under ~~directly~~the BBA of 2013, for ~~their~~discharges ~~services~~occurring ~~have~~in ~~tended~~cost toreporting ~~reduce~~periods beginning on or after October 1, 2015, LTCH cases paid at the ~~amounts~~site-neutral ~~that~~rate ~~rehabilitation~~and ~~providers~~Medicare ~~can receive~~Advantage ~~for~~cases ~~services~~are ~~furnished~~excluded from tothe ~~many~~LTCH ~~skilled~~average ~~nursing~~length ~~facility~~of ~~residents~~stay calculation.

Specialty hospital Medicaid reimbursement. The Medicaid program is designed to provide medical assistance to individuals unable to afford care. The program is governed by the Social Security Act of 1965 and administered and funded jointly by each individual state government and CMS. Medicaid payments are made under a number of different systems, which include cost based reimbursement, prospective payment systems or programs that negotiate payment levels with individual hospitals. In addition, Medicaid programs are subject to statutory and regulatory changes, administrative rulings, interpretations of policy by the state agencies and certain government funding limitations, all of which may increase or decrease the level of program payments to our hospitals. Medicaid payments accounted for approximately 2% of our long-term acute care net operating revenues for the year ended December 31, 2005. 14

~~Workers’~~Table ~~compensation. Workers’ compensation programs accounted for approximately 21%~~ of ~~our revenue~~Contents from outpatient rehabilitation services for the year ended December 31, 2005. Workers’ compensation is a state mandated, comprehensive insurance program that requires employers to fund or insure medical expenses, lost wages and other costs resulting from work related injuries and illnesses. Workers’ compensation benefits and arrangements vary on a state-by-state basis and are often highly complex. In some states, payment for services covered by workers’ compensation programs are subject to cost containment features, such as requirements that all workers’ compensation injuries be treated through a managed care program, or the imposition of payment caps. In addition, these workers’ compensation programs may impose requirements that affect the operations of our outpatient rehabilitation services.

~~Other~~ Prior ~~Healthcare~~to ~~Regulations~~qualifying under the payment system applicable to LTCHs, a new LTCH initially receives payments under the general acute care hospital IPPS. The LTCH must continue to be paid under this system for a minimum of six months while meeting certain Medicare LTCH requirements, the most significant requirement being an average length of stay for Medicare patients (including both Medicare covered and non-covered days) greater than 25 days.

~~Fraud~~ ~~and~~25 ~~abuse~~Percent enforcement. Various federal laws prohibit the submission of false or fraudulent claims, including claims to obtain payment under Medicare, Medicaid and other government healthcare programs. Penalties for violation of these laws include civil and criminal fines, imprisonment and exclusion from participation in federal and state healthcare programs. In recent years, federal and state government agencies have increased the level of enforcement resources and activities targeted at the healthcare industry. In addition, the federal False Claims Act allows an individual to bring lawsuits on behalf of the government, in what are known as qui tam or “whistleblower” actions, alleging false or fraudulent Medicare or Medicaid claims or other violations of the statute. The use of these private enforcement actions against healthcare providers has increased dramatically in the recent past, in part Rule

- The 17"25 Percent Rule" is a downward payment adjustment that applies if the percentage of Medicare patients discharged from LTCHs who were admitted from a referring hospital (regardless of whether the LTCH or LTCH satellite is co-located with the referring hospital) exceeds the applicable percentage admissions threshold during a particular cost reporting period. Specifically, the payment rate for Medicare patients above the percentage admissions threshold are subject to a downward payment adjustment. For Medicare patients above the applicable percentage admissions threshold, the LTCH is reimbursed at a rate comparable to that under general acute care hospital IPPS, which is generally lower than LTCH-PPS rates. Cases that reach outlier status in the referring hospital do not count toward the admissions threshold and are paid under LTCH-PPS.

~~Table~~ The SCHIP Extension Act, as amended by the ARRA and the ACA, has limited the full application of ~~Contents~~the 25 Percent Rule. However, the SCHIP Extension Act did not postpone the application of the percentage admissions threshold to those Medicare patients discharged from an LTCH HIH or satellite that were admitted from a non-co-located hospital. In addition, CMS adopted regulations providing for a one-year extension of relief from the full application of the 25 Percent Rule. As a result, full implementation of the Medicare percentage admissions thresholds did 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 through September 30, 2012. Specifically, those freestanding facilities, grandfathered HIHs and grandfathered satellites with cost reporting periods beginning on or after July 1, 2012 and through September 30, 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.

~~because~~ The BBA ~~the~~of ~~individual~~2013 ~~filing~~further delays, and in some cases permanently suspends, the ~~initial~~application ~~complaint~~of isthe ~~entitled~~25 Percent toRule. ~~share~~The infollowing atable ~~portion~~describes the types of ~~any~~LTCHs and the statutory ~~settlement~~and orregulatory ~~judgment.~~relief ~~See~~they ~~“Legal~~have ~~Proceedings~~received —from ~~Other~~the ~~Legal~~payment ~~Proceedings.”~~ adjustment for these discharges:

From time to time, various federal and state agencies, such as the Office of the Inspector General of the Department of Health and Human Services, issue a variety of pronouncements, including fraud alerts, the Office of Inspector General’s Annual Work Plan and other reports, identifying practices that may be subject to heightened scrutiny. These pronouncements can identify issues relating to long-term acute care hospitals, inpatient rehabilitation facilities or outpatient rehabilitation services or providers. For example, the Office of Inspector General’s 2004 Work Plan describes the government’s intention to study providers’ use of the “hospital within a hospital” model for furnishing long-term acute care hospital services and whether they comply with the 5% limitation on discharges to the host hospital that are subsequently readmitted to the hospital within a hospital. The 2005 Work Plan describes plans to study whether patients in long-term acute care hospitals are receiving acute-level services or could be cared for in skilled nursing facilities. The 2006 Work Plan describes plans to study the accuracy of Medicare payment for inpatient rehabilitation stays when patient assessments are entered later than the required deadlines, to study both inpatient rehabilitation facility and long-term acute care hospital payments in order to determine whether they were made in accordance with applicable regulations, including policies on outlier payments and interrupted stays, and to study physical and occupational therapy claims in order to determine whether the services were medically necessary and adequately documented. We monitor government publications applicable to us and focus a portion of our compliance efforts towards these areas targeted for enforcement.

Type of LTCH	Non Co-located Admissions⁽¹⁾	Co-located Admissions⁽²⁾

Non-grandfathered HIHs and satellite facilities opened before October 1, 2004 (67 owned hospitals)	LTCHs in this category are subject to a payment adjustment for discharged Medicare patients exceeding 25% of the LTCH's total Medicare population.	Percentage admissions threshold was raised from 25% to 50%. In the special case of rural LTCHs, LTCHs co-located with an urban single hospital, or LTCHs co-located with an MSA-dominant hospital the referral percentage was raised from 50% to 75%. This relief is now effective until cost reporting periods beginning on or after October 1, 2016.
Grandfathered HIHs (3 owned hospitals)	25 Percent Rule not applicable.	25 Percent Rule not applicable.

We endeavor to conduct our operations in compliance with applicable laws, including healthcare fraud and abuse laws. If we identify any practices as being potentially contrary to applicable law, we will take appropriate action to address the matter, including, where appropriate, disclosure to the proper authorities. 15

~~Remuneration~~Table and fraud measures. The federal “anti-kickback” statute prohibits some business practices and relationships under Medicare, Medicaid and other federal healthcare programs. These practices include the payment, receipt, offer or solicitation of remuneration in connection with, to induce, or to arrange for, the referral of patients covered by a federal or state healthcare program. Violations of the anti-kickback law may be punished by a criminal fine of up to $50,000 or imprisonment for each violation, or both, civil monetary penalties of $50,000 and damages of up to three times the total amount of remuneration, and exclusion from participation in federal or state healthcare programs. Contents

Section 1877 of the Social Security Act, commonly known as the “Stark Law,” prohibits referrals for designated health services by physicians under the Medicare and Medicaid programs to other healthcare providers in which the physicians have an ownership or compensation arrangement unless an exception applies. Sanctions for violating the Stark Law include civil monetary penalties of up to $15,000 per prohibited service provided, assessments equal to three times the dollar value of each such service provided and exclusion from the Medicare and Medicaid programs and other federal and state healthcare programs. The statute also provides a penalty of up to $100,000 for a circumvention scheme. In addition, many states have adopted or may adopt similar anti-kickback or anti-self-referral statutes. Some of these statutes prohibit the payment or receipt of remuneration for the referral of patients, regardless of the source of the payment for the care.

Type of LTCH	Non Co-located Admissions⁽¹⁾	Co-located Admissions⁽²⁾

Grandfathered satellites (0 owned hospitals)	LTCHs in this category are subject to a payment adjustment for discharged Medicare patients exceeding 25% of the LTCH's total Medicare population.	Percentage admissions threshold was raised from 25% to 50%. In the special case of rural LTCHs, LTCHs co-located with an urban single hospital, or LTCHs co-located with an MSA-dominant hospital the referral percentage was raised from 50% to 75%. This relief is now effective until cost reporting periods beginning on or after July 1, 2016.
Freestanding facilities (29 owned hospitals)	Percentage admissions threshold is suspended until cost reporting periods beginning on or after July 1, 2016.	25 Percent Rule not applicable.
Facilities co-located with a provider-based, off-campus, non-inpatient location of an inpatient prospective payment system hospital (0 owned hospitals)	Percentage admissions threshold is suspended until cost reporting periods beginning on or after July 1, 2016.	Percentage admissions threshold is suspended until cost reporting periods beginning on or after July 1, 2016.
HIHs and satellite facilities opened on or after October 1, 2004 (13 owned hospitals)	LTCHs in this category are subject to a payment adjustment for discharged Medicare patients exceeding 25% of the LTCH's total Medicare population.	LTCHs in this category are subject to a payment adjustment for discharged Medicare patients exceeding 25% of the LTCH's total Medicare population. In the special case where an LTCH is co-located with an MSA-dominant hospital, the referral percentage is no more than 50%, nor less than 25%.

~~Provider-based status. The designation “provider-based” refers to circumstances in which a~~ ~~subordinate~~ ~~facility~~ (~~e.g., a separately certified~~ 1)Medicare ~~provider, a department of a provider or~~ apatients ~~satellite~~admitted ~~facility)~~from ~~is treated as part of~~ a ~~provider~~hospital ~~for~~not ~~Medicare~~located ~~payment~~in ~~purposes. In these cases,~~ the ~~services~~same ofbuilding ~~the~~or ~~subordinate facility are included~~ on the ~~“main”~~same ~~provider’s~~campus ~~cost~~as ~~report and~~the ~~overhead~~LTCH ~~costs~~or satellites of the LTCH. (2)Medicare patients ~~main~~admitted ~~provider~~from ~~can~~a behospital ~~allocated~~located toin the ~~subordinate~~same ~~facility,~~building toor on the ~~extent that~~same ~~they~~campus ~~are~~as ~~shared.~~the WeLTCH ~~operate~~or ~~17 specialty hospitals that are treated as provider-based~~ satellites of ~~certain~~the ofLTCH. ~~our other facilities, certain of our outpatient rehabilitation services~~ ~~are~~ ~~operated as departments of our inpatient~~

After the expiration of the regulatory relief, as described above, our LTCHs (whether freestanding, HIH or satellite) will be subject to a downward payment adjustment for any Medicare patients who were admitted from a co-located 18or a non-co-located hospital and that exceed the applicable percentage admissions threshold of all Medicare patients discharged from the LTCH during the cost reporting period. These regulatory changes will have an adverse financial impact on the net operating revenues and profitability of many of these hospitals for cost reporting periods beginning on or after July 1, 2016.

~~Table~~ The BBA of ~~Contents~~2013 requires CMS to report to Congress before October 2016 on the need for any further extensions or modifications of the extensions of the 25 Percent Rule. In addition, the BBA of 2013 requires the Medicare Payment Advisory Commission, or "MedPAC," to report to Congress by June 2019 on the need to continue applying the 25 Percent Rule, the effect of site-neutral payment on LTCHs, and recommendations on how to change the site-neutral payment policy.

rehabilitation facilities, and we provide rehabilitation management and staffing services to hospital rehabilitation departments that may be treated as provider-based. These facilities are required to satisfy certain operational standards in order to retain their provider-based status. 16

~~Health~~Table ~~information practices. In addition to broadening the scope~~ of the fraud and abuse laws, the Health Insurance Portability and Accountability Act of 1996, commonly known as HIPAA, also mandates, among other things, the adoption of standards for the exchange of electronic health information in an effort to encourage overall administrative simplification and enhance the effectiveness and efficiency of the healthcare industry. If we fail to comply with the standards, we could be subject to criminal penalties and civil sanctions. Among the standards that the Department of Health and Human Services has adopted or will adopt pursuant to HIPAA are standards for electronic transactions and code sets, unique identifiers for providers (referred to as National Provider Identifier or NPI), employers, health plans and individuals, security and electronic signatures, privacy and enforcement. Contents

~~The~~ ~~Department~~Moratorium ofon ~~Health~~New ~~and~~LTCHs, ~~Human~~LTCH ~~Services~~Satellite ~~has~~Facilities ~~adopted~~and ~~standards~~LTCH ~~in three areas that most affect our operations.~~ beds

~~Standards~~ The ~~relating~~SCHIP toExtension ~~electronic~~Act ~~transactions~~imposed a moratorium on the establishment and ~~code~~classification ~~sets~~of ~~require~~new LTCHs, LTCH satellite facilities and LTCH beds in existing LTCHs or satellite facilities. The ACA extended this moratorium by two years. The moratorium expired on December 28, 2012. The BBA of 2013 reinstated the ~~use~~moratorium on the establishment and classification of ~~uniform~~new ~~standards~~LTCHs ~~for~~or ~~common~~LTCH ~~healthcare~~satellite ~~transactions~~facilities, ~~including~~and ~~healthcare~~on ~~claims~~the increase of LTCH beds in existing LTCHs or satellite facilities beginning January 1, 2015 through ~~information~~September 30, ~~plan~~2017. ~~eligibility~~The PAMA advanced the commencement date of the reinstated moratorium from January 1, ~~referral~~2015 ~~certification~~to April 1, 2014. The PAMA includes exceptions to the moratorium that are applicable to the establishment and ~~authorization~~classification of new LTCHs or LTCH satellites facilities currently under development. The new moratorium will not apply to LTCHs or LTCH satellites facilities that: (1) began their qualifying period to become an LTCH on or before April 1, ~~claims~~2014; ~~status~~(2) had a binding written agreement as of April 1, ~~plan~~2014 with an unrelated party for ~~enrollment~~construction, renovation, or lease for an LTCH and ~~disenrollment~~have expended, ~~payment~~before ~~and~~April 1, ~~remittance~~2014, ~~advice~~at least 10% of the estimated cost of the project (or, ~~plan~~if ~~premium~~less, ~~payments~~$2,500,000); ~~and~~or ~~coordination~~(3) had obtained a certificate of ~~benefits.~~need Weon ~~were~~or ~~required~~before toApril 1, ~~comply~~2014. ~~with~~The ~~these~~moratorium ~~requirements~~as byreinstated ~~October~~on April 161, ~~2003~~2014 provides no exceptions for increases in the number of certified beds in existing LTCHs and LTCH satellites. Further, any LTCH that establishes a new satellite, based upon meeting the criteria for an exception to the moratorium, must reduce beds elsewhere in the LTCH in order to have beds in the new satellite location.

~~Standards~~ ~~relating~~One-Time toBudget ~~the~~Neutrality privacy of individually identifiably health information govern our use and disclosure of protected health information, and require us to impose those rules, by contract, on any business associate to whom such information is disclosed. We were required to comply with these standards by April 14, 2003. Adjustment

~~Standards~~ Congress ~~for~~required that the ~~security~~LTCH-PPS payment rates maintain budget neutrality during the first years of ~~electronic~~the ~~health~~prospective ~~information~~payment ~~require~~system with ustotal expenditures that would have been made under the previous reasonable cost-based payment system. The LTCH-PPS regulations give CMS the ability to ~~implement~~make a one-time adjustment to the standard ~~various~~federal ~~administrative,~~rate ~~physical~~to correct any "significant difference between actual payments and ~~technical~~estimated ~~safeguards~~payments for the first year" of LTCH-PPS. The SCHIP Extension Act precluded CMS from implementing the one-time prospective adjustment to ~~ensure~~the LTCH standard federal rate for a period of three years. The ACA extended the ~~integrity~~stay on CMS's ability to adopt a one-time budget neutrality adjustment to LTCH-PPS through December 28, 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 ~~confidentiality~~adjustment of ~~electronic~~3.75% ~~protected~~to ~~health~~the ~~information~~LTCH base rate. WeCMS ~~were~~is ~~required~~implementing tothe ~~comply~~adjustment ~~with~~over a three-year period by applying a factor of 0.98734 to the standard federal rate in fiscal years 2013, 2014 and 2015, ~~security~~except ~~standards~~that bythe ~~April~~adjustment would not apply to payments for discharges occurring on or after October 201, ~~2005~~2012 through December 28, 2012.

~~The~~ ~~NPI~~Annual ~~will~~Payment ~~replace~~Rate health care provider identifiers that are in use today in standard transactions. Implementation of the NPI will eliminate the need for health care providers to use different identification numbers to identify themselves when conducting standard transactions with multiple health plans. We are required to comply with the use of NPIs in standard transactions by May 23, 2007. Update

~~We maintain~~ Fiscal aYear ~~HIPAA~~2013. On ~~Committee~~August 1, ~~that~~2012, isCMS ~~charged~~published ~~with~~the ~~evaluating~~final rule updating the policies and payment rates for ~~monitoring~~LTCH-PPS ~~our~~for ~~compliance~~fiscal ~~with~~year 2013 (affecting discharges and cost reporting periods beginning on or after October 1, 2012 through September 30, 2013). Two different standard federal rates ~~HIPAA~~apply during fiscal year 2013. The ~~Committee~~standard ~~monitors~~federal ~~HIPAA’s~~rate ~~regulations~~for asdischarges ~~they~~on ~~have~~or ~~been~~after ~~adopted~~October 1, to2012 ~~date~~ and asbefore ~~additional~~December 29, ~~standards~~2012 is $40,916 and ~~modifications~~the ~~are~~standard ~~adopted.~~federal ~~Although health~~rate ~~information~~for ~~standards~~discharges on ~~have~~or ~~had~~after aDecember 29, ~~significant~~2012 ~~effect~~for on the ~~manner~~remainder inof fiscal year 2013 is $40,398, both of which weare ~~handle~~an ~~health~~increase ~~data~~from ~~and~~the ~~communicate~~fiscal ~~with payors~~year 2012 standard federal rate of $40,222. The update to the standard ~~cost~~federal ofrate ~~our~~for ~~compliance~~fiscal ~~has~~year ~~not~~2013 ~~had~~through December 28, 2012 included a ~~material~~market ~~adverse~~basket ~~effect~~increase ~~on our~~of ~~business~~2.6%, ~~financial~~less ~~condition~~a orproductivity ~~results~~adjustment of ~~operations~~0.7%, Weand ~~cannot~~less ~~estimate~~an additional reduction of 0.1% mandated by the ~~cost~~ACA. The standard federal rate for the period of ~~compliance~~December 29, ~~with~~2012 ~~standards~~through ~~that~~the ~~have not~~remainder ~~been~~of ~~issued~~fiscal or2013 ~~finalized~~is further reduced by ~~the~~a ~~Department~~portion of ~~Health~~the ~~and~~one-time ~~Human~~budget neutrality ~~Services~~adjustment of 1.266%, as discussed above. The final rule establishes a fixed-loss amount for high cost outlier cases for fiscal year 2013 of $15,408, which is a decrease from the fixed-loss amount in the 2012 fiscal year of $17,931.

~~Compliance~~ Fiscal ~~Program~~Year 2014. On August 19, 2013, CMS published the final rule updating the policies and payment rates for LTCH-PPS for fiscal year 2014 (affecting discharges and cost reporting periods

~~Our Compliance Program~~ 17

~~In late~~Table ~~1998, we voluntarily adopted our code~~ of conduct. The code is reviewed and amended as necessary and is the basis for our company-wide compliance program. Our written code of conduct provides guidelines for principles and regulatory rules that are applicable to our patient care and business activities. These guidelines are implemented by a compliance officer, a compliance committee and subcommittees, and Contents

-beginning on 19or after October 1, 2013 through September 30, 2014). The standard federal rate was set at $40,607, an increase from the standard federal rate applicable during the period from December 29, 2012 through September 30, 2013 of $40,398. The update to the standard federal rate for fiscal year 2014 includes a market basket increase of 2.5%, less a productivity adjustment of 0.5%, less a reduction of 0.3% mandated by the ACA, and less a budget neutrality adjustment of 1.266%, as discussed above. The fixed-loss amount for high cost outlier cases was set at $13,314, which is a decrease from the fixed-loss amount in the 2013 fiscal year of $15,408.

~~Table~~ Fiscal Year 2015. On August 22, 2014, CMS published the final rule updating policies and payment rates for LTCH-PPS for fiscal year 2015 (affecting discharges and cost reporting periods beginning on or after October 1, 2014 through September 30, 2015). The standard federal rate is set at $41,044, an increase from the standard federal rate applicable during fiscal year 2014 of ~~Contents~~$40,607. The update to the standard federal rate for fiscal year 2015 includes a market basket increase of 2.9%, less a productivity adjustment of 0.5%, less an additional reduction of 0.2% mandated by the ACA, and less a budget neutrality adjustment of 1.266%, as discussed above. The fixed-loss amount for high cost outlier cases is set at $14,972, which is an increase from the fixed-loss amount in the 2014 fiscal year of $13,314.

~~employee~~ ~~education~~Medicare ~~and~~Market ~~training.~~Basket ~~We also have established a reporting system, auditing and monitoring programs, and a disciplinary system as a means for enforcing the code’s policies.~~ Adjustments

~~Operating~~ The ~~Our~~ACA ~~Compliance~~instituted ~~Program~~a market basket payment adjustment to LTCHs. In fiscal years 2015 and 2016 the market basket update will be reduced by 0.2%. In fiscal years 2017 through 2019, the market basket update will be reduced by 0.75%. The ACA specifically allows these market basket reductions to result in less than a 0% payment update and payment rates that are less than the prior year.

We ~~focus~~Medicare onReimbursement integrating compliance responsibilities with operational functions. We recognize that our compliance with applicable laws and regulations depends upon individual employee actions as well as company operations. As a result, we have adopted an operations team approach to compliance. Our corporate executives, with the assistance of ~~corporate~~Inpatient ~~experts,~~Rehabilitation ~~designed~~Facility the programs of the compliance committee. We utilize facility leaders for employee-level implementation of our code of conduct. This approach is intended to reinforce our company-wide commitment to operate in accordance with the laws and regulations that govern our business. Services

~~Compliance~~ IRFs ~~Committee~~are paid under a prospective payment system specifically applicable to this provider type, which is referred to as "IRF-PPS." Under the IRF-PPS, each patient discharged from an IRF is assigned to a case mix group, or "IRF-CMG," containing patients with similar clinical conditions that are expected to require similar amounts of resources. An IRF is generally paid a pre-determined fixed amount applicable to the assigned IRF-CMG (subject to applicable case adjustments related to length of stay and facility level adjustments for location and low income patients). The payment amount for each IRF-CMG is intended to reflect the average cost of treating a Medicare patient's condition in an IRF relative to patients with conditions described by other IRF-CMGs. The IRF-PPS also includes special payment policies that adjust the payments for some patients based on the patient's length of stay, the facility's costs, whether the patient was discharged and readmitted and other factors.

~~Our~~ ~~compliance~~Facility ~~committee~~Certification is made up of members of our senior management and in-house counsel. The compliance committee meets on a quarterly basis and reviews the activities, reports and operation of our compliance program. In addition, the HIPAA committee meets on a regular basis to review compliance with HIPAA regulations and provides reports to the compliance committee. Criteria

~~Compliance~~ Our ~~Issue~~rehabilitation ~~Reporting~~hospitals must meet certain facility criteria to be classified as an IRF by the Medicare program, including: (1) a provider agreement to participate as a hospital in Medicare, (2) a preadmission screening procedure, (3) ensuring that patients receive close medical supervision and furnish, through the use of qualified personnel, rehabilitation nursing, physical therapy, and occupational therapy, plus, as needed, speech therapy, social or psychological services, and orthotic and prosthetic services, (4) a full-time, qualified director of rehabilitation, (5) a plan of treatment for each inpatient that is established, reviewed, and revised as needed by a physician in consultation with other professional personnel who provide services to the patient, and (6) a coordinated multidisciplinary team approach in the rehabilitation of each inpatient, as documented by periodic clinical entries made in the patient's medical record to note the patient's status in relationship to goal attainment, and that team conferences are held at least every two weeks to determine the appropriateness of treatment. Failure to comply with any of the classification criteria may result in the denial of claims for payment or cause a hospital to lose its status as an IRF and be paid under the prospective payment system that applies to general acute care hospitals.

In order to facilitate our employees’ ability to report known, suspected or potential violations of our code of conduct, we have developed a system of anonymous reporting. This anonymous reporting may be accomplished through our toll free compliance hotline, compliance e-mail address or our compliance post office box. The compliance officer and the compliance committee are responsible for reviewing and investigating each compliance incident in accordance with the compliance department’s investigation policy. 18

~~Compliance~~Table ~~Monitoring~~of ~~and~~Contents ~~Auditing/ Comprehensive Training and Education~~

~~Monitoring~~ ~~reports~~Patient ~~and~~Classification the results of compliance for each of our business segments are reported to the compliance committee on a quarterly basis. We train and educate our employees regarding the code of conduct, as well as the legal and regulatory requirements relevant to each employee’s work environment. New and current employees are required to sign a compliance certification form certifying that the employee has read, understood, and has agreed to abide by the code of conduct. Additionally all employees are required to re-certify compliance with the code on an annual basis. Criteria

~~Policies~~ Under ~~and~~the ~~Procedures~~IRF ~~Reflecting~~certification ~~Compliance~~criteria ~~Focus~~that ~~Areas~~has been in effect since 1983, in order to qualify as an IRF, a hospital was required to satisfy certain operational criteria as well as demonstrate that, during its most recent 12-month cost reporting period, it served an inpatient population of whom at least 75% required intensive rehabilitation services for one or more of 10 conditions specified in the regulation. We refer to such 75% requirement as the "75% Rule."

We New ~~review~~IRF ~~our~~certification ~~policies~~criteria ~~and~~became ~~procedures~~effective for ~~our~~cost reporting periods beginning on or after July 1, 2004 as a result of the major changes that CMS adopted on May 7, 2004 to the 75% Rule that: (1) temporarily lowered the 75% compliance ~~program~~threshold (starting at 50% and phasing to 75% over four years), (2) modified and expanded from ~~time~~10 to ~~time~~13 inthe ~~order~~medical conditions used to ~~improve~~determine ~~operations~~whether a hospital qualifies as an IRF, (3) identified the conditions under which comorbidities can be used to verify compliance with the 75% Rule, and (4) changed the timeframe used to ~~ensure~~determine compliance with ~~requirements~~the of75% ~~standards,~~Rule ~~laws~~from ~~and~~"the ~~regulations~~most recent 12-month cost reporting period" to "the most recent, consecutive, and toappropriate ~~reflect~~12-month period," with the ~~on-going~~result that a determination of non-compliance ~~focus~~with ~~areas~~the ~~which~~applicable ~~have~~compliance ~~been~~threshold ~~identified~~will byaffect the ~~compliance~~facility's certification as an IRF for ~~committee~~its cost reporting period that begins immediately after the 12-month review period.

~~Internal~~ Under the ~~Audit~~Deficit Reduction Act of 2005 (the "DRA"), enacted on February 8, 2006, Congress extended the phase-in period for the 75% Rule by maintaining the compliance threshold at 60% (rather than increasing it to the scheduled 65%) during the 12-month period beginning on July 1, 2006. The compliance threshold was then to increase to 65% for cost reporting periods beginning on or after July 1, 2007 and again to 75% for cost reporting periods beginning on or after July 1, 2008. However, the SCHIP Extension Act included a permanent freeze in the 75% Rule patient classification criteria compliance threshold at 60% (with comorbidities counting toward this threshold), at which time the requirement became known as the "60% Rule."

In Compliance with ~~addition~~the topatient ~~and~~classification incriteria ~~support~~is ofdemonstrated through either medical review or the ~~efforts~~"presumptive" method, in which a patient's diagnosis codes are compared to a "presumptive compliance" list. CMS has announced that it will remove a number of ~~our~~diagnosis codes from the presumptive compliance ~~department~~list. According to CMS, ~~during~~these ~~2001~~conditions wedo not demonstrate the need ~~established~~for anintensive ~~internal~~inpatient ~~audit~~rehabilitation ~~function~~services in the absence of additional facts that would have to be pulled from a patient's medical record. ~~The~~As ~~compliance~~a ~~officer~~result, ~~manages~~beginning ~~the~~on ~~combined~~or ~~Compliance~~after October 1, ~~and~~2015, ~~Audit~~a ~~Department~~number ~~and~~of ~~meets~~diagnosis ~~with~~codes previously on the ~~audit~~presumptive ~~committee~~compliance oflist will be removed, including diagnosis codes in the ~~board~~following ofcategories: ~~directors~~non-specific ondiagnosis acodes, ~~quarterly~~arthritis ~~basis~~diagnosis tocodes, ~~discuss~~unilateral ~~audit~~upper ~~results.~~extremity amputations diagnosis, amputation status codes, prosthetic fitting and adjustment codes, some congenital anomalies diagnosis codes, other miscellaneous diagnosis codes.

~~ITEM~~ ~~1A.~~Annual ~~RISK~~Payment ~~FACTORS~~ Rate Update

~~Our~~ Fiscal ~~business~~Year ~~involves~~2013. On aJuly 30, ~~number~~2012, ofCMS ~~risks~~published the final rule updating policies and payment rates for IRF-PPS for fiscal year 2013 (affecting discharges and cost reporting periods beginning on or after October 1, ~~some~~2012 ofthrough September 30, 2013). The standard payment conversion factor for discharges during fiscal year 2013 is $14,343, which ~~are~~is ~~beyond~~an ~~our~~increase ~~control~~from the fiscal year 2012 standard payment conversion factor of $14,076. The ~~risk~~update ~~and~~to the standard payment conversion factor for ~~uncertainties~~fiscal weyear ~~describe~~2013 ~~below~~includes ~~are~~a ~~not~~market ~~the~~basket ~~only~~increase ~~ones~~of we2.7%, ~~face~~less a productivity adjustment of 0.7%, ~~Additional~~less ~~risks~~an ~~and~~additional ~~uncertainties~~reduction of 0.1% mandated by the ACA. CMS decreased the outlier threshold amount ~~that~~ for fiscal year 2013 to $10,466 from $10,713 established in the final rule for fiscal year 2012.

- Fiscal 20Year 2014. On August 6, 2013, CMS published the final rule updating policies and payment rates for IRF-PPS for fiscal year 2014 (affecting discharges and cost reporting periods beginning on or after October 1, 2013 through September 30, 2014). The standard payment conversion factor for discharges for fiscal year 2014 is $14,846, which is an increase from the fiscal year 2013 standard payment conversion factor of $14,343. The update to the standard payment conversion factor for fiscal year 2014

~~Table of Contents~~19

weTable doof ~~not currently know or that we currently believe to be immaterial may also adversely affect our business.~~ Contents

~~Compliance~~includes a ~~with~~market ~~recent~~basket ~~changes~~increase inof ~~federal~~2.6%, ~~regulations~~less ~~applicable~~a toproductivity ~~long-term~~adjustment ~~acute~~of ~~care hospitals~~0.5%, ~~operated~~less asan ~~“hospitals~~additional ~~within~~reduction ~~hospitals”~~of or0.3% asmandated ~~“satellites”~~by ~~will~~the ~~result~~ACA. inCMS ~~increased capital~~decreased ~~expenditures~~the ~~and~~outlier ~~may~~threshold ~~have~~amount anfor ~~adverse~~fiscal ~~effect~~year 2014 onto ~~our~~$9,272 ~~future~~from ~~net~~$10,466 ~~operating~~established ~~revenues~~in ~~and profitability~~the final rule for fiscal year 2013.

Fiscal Year 2015. On August 116, ~~2004~~2014, ~~the Centers for Medicare & Medicaid Services, also known as~~ 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. Effective for hospital cost reporting periods beginning on or after October 1, 2004, the final ~~regulations,~~rule ~~subject~~updating topolicies ~~certain~~and ~~exceptions,~~payment ~~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 phasedIRF-inPPS ~~over~~for afiscal ~~four-~~year ~~period~~2015 ~~starting~~(affecting ~~with~~discharges ~~hospital~~and 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~~2014 ~~and~~through ~~before October~~September 130, ~~2005, the Medicare admissions threshold was the Fiscal 2004 Percentage (as defined below~~2015). ofThe ~~Medicare~~standard ~~discharges~~payment ~~admitted~~conversion ~~from~~factor ~~the host hospital; (ii)~~ for discharges ~~during~~for ~~the~~fiscal ~~cost~~year ~~reporting~~2015 ~~period~~is ~~beginning on or after October 1~~$15, ~~2005 and before October 1~~198, ~~2006,~~which ~~the Medicare admissions threshold~~ is ~~the~~an ~~lesser~~increase ~~of the Fiscal 2004 Percentage of Medicare discharges admitted~~ from the ~~host~~fiscal ~~hospital~~year or2014 ~~75%;~~standard ~~(iii) for~~payment ~~discharges~~conversion ~~during~~factor ~~the~~of ~~cost reporting period beginning on or after October 1~~$14,846. ~~2006~~The ~~and~~update ~~before~~to ~~October 1, 2007,~~ the ~~Medicare admissions~~standard ~~threshold~~payment isconversion ~~the~~factor ~~lesser of the Fiscal 2004 Percentage of Medicare discharges admitted~~for ~~from~~fiscal ~~the~~year ~~host~~2015 ~~hospital~~includes ora ~~50%;~~market ~~and~~basket ~~(iv) for~~increase ~~discharges~~of ~~during cost reporting periods beginning on or after October 1~~2.9%, ~~2007,~~less ~~the~~a ~~Medicare~~productivity ~~admissions~~adjustment ~~threshold~~of ~~is 25%~~0. ~~As used above~~5%, ~~“Fiscal~~less ~~2004 Percentage”~~an ~~means,~~additional ~~with~~reduction ~~respect to any HIH, the percentage~~ of ~~all~~0.2% ~~Medicare~~mandated ~~patients discharged~~ by ~~such~~ ~~HIH~~the ~~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~~ACA. AsCMS ofdecreased ~~December 31,~~the ~~2005,~~outlier 93threshold ~~of our 97~~amount ~~long-term~~for ~~acute~~fiscal ~~care hospitals operated as HIHs. For the~~ year ~~ended~~2015 ~~December 31, 2005, approximately 56% of the Medicare admissions~~ to ~~these HIHs were from host hospitals. For the year ended December 31~~$8,848 ~~2005, approximately 10% of these HIHs admitted 25% or fewer of their Medicare patients~~ from ~~their host hospitals~~$9,272 ~~approximately~~established ~~34%~~in ofthe ~~these~~final ~~HIHs~~rule admitted 50% or fewer of their Medicare patients from their host hospitals, and approximately 74% of these HIHs admitted 75% or fewer of their Medicare patients from their host hospitals. The admissions data for ~~the~~fiscal year ~~ended December 31, 2005 is not necessarily indicative of the admissions mix these hospitals will experience in the future~~2014.

~~These~~ ~~new~~Medicare ~~HIH~~Market ~~regulations~~Basket had only a negligible impact on our 2005 financial results, but could have a significant negative impact on our financial results thereafter. In order to minimize the more significant impact of the HIH regulations in 2006 and future years, 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 a small number of facilities. There can be no assurance that we can successfully implement such changes to our existing HIH business model or successfully control the capital expenditures associated with such changes. As a result, our ability to operate our long-term acute care hospitals effectively and our net operating revenues and profitably may be adversely affected. For example, because physicians generally direct the majority of hospital admissions, our net operating revenues and profitability may decline if the relocation efforts for certain of our HIHs adversely affect our relationships with the physicians in those communities. See “Business — Specialty Hospitals — Adjustments

- The 21ACA -instituted a market basket payment adjustment for IRFs. In fiscal years 2015 and 2016, the market basket update will be reduced by 0.2%. In fiscal years 2017 through 2019, the market basket update will be reduced by 0.75%. The ACA specifically allows these market basket reductions to result in less than a 0% payment update and payment rates that are less than the prior year.

~~Table~~ Medicare Reimbursement of ~~Contents~~Outpatient Rehabilitation Services

~~Recent~~ The ~~Long-Term~~Medicare ~~Acute~~program ~~Care~~reimburses ~~Hospital~~outpatient ~~Regulatory~~rehabilitation ~~Developments”~~providers ~~and~~based ~~“Business~~on —the ~~Government~~Medicare physician fee schedule. The Medicare ~~Regulations~~physician —fee ~~Overview~~schedule rates are automatically updated annually based on a formula, called the sustainable growth rate, or "SGR," formula, contained in legislation. The SGR formula has resulted in automatic reductions in rates every year since 2002; however, for each year through March 31, 2015 CMS or Congress has taken action to prevent the SGR formula reductions. CMS estimated on November 13, 2014 that beginning April 1, 2015 the Medicare physician fee schedule payment rates would be reduced by 21.2% as a result of Uthe SGR formula.S The PAMA temporarily blocks the payment reduction caused by the SGR formula through March 31, 2015 and replaces it with a 0.5% payment increase for services provided through December 31, 2014 and ~~State~~a ~~Government~~0% ~~Reimbursements~~payment —update from ~~Regulatory~~January 1, ~~Changes~~2015 through March 31, 2015.” Automatic reductions in the Medicare physician fee schedule payment rates will commence on April 1, 2015, unless Congress again takes legislative action to prevent the SGR formula reductions from going into effect. For the year ended December 31, 2014, we received approximately 10% of our outpatient rehabilitation net operating revenues from Medicare.

~~Government~~ In addition, ~~implementation~~MedPAC ofrecommended ~~recently~~that ~~proposed~~Congress ~~changes~~direct CMS to ~~Medicare’s~~collect ~~method~~data ofon ~~reimbursing~~provider ~~our~~service volume and work time to establish more accurate relative value unit payment rates and to ~~long-term~~identify ~~acute~~and ~~care~~reduce ~~hospitals~~overpriced ~~may~~fee ~~have~~schedule anservices. ~~adverse~~Similarly, ~~effect~~the onACA ~~our~~requires ~~future~~CMS ~~net~~to ~~operating~~identify ~~revenues~~and review potentially misvalued codes and make appropriate adjustments to the relative values of ~~profitability~~those services identified as being misvalued.

~~All~~ ~~Medicare~~Therapy payments to our long-term acute care hospitals are made in accordance with a new prospective payment system specifically applicable to long-term acute care hospitals, referred to as “LTCH-PPS”. Under LTCH-PPS, a long-term acute care hospital is paid a predetermined fixed amount depending upon the long-term care diagnosis-related group, or “LTC-DRG,” to which each patient is assigned. LTCH-PPS includes special payment policies that adjust the payments for some patients based on a variety of factors. On January 27, 2006, the Centers for Medicare & Medicaid Services (known as “CMS”) published its proposed annual payment rate updates for the 2007 LTCH-PPS rate year (affecting cost reporting periods beginning on or after July 1, 2006 and before July 1, 2007). The January 2006 proposed rule includes the following proposed changes to LTCH-PPS payment methodologies: (i) addition of a new payment methodology for Medicare patients with a length of stay less than or equal to 5/6ths of the geometric average length of stay for each LTC-DRG (referred to as “short-stay outlier” or “SSO” cases), so that payment for a significant portion of SSO cases will be reduced to an amount comparable with that paid under the general acute care hospital reimbursement methodology; (ii) a zero-percent update to the LTCH-PPS standard federal rate used as a basis for LTCH-PPS payments; (iii) sunset of the surgical case exception to the three-day or less interruption of stay policy, under which 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 (iv) 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. CMS estimates that the changes it is proposing for the 2007 LTCH-PPS rate year will result in an approximately 11 percent decrease in Medicare payments to long-term acute care hospitals as compared to the 2006 rate year. Consistent with its standard process for adopting regulations, CMS has solicited and will consider comments on the January 2006 proposed rule before it publishes a final update for the 2007 LTCH-PPS rate year. As a result, CMS may elect not to adopt certain of its proposals or the agency may adopt the proposals with modifications. If, however, the January 2006 proposals are adopted without modification, these changes in LTCH-PPS reimbursement policy will reduce our net operating revenues and will adversely affect our financial performance. See “Business — Specialty Hospitals — Recent Long-Term Acute Care Hospital Regulatory Developments” and “Business — Government Regulations — Overview of U.S. and State Government Reimbursements — Long-term acute care hospital Medicare reimbursement.” Caps

If Beginning ~~our~~on ~~long-term~~January 1, ~~acute~~1999, ~~care~~the ~~hospitals~~Balanced ~~fail~~Budget toAct ~~maintain~~of ~~their~~1997 ~~certifications~~subjected ascertain ~~long-term~~outpatient ~~acute~~therapy providers reimbursed under ~~care~~the ~~hospitals~~Medicare orphysician iffee ~~our~~schedule ~~facilities~~to ~~operated~~annual aslimits ~~HIHs~~for ~~fail~~therapy toexpenses. ~~qualify~~Effective asJanuary 1, ~~hospitals~~2015, ~~separate~~the ~~from their~~annual ~~host~~limit ~~hospitals~~on outpatient therapy services is $1,940 ~~our~~for ~~net~~combined ~~operating~~physical ~~revenues~~and speech language pathology services and ~~profitability~~$1,940 ~~may~~for ~~decline~~occupational therapy services. The per beneficiary caps were $1,920 for calendar year 2014.

As The annual oflimits ~~December 31,~~for ~~2005,~~therapy ~~all~~expenses ofhistorically ~~our~~did ~~long-term~~not ~~acute~~apply ~~care~~to ~~hospitals~~services ~~were~~furnished ~~certified~~and billed by ~~Medicare as~~outpatient ~~long-term~~hospital ~~acute care hospitals~~departments. IfHowever, ~~our long-term acute care hospitals fail to meet or maintain~~ the ~~standards for certification as long-term acute care hospitals~~PAMA, ~~namely~~and ~~minimum~~prior ~~average length of patient stay~~legislation, ~~they will receive payments under~~ extended the ~~prospective~~annual ~~payment~~limits ~~system~~on ~~applicable~~therapy toexpenses ~~general acute~~and ~~care hospitals rather than payment under~~ the ~~system~~manual ~~applicable~~medical toreview ~~long-term~~thresholds ~~acute care hospitals. Payments at rates applicable~~ to ~~general~~services ~~acute~~furnished ~~care hospitals would result~~ in ~~our long-term~~hospital ~~acute~~outpatient ~~care~~department ~~hospitals~~settings ~~receiving~~through ~~less~~March 31, ~~Medicare~~2015. ~~reimbursement~~The ~~than~~application ~~they~~of ~~currently receive~~annual ~~for~~limits ~~their~~to ~~patient~~hospital ~~services.~~outpatient Indepartment ~~its~~settings ~~preamble~~will tosunset ~~the~~on ~~January~~March 2731, ~~2006~~2015 ~~proposed~~unless ~~rule~~Congress ~~updating~~extends ~~the long-term acute care Medicare prospective payment system, CMS discussed the contract that~~ it. ~~has awarded~~We tooperated ~~Research Triangle Institute~~1,023 ~~International (“RTI”) to examine recent recommendations made by the Medicare Payment Advisory Commission, or MedPAC, concerning how long-term acute care hospitals are defined and differentiated~~

~~- 22 -~~ 20

Table of Contents

~~from other types of Medicare providers. MedPAC is an independent federal body that advises~~outpatient ~~Congress~~rehabilitation onclinics ~~issues~~at ~~affecting the Medicare program. In its June~~December ~~2004~~31, ~~“Report to Congress~~2014,” ~~MedPAC recommended the adoption by CMS~~ of ~~new~~which ~~facility~~164 ~~staffing and services criteria and patient clinical characteristics and treatment requirements for long-term acute care hospitals in order to ensure that only appropriate patients~~ are ~~admitted~~provider tobased ~~these~~outpatient ~~facilities.~~rehabilitation ~~CMS indicated~~clinics ~~that~~operated itas ~~expects~~departments RTI’s final report to be submitted to the agency in late Spring 2006. While acknowledging that RTI’s findings are expected to have a substantial impact on future Medicare policy for long-term acute care hospitals, CMS stated its belief that many of the ~~specific~~inpatient ~~payment~~rehabilitation ~~adjustment features of LTCH-PPS presently in place may still be necessary and appropriate even with the development of patient- and facility-level criteria for long-term acute care~~ hospitals. Failure to meet existing long-term acute care certification criteria or implementation of additional criteria that would limit the population of patients eligible for our hospitals’ services or change the basis on which we ~~are~~ ~~paid could adversely affect our net operating revenues and profitability~~operated.

~~Nearly~~ In the ~~all~~DRA, ofCongress ~~our~~implemented ~~long-term~~an ~~acute~~exceptions ~~care~~process ~~hospitals~~to ~~operate~~the asannual ~~HIHs~~limit ~~and~~for astherapy aexpenses. ~~result~~Under ~~are~~this ~~subject to~~process, ~~additional~~a Medicare ~~criteria~~enrollee ~~that~~(or ~~require~~person ~~certain~~acting ~~indications~~on behalf of ~~separateness~~the Medicare enrollee) is able to request an exception from the ~~host hospital.~~therapy Ifcaps ~~any~~if ofthe ~~our~~provision ~~long-term~~of ~~acute~~therapy ~~care~~services ~~HIHs~~was ~~fail~~deemed to ~~meet~~be ~~the~~medically ~~separateness~~necessary. ~~requirements,~~Therapy ~~they will~~cap beexceptions ~~reimbursed~~have atbeen ~~the~~available ~~lower~~automatically ~~general~~for certain ~~acute~~conditions ~~care~~and ~~hospital~~on ~~rate,~~a ~~which~~case ~~would~~by ~~likely~~case ~~cause~~basis ~~our~~upon ~~net operating~~submission ~~revenues~~of ~~and~~documentation ~~profitability~~of tomedical ~~decrease~~necessity. ~~See~~The ~~“Business~~PAMA —extends ~~Government~~the ~~Regulations~~exceptions —process ~~Overview of~~for Uoutpatient therapy caps through March 31, 2015.S. Unless ~~and~~Congress ~~State~~extends ~~Government~~the ~~Reimbursements~~exceptions —process, ~~Long-term~~the ~~acute~~therapy ~~care~~caps ~~hospital~~will ~~Medicare~~apply to all outpatient therapy services beginning April 1, 2015, except those services furnished and billed by outpatient ~~reimbursement~~hospital departments.”

~~Implementation~~ The Middle Class Tax Relief and Job Creation Act of ~~modifications~~2012 made several changes to the ~~admissions~~exceptions ~~policies~~process to the annual limit for ~~our~~therapy ~~inpatient~~expenses. ~~rehabilitation~~For any claim above the annual limit, ~~facilities~~the asclaim ~~required~~must contain a modifier indicating that the services are medically necessary and justified by appropriate documentation in ~~order~~the medical record. Effective October 1, 2012, all claims exceeding $3,700 are subject to ~~achieve~~a ~~compliance~~manual ~~with~~medical review process. The $3,700 threshold is applied separately to the combined physical therapy/speech therapy cap and the occupational therapy cap. The PAMA extends through March 31, 2015 the requirement that Medicare ~~regulations~~perform ~~may~~manual ~~result~~medical review of therapy services when an exception is requested for cases in awhich the beneficiary has reached ~~loss~~a ofspecified ~~patient~~dollar ~~volume~~aggregate atthreshold. ~~these~~Effective ~~hospitals~~October 1, ~~and~~2012, asall atherapy ~~result~~claims, ~~may~~whether ~~reduce~~above ~~our~~or ~~future~~below ~~net~~the ~~operating~~annual limit, must include the national provider identifier (NPI) of the ~~revenues~~physician responsible for certifying and ~~profitability~~periodically reviewing the plan of care.

As ofMultiple ~~December 31,~~Procedure ~~2005,~~Payment our four acute medical rehabilitation hospitals were certified by Medicare as inpatient rehabilitation facilities. Under the historic inpatient rehabilitation facility, or IRF, certification criteria that had been in effect since 1983, in order to qualify as an IRF, a hospital was required to satisfy certain operational criteria as well as demonstrate that, during its most recent 12-month cost reporting period, it served an inpatient population of whom at least 75% required intensive rehabilitation services for one or more of ten conditions specified in the regulations (referred to as the “75% test”). In 2002, CMS became aware that its various contractors were using inconsistent methods to assess compliance with the 75% test and that many inpatient rehabilitation facilities were not in compliance with the 75% test. In response, in June 2002, CMS suspended enforcement of the 75% test and, on September 9, 2003, proposed modifications to the regulatory standards for certification as an IRF. Notwithstanding concerns stated by the industry and Congress in late 2003 and early 2004 about the adverse impact that CMS’s proposed changes and renewed enforcement efforts might have on access to inpatient rehabilitation facility services, and notwithstanding Congressional requests that CMS delay implementation of or changes to the 75% test for additional study of clinically appropriate certification criteria, on May 7, 2004, CMS adopted a final rule that made significant changes to the certification standard. CMS temporarily lowered the 75% compliance threshold to 50%, with a gradual increase back to 75% over the course of a four-year period. CMS also expanded from 10 to 13 the number of medical conditions used to determine compliance with the 75% test (or any phase-in percentage) and finalized the conditions under which comorbidities may be used to satisfy the 75% test. Finally, CMS changed the timeframe used to determine a provider’s compliance with the inpatient rehabilitation facility criteria including the 75% test so that any changes in a facility’s certification based on compliance with the 75% test may be made effective in the cost reporting period immediately following the review period for determining compliance. Congress temporarily suspended enforcement of the 75% test when it enacted the Consolidated Appropriations Act, 2005, which requires the Secretary of Health and Human Services to respond within 60 days to a report by the Government Accountability Office, or GAO, on the standards for defining inpatient rehabilitation services before the Secretary may terminate a hospital’s designation as an inpatient rehabilitation facility for failure to meet the 75% test. The GAO issued its report on April 22, 2005, and recommended that CMS, based on further research, refine the 75% test to Reduction

CMS adopted MPPR Reduction for therapy services in the final update to the Medicare physician fee schedule for calendar year 2011. This MPPR Reduction policy became effective January 1, 2011 and applies to all outpatient therapy services paid under Medicare Part B. The MPPR Reduction policy applies across all therapy disciplines — occupational therapy, physical therapy and speech-language 23pathology. Under the policy, the Medicare program pays 100% of the practice expense component of the therapy procedure or unit of service with the highest Relative Value Unit, and then reduces the payment for the practice expense component for the second and subsequent therapy procedures or units of service furnished during the same day for the same patient, regardless of whether those therapy services are furnished in separate sessions. In 2011 and 2012, the second and subsequent therapy service furnished during the same day for the same patient was reduced by 20% in office and other non-institutional settings and by 25% in institutional settings. The American Taxpayer Relief Act of 2012 increased the payment reduction in either setting to 50% effective April 1, 2013 for all outpatient therapy services. Our outpatient rehabilitation therapy services are primarily offered in institutional settings and, as such, were subject to the applicable 25% payment reduction in the practice expense component for the second and subsequent therapy services furnished by us to the same patient on the same day until April 1, 2013 when the payment reduction was increased to 50%.

~~Table~~ ofOther ~~Contents~~Requirements for Payment

~~describe~~ Historically, ~~more~~outpatient ~~thoroughly~~rehabilitation ~~the~~services ~~subgroups~~have ofbeen ~~patients~~subject ~~within~~to scrutiny by the ~~qualifying~~Medicare ~~conditions~~program ~~that~~for, ~~are~~among other things, medical necessity for services, appropriate documentation for ~~care~~services, insupervision anof ~~inpatient~~therapy ~~rehabilitation~~aides ~~facility.~~and ~~The~~students ~~Secretary~~and ~~issued~~billing afor ~~formal~~single rather than group therapy when services are furnished to more than one ~~response~~patient. CMS has issued guidance to ~~the~~clarify ~~GAO~~that ~~study~~services onperformed ~~June 24,~~by ~~2005,~~a instudent ~~which~~are itnot ~~concluded~~reimbursed ~~that~~even ~~the~~if ~~revised~~provided ~~inpatient rehabilitation~~under ~~facility~~"line ~~certification~~of ~~standards,~~sight" ~~including~~supervision of the ~~75%~~therapist. ~~test~~Likewise, ~~were~~CMS ~~consistent~~has ~~with~~reiterated ~~the~~that ~~recommendations~~Medicare indoes not pay for services provided by aides regardless of the ~~GAO~~level ~~report~~of supervision. InCMS ~~light~~also ofhas ~~this~~issued ~~determination,~~instructions ~~the~~that ~~Secretary~~outpatient ~~announced~~physical and occupational therapy services provided ~~that~~simultaneously ~~CMS~~to ~~would~~two ~~immediately~~or ~~begin~~more ~~enforcement~~individuals ofby ~~the~~a ~~revised~~practitioner ~~certification~~should ~~standards~~be billed as group therapy services.

Subsequently, under the Deficit Reduction Act of 2005, enacted on February 8, 2006, Congress extended the phase-in period for the 75% test by maintaining the compliance threshold at 60% (rather than increasing it to 65%) during the 12-month period beginning on July 1, 2006. The compliance threshold then increases to 65% for cost reporting periods beginning on or after July 1, 2007 and again to 75% for cost reporting periods beginning on or after July 1, 2008. 21

~~The~~Table ~~inpatient rehabilitation facilities we acquired as part~~ of our Kessler acquisition in September 2003 may not have fully met the historic standard. In order to achieve compliance with the revised 75% test, it may be necessary for us to implement more restrictive admissions policies at our inpatient rehabilitation facilities and not admit patients whose diagnoses fall outside the specified conditions. Such policies may result in decreased patient volumes, which could have a negative effect on the financial performance of these facilities. See “Business — Government Regulations — Overview of U.S. and State Government Reimbursements — Inpatient rehabilitation facility Medicare reimbursement.” Contents

~~Implementation~~ ofBudget ~~annual~~Control ~~caps~~Act ~~that~~of ~~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.~~ 2011

~~Our~~ The ~~outpatient~~Budget ~~rehabilitation~~Control ~~clinics~~Act ~~receive~~of ~~payments~~2011 ~~from~~ (the ~~Medicare~~"BCA ~~program~~of ~~under a fee schedule. Congress has established annual caps that limit the amounts that can be paid (including deductible and coinsurance amounts~~2011"), ~~for~~enacted ~~outpatient therapy services rendered to any Medicare beneficiary. These annual caps were to go into effect~~ on ~~January~~August 12, ~~1999~~2011, ~~however,~~increased ~~after their adoption, Congress imposed a moratorium on~~ the ~~caps~~federal ~~through~~debt ~~2002,~~ceiling ~~and~~in ~~then re-imposed the~~connection ~~moratorium~~with ~~for~~deficit ~~2004~~reductions ~~and~~over ~~2005. Congress allowed~~ the ~~therapy~~next ~~caps~~ten toyears. goThe ~~back~~BCA ~~into~~of ~~effect~~2011 onrequires ~~January 1,~~automatic ~~2006.~~reductions ~~The~~in ~~inflation~~federal ~~adjusted~~spending ~~caps~~by ~~are~~approximately $1~~,740 in 2006~~.2 Astrillion ~~directed~~split byevenly ~~Congress~~between indomestic ~~the~~and ~~Deficit Reduction~~defense ~~Act of 2005, CMS is implementing an exceptions process for therapy expenses incurred in 2006~~spending. Payments ~~Under~~to ~~this process, a~~ Medicare ~~enrollee~~providers ~~may~~are ~~request~~subject anto ~~exception~~these ~~from~~automatic ~~the~~spending ~~therapy~~reductions, ~~caps~~subject ~~if the provision of therapy services is deemed~~ to bea ~~medically~~2% ~~necessary~~cap. ~~Therapy~~On ~~cap~~April 1, ~~exceptions~~2013, ~~will be available automatically for certain conditions and on~~ a ~~case-by-case~~2% ~~basis~~reduction ~~upon~~to ~~submission~~Medicare ~~of documentation~~payments ofwas ~~medical necessity~~implemented.

We ~~believe~~Improving ~~these therapy caps could have an adverse effect on the net operating revenues we generate from providing outpatient rehabilitation services to~~ Medicare ~~beneficiaries,~~Post-Acute toCare ~~the~~Transformation ~~extent that~~Act ~~such patients receive services for which total payments would exceed the annual caps. For the year ended December 31, 2005, we received approximately 11%~~ of our outpatient rehabilitation net operating revenues from Medicare. See “Business — Government Regulations — Overview of U.S. and State Government Reimbursements — Outpatient rehabilitation services Medicare reimbursement.” 2014

If The ~~there~~Improving ~~are~~Medicare ~~changes~~Post-Acute Care Transformation Act of 2014, enacted on October 6, 2014, requires our specialty hospitals to collect and report additional patient assessment data and clinical measures on each Medicare beneficiary who receives inpatient services in our facilities. Specialty hospitals must begin reporting this data no later than October 1, 2018. Within two years after that, CMS will begin making this data available to the public. Facilities that fail to report the required data will be subject to a 2% reduction in their payment rates. The orreduction ~~methods~~may result in an annual update of ~~government~~less ~~reimbursements~~than zero for ~~our~~the ~~services~~applicable rate year. However, ~~our~~ ~~net~~any ~~operating~~reduction ~~revenues~~is limited to the applicable fiscal year and ~~profitability~~is ~~could~~not ~~decline~~cumulative. We expect CMS to publish additional regulations and guidance implementing this new law.

~~Approximately~~ ~~56%~~Specialty ofHospital ~~our~~Medicaid net operating revenues for the year ended December 31, 2005 came from the highly regulated federal Medicare program. In recent years, through legislative and regulatory actions, the federal government has made substantial changes to various payment systems under the Medicare program. Additional changes to these payment systems, including modifications to the conditions on qualification for payment and the imposition of enrollment limitations on new providers, Reimbursement

- The 24Medicaid -program is designed to provide medical assistance to individuals unable to afford care. The program is governed by the Social Security Act of 1965, funded jointly by each individual state and the federal government, and administered by state agencies. Medicaid payments are made under a number of different systems, which include cost based reimbursement, prospective payment systems or programs that negotiate payment levels with individual hospitals. In addition, Medicaid programs are subject to statutory and regulatory changes, administrative rulings, interpretations of policy by the state agencies and certain government funding limitations, all of which may increase or decrease the level of program payments to our hospitals. Net operating revenues generated directly from the Medicaid program represented approximately 5% of our specialty hospital net operating revenues for the year ended December 31, 2014.

~~Table~~ ofWorkers' ~~Contents~~Compensation

~~may~~ Workers' becompensation ~~proposed~~is ora ~~could~~state ~~be adopted~~mandated, ~~either~~comprehensive ininsurance ~~Congress~~program orthat byrequires ~~CMS.~~employers ~~For instance, in its preamble~~ to ~~the~~fund ~~January 27,~~or ~~2006~~insure ~~proposed~~medical ~~rule updating the long-term acute care hospital Medicare~~expenses, ~~prospective~~lost ~~payment~~wages ~~system,~~and ~~CMS~~other ~~announced~~costs ~~that~~resulting itfrom iswork ~~studying~~related ~~whether~~injuries ~~payment~~and ~~adjustments~~illnesses. ~~similar to~~Workers' ~~those~~compensation ~~adopted~~benefits ~~with~~and ~~respect~~arrangements tovary ~~HIHs~~on ina ~~2004~~state-by-state ~~should~~basis ~~also~~and beare ~~adopted~~often ~~with~~highly ~~respect~~complex. toIn ~~free-standing~~some ~~long-term~~states, ~~acute~~payment ~~care~~for ~~hospitals.~~services ~~Such~~covered ~~adjustments~~by ~~could~~workers' ~~include limiting~~compensation ~~payments~~programs toare ~~free-standing~~subject ~~long-term acute~~to ~~care~~cost ~~hospitals~~containment tofeatures, ~~the~~such ~~extent~~as requirements that ~~greater~~all ~~than~~workers' ~~25%~~compensation ofinjuries abe ~~facility’s~~treated ~~admissions~~through ~~come from~~ a ~~single~~managed ~~general acute~~ care ~~hospital.~~program, ~~Because~~or of the ~~possibility~~imposition of ~~adoption~~payment ofcaps. ~~these~~In ~~kinds of proposals~~addition, ~~the~~these ~~availability,~~workers' ~~methods~~compensation ~~and~~programs ~~rates~~may ofimpose ~~Medicare~~requirements ~~reimbursements~~that ~~for~~affect ~~services of~~ the ~~type furnished~~operations atof our ~~facilities~~outpatient ~~could~~rehabilitation ~~change~~services. Net atoperating ~~any~~revenues ~~time.~~generated ~~Some~~directly offrom ~~these~~workers' ~~changes~~compensation ~~and~~programs ~~proposed~~represented ~~changes could~~approximately ~~adversely~~17% ~~affect~~of our ~~business~~net ~~strategy,~~operating ~~operations~~revenue ~~and~~from ~~financial~~outpatient ~~results.~~rehabilitation Inservices ~~addition,~~and ~~there can~~1% beof noour ~~assurance~~net operating ~~that~~revenue ~~any~~from ~~increases~~our inspecialty ~~Medicare~~hospitals ~~reimbursement~~for ~~rates~~the ~~established~~year byended ~~CMS~~December 31, ~~will fully reflect increases in our operating costs~~2014.

We ~~conduct~~Other ~~business~~Medicare ~~in a heavily regulated industry, and changes in regulations or violations of regulations may result in increased costs or sanctions that reduce our net operating revenues and profitability.~~ Regulations

~~The~~ ~~healthcare~~Medicare ~~industry~~Quality ~~is subject to extensive federal, state and local laws and regulations relating to:~~ Reporting

• The ~~facility~~ACA established quality reporting requirements for LTCHs and ~~professional~~IRFs. ~~licensure,~~These ~~including~~programs ~~certificates~~are ofmandatory. ~~need;~~For •fiscal ~~conduct~~year of2014 ~~operations~~and each subsequent year, ~~including~~LTCHs ~~financial~~and ~~relationships~~IRFs ~~among~~that ~~healthcare~~do ~~providers,~~not ~~Medicare~~submit ~~fraud~~the ~~and~~required ~~abuse,~~quality ~~and~~data ~~physician~~will ~~self-referral;~~be •subject ~~addition~~to ofa ~~facilities~~2% ~~and~~reduction ~~services~~in ~~and~~their ~~enrollment~~annual ofpayment ~~newly~~update. ~~developed~~The ~~facilities~~reduction can result in payment rates less than the prior ~~Medicare~~year. ~~program;~~However, ~~and~~the •reduction ~~payment~~will ~~for~~not ~~services~~carry over into the subsequent fiscal years.

Recently, there have been heightened coordinated civil and criminal enforcement efforts by both federal and state government agencies relating to the healthcare industry. The ongoing investigations relate to, among other things, various referral practices, cost reporting, billing practices, physician ownership and joint ventures involving hospitals. In the future, different interpretations or enforcement of these laws and regulations could subject our current practices to allegations of impropriety or illegality or could require us to make changes in our facilities, equipment, personnel, services and capital expenditure programs, increase our operating expenses and reduce our operating revenues. If we fail to comply with these extensive laws and government regulations, we could become ineligible to receive government program reimbursement, suffer civil or criminal penalties or be required to make significant changes to our operations. In addition, we could be forced to expend considerable resources responding to an investigation or other enforcement action under these laws or regulations. See “Business — Government Regulations.” 22

~~Future~~Table ~~acquisitions~~of ~~may use significant resources, may be unsuccessful and could expose us to unforeseen liabilities.~~ Contents

As The Physician ~~part~~Quality ofReporting ~~our~~System, ~~growth~~or ~~strategy~~"PQRS," weis ~~may~~a ~~pursue~~CMS ~~acquisitions~~reporting program that uses a combination of ~~specialty~~incentive ~~hospitals~~payments and payment reductions to promote reporting of quality ~~outpatient~~information ~~rehabilitation~~by ~~clinics~~"eligible professionals." ~~Acquisitions~~Although ~~may~~physical ~~involve~~therapists, ~~significant~~occupational ~~cash~~therapists ~~expenditures~~and qualified speech-language therapists are generally able to participate in the PQRS program, ~~debt~~therapy ~~incurrence,~~professionals ~~additional~~for ~~operating~~whose ~~losses~~services ~~and~~we ~~expenses~~bill ~~that~~through ~~could~~our ~~have~~rehab aagencies ~~material~~cannot ~~adverse~~participate ~~effect~~because onthe Medicare claims processing systems currently cannot accommodate institutional providers such as rehab ~~our~~agencies. ~~financial~~Eligible ~~condition~~professionals, ~~and~~such ~~results~~as those of ~~operations.~~our ~~Acquisitions~~therapy ~~involve~~professionals ~~numerous~~for ~~risks~~whose services we bill using their individual Medicare provider numbers, ~~including:~~who do not satisfactorily report data on quality measures will be subject to a 2% reduction in their Medicare payment. Eligible professionals who satisfactorily report data on PQRS quality measures will earn a 0.5% incentive payment.

• ~~the~~Medicare ~~difficulty~~Productivity ~~and expense of integrating acquired personnel into our business; • diversion of management’s time from existing operations;~~Adjustment

The ACA implemented a separate annual productivity adjustment for the first time for hospital inpatient services beginning in fiscal year 2012 for LTCHs and IRFs. This provision applied a negative productivity adjustment to the market basket that is used to update the standard federal rate on an annual basis. The market basket does not currently account for increases in provider productivity that could reduce the actual cost of providing services (e.g., through new technology or fewer inputs). The productivity adjustment will equal the 10-year 25moving average of changes in the annual economy-wide private non-farm business multi-factor productivity. This is a statistic reported by the Bureau of Labor Statistics and updated in the spring of each year. While this adjustment will change each year, it is currently estimated that this adjustment to the market basket will be approximately minus 1.0% on average.

~~Table~~ ofHospital ~~Contents~~Wage Index

• As ~~potential~~part ~~loss~~ of ~~key~~the ~~employees~~methodology orfor ~~customers~~determining ofprospective ~~acquired~~payments ~~companies;~~to LTCHs and •IRFs, ~~assumption~~CMS adjusts the standard payment amounts for area differences in hospital wage levels by a factor reflecting the relative hospital wage level in the geographic area of the ~~liabilities~~hospital compared to the national average hospital wage level. This adjustment factor is the hospital wage index. CMS currently defines hospital geographic areas (labor market areas) based on the definitions of Core-Based Statistical Areas established by the Office of Management and ~~exposure~~Budget. The ACA calls for CMS to ~~unforeseen~~develop ~~liabilities~~and present to Congress a comprehensive reform plan using Bureau of ~~acquired~~Labor ~~companies~~Statistics data, ~~including~~or ~~liabilities~~other data or methodologies, to calculate relative wages for each ~~failure~~geographic area involved. In the preamble to ~~comply~~the ~~with~~proposed ~~healthcare~~rule ~~regulations~~for LTCH-PPS for fiscal year 2012, CMS solicited public comments on ways to redefine the geographic reclassification requirements to more accurately define labor markets. To date CMS has not presented a comprehensive reform plan to Congress.

We ~~cannot~~Independent ~~assure~~Payment ~~you~~Advisory that we will succeed in obtaining financing for acquisitions at a reasonable cost, or that such financing will not contain restrictive covenants that limit our operating flexibility. We also may be unable to operate acquired hospitals and outpatient rehabilitation clinics profitably or succeed in achieving improvements in their financial performance. Board

~~Future~~ The ~~cost~~ACA ~~containment~~established ~~initiatives~~an ~~undertaken~~independent byboard ~~private~~called ~~third-party~~the ~~payors~~Independent ~~may~~Payment ~~limit~~Advisory ~~our~~Board that is authorized to develop and submit ~~future~~proposals ~~net~~to ~~operating~~the ~~revenues~~President and ~~profitability~~Congress to reduce Medicare spending to meet specified targets. The Independent Payment Advisory Board is precluded from submitting proposals that reduce Medicare payments prior to December 31, 2019 for providers, including LTCHs and IRFs, scheduled to receive a reduction in their payment updates in addition to the Medicare productivity adjustment (discussed above). The Independent Payment Advisory Board's proposals would go into effect automatically unless Congress enacts alternative legislation to achieve the required savings (with certain exceptions). The ACA authorized the Independent Payment Advisory Board to issue its first recommendations by January 2014 for implementation in 2015 if the Medicare per capita target growth rate is exceeded, but the CMS Office of the Actuary has determined that the Medicare spending target will not be triggered for 2015. To date, no Independent Payment Advisory Board members have been appointed, and there have been repeated legislative attempts to repeal the provision of the ACA authorizing the establishment of the Independent Payment Advisory Board.

Initiatives undertaken by major insurers and managed care companies to contain healthcare costs affect the profitability of our specialty hospitals and outpatient rehabilitation clinics. These payors attempt to control healthcare costs by contracting with hospitals and other healthcare providers to obtain services on a discounted basis. We believe that this trend may continue and may limit reimbursements for healthcare services. If insurers or managed care companies from whom we receive substantial payments reduce the amounts they pay for services, our profit margins may decline, or we may lose patients if we choose not to renew our contracts with these insurers at lower rates. 23

IfTable weof ~~fail to maintain established relationships with the physicians in our markets, our net operating revenues may decrease.~~ Contents

~~Our~~ ~~success~~Physician-Owned ~~is,~~Hospital in part, dependent upon the admissions and referral practices of the physicians in the communities our hospitals and our outpatient rehabilitation clinics serve, and our ability to maintain good relations with these physicians. Physicians referring patients to our hospitals and clinics are generally not our employees and, in many of the markets that we serve, most physicians have admitting privileges at other hospitals and are free to refer their patients to other providers. If we are unable to successfully cultivate and maintain strong relationships with these physicians, our hospitals’ admissions and clinics’ businesses may decrease, and our net operating revenues may decline. Limitations

~~Shortages~~ CMS regulations include a number of hospital ownership and physician referral provisions, including certain obligations requiring physician-owned hospitals to disclose ownership or investment interests held by the referring physician or his or her immediate family members. In particular, physician-owned hospitals must furnish to patients, on request, a list of physicians or immediate family members who own or invest in ~~qualified~~the ~~nurses~~hospital. Moreover, a physician-owned hospital must require all physician owners or ~~therapists~~investors ~~could~~who ~~increase~~are also ~~our~~active ~~operating~~members ~~costs~~of ~~significantly~~the hospital's medical staff to disclose in writing their ownership or investment interests in the hospital to all patients they refer to the hospital. CMS can terminate the Medicare provider agreement of a physician-owned hospital if it fails to comply with these disclosure provisions or with the requirement that a hospital disclose in writing to all patients whether there is a physician on-site at the hospital 24 hours per day, seven days per week.

~~Our~~ Under the ~~specialty~~transparency ~~hospitals~~and ~~are~~program ~~highly~~integrity ~~dependent~~provisions onof ~~nurses~~the ~~for~~ACA, ~~patient~~the ~~care~~exception ~~and~~to ~~our~~the ~~outpatient rehabilitation~~federal ~~clinics~~self-referral ~~are~~law, ~~highly~~or ~~dependant~~"Stark onlaw," ~~therapists~~that ~~for~~permits ~~patient~~physicians ~~care.~~to ~~The~~refer ~~availability~~patients ofto hospitals ~~qualified~~in ~~nurses~~which ~~and~~they ~~therapists~~have ~~nationwide~~an ownership or investment interest has ~~declined~~been indramatically ~~recent~~curtailed. ~~years~~Only hospitals, including specialty hospitals, with physician ownership and ~~the~~a ~~salaries~~provider ~~for~~agreement in place on ~~nurses~~December 31, ~~and~~2010 ~~therapists~~are ~~have~~exempt ~~risen~~from ~~accordingly.~~the Wegeneral ~~cannot~~ban ~~assure~~on ~~you~~self-referral. weExisting ~~will~~physician-owned behospitals ~~able~~are toprohibited ~~attract~~from ~~and retain~~increasing ~~qualified~~the ~~nurses~~percentage of physician ownership or ~~therapists~~investment interests held in the ~~future~~hospital after March 23, 2010. ~~Additionally~~In addition, physician-owned hospitals are prohibited from increasing the ~~cost~~number of ~~attracting~~licensed ~~and~~beds after March 23, 2010, unless ~~retaining~~meeting ~~nurses~~specific exceptions related to the hospital's location and ~~therapists~~patient ~~may~~population. beIn ~~higher~~order ~~than~~to weretain ~~anticipate,~~their ~~and~~exemption asfrom athe ~~result~~general ban on self-referrals, our physician-owned hospitals are ~~profitability~~required ~~could~~to ~~decline~~adopt specific measures relating to conflicts of interest, bona fide investments and patient safety. As of December 31, 2014, we operated 11 hospitals that are owned in-part by physicians.

~~Competition~~ ~~may~~Provider ~~limit our ability to acquire hospitals~~ and ~~clinics~~Employee ~~and adversely affect our growth.~~ Screening

We The ~~have~~ACA ~~historically~~imposed ~~faced~~new ~~limited~~screening ~~competition~~requirements inon ~~acquiring~~all ~~specialty~~Medicare ~~hospitals~~providers, including LTCHs, IRFs and outpatient rehabilitation ~~clinics,~~providers. The ~~but~~screening wemust include a licensure check and may ~~face~~include ~~heightened~~other ~~competition~~procedures insuch ~~the~~as ~~future.~~a ~~Our~~criminal ~~competitors~~background ~~may~~check, fingerprinting, unscheduled and unannounced site visits, database checks, and other ~~acquire~~screening ortechniques ~~seek~~CMS todeems ~~acquire~~appropriate ~~many~~to ofprevent ~~the~~fraud, ~~hospitals~~waste and ~~clinics~~abuse. ~~that~~Effective ~~would~~March 23, be2011, ~~suitable~~Medicare ~~acquisition~~providers and ~~candidates~~suppliers ~~for~~submitting ~~us.~~new ~~This~~enrollment ~~could~~applications ~~limit~~or ~~our~~revalidating ~~ability~~their existing enrollment status are required to ~~grow~~pay bya ~~acquisitions~~$500 orapplication ~~make~~fee ~~our~~that ~~cost~~is ofadjusted annually by the percentage change in the ~~acquisitions~~consumer ~~higher~~price index. The ACA also imposed new disclosure requirements and ~~therefore~~authorizes ~~decrease~~surety ~~our~~bonds ~~profitability~~for the enrollment of new providers and suppliers.

If In addition, wethe ~~fail~~ACA requires LTCHs to ~~compete~~conduct ~~effectively~~national ~~with~~and ~~other~~state ~~hospitals~~criminal background checks, ~~clinics~~including fingerprint checks of their employees and ~~healthcare~~contractors ~~providers,~~who ~~our~~have (or may have) ~~net~~one-on-one ~~operating~~contact ~~revenues~~with ~~and~~patients. ~~profitability~~Our ~~may~~LTCHs ~~decline~~are prohibited from hiring or retaining workers with a history of patient or resident abuse.

- 26Medicare - Compliance Requirements and Penalties

~~Table~~ The ACA included new compliance requirements and increases existing penalties for non-compliance with federal law and the Medicare conditions of ~~Contents~~participation. In addition, Medicare claims will be paid only if submitted within 12 months. Penalties for submitting false claims and for submitting false statements material to a false claim will be increased. The Secretary will be granted the authority to suspend payments to a provider pending an investigation of credible allegations of fraud. Further, the Recovery Audit Contractor program has been extended to Medicare Parts C and D and Medicaid.

~~The~~ healthcare business is highly competitive, and we compete with other hospitals, rehabilitation clinics and other healthcare providers for patients. If we are unable to compete effectively in the specialty hospital and outpatient rehabilitation businesses, our net operating revenues and profitability may decline. Many of our specialty hospitals operate in geographic areas where we compete with at least one other hospital that provides similar services. Our outpatient rehabilitation clinics face competition from a variety of local and national outpatient rehabilitation providers. Other ~~outpatient~~Healthcare rehabilitation clinics in markets we serve may have greater name recognition and longer operating histories than our clinics. The managers of these clinics may also have stronger relationships with physicians in their communities, which could give them a competitive advantage for patient referrals. Regulations

~~Our~~ Medicare ~~business~~Recovery ~~operations~~Audit ~~could~~Contractors. The beTax ~~significantly~~Relief ~~disrupted~~and ifHealth weCare ~~lose~~Act ~~key~~of ~~members~~2006 ofinstructed ~~our~~CMS to contract with third-party ~~management~~organizations, ~~team.~~known as Recovery Audit Contractors, or "RACs," to identify Medicare underpayments and overpayments, and to authorize RACs to recoup any overpayments. The

Our success depends to a significant degree upon the continued contributions of our senior officers and key employees, both individually and as a group. Our future performance will be substantially dependent on our ability to retain and motivate these individuals. The loss of the services of any of our senior officers or key employees, particularly our executive officers named in “Executive Officers and Directors of the Registrant,” could prevent us from successfully executing our business strategy and could have a material adverse affect on our results of operations. 24

~~Significant~~Table ~~legal actions as well as the cost and possible lack~~ of ~~available insurance could subject us to substantial uninsured liabilities.~~ Contents

Incompensation paid ~~recent~~to ~~years,~~each ~~physicians,~~RAC ~~hospitals~~is ~~and~~based ~~other~~on ~~healthcare~~a ~~providers~~percentage ~~have~~of ~~become~~overpayment ~~subject~~recoveries ~~to an~~identified ~~increasing~~by ~~number~~the ofRAC. ~~legal~~CMS ~~actions~~has ~~alleging~~selected ~~malpractice~~and entered into contracts with four RACs, ~~product~~each ~~liability~~of orwhich ~~related~~has ~~legal~~begun their audit ~~theories~~activities in specific jurisdictions. ~~Many~~RAC audits of ~~these~~our ~~actions~~Medicare ~~involve~~reimbursement ~~large~~may ~~claims~~lead ~~and~~to ~~significant~~assertions ~~defense~~that ~~costs.~~we Wehave ~~are~~been ~~also subject~~overpaid, torequire ~~lawsuits~~us ~~under~~to aincur ~~federal~~additional ~~whistleblower~~costs ~~statute~~to ~~designed~~respond to ~~combat~~requests ~~fraud~~for records and ~~abuse~~pursue in the ~~healthcare~~ ~~industry.~~reversal ~~These~~of ~~lawsuits~~payment ~~can~~denials, ~~involve~~and ~~significant~~ultimately ~~monetary~~require ~~damages~~us ~~and~~to ~~award~~refund ~~bounties~~any amounts determined to ~~private~~ ~~plaintiffs~~have ~~who~~been ~~successfully~~overpaid. ~~bring~~We cannot predict the ~~suits.~~impact ~~See~~of ~~“Legal~~future ~~Proceedings.”~~RAC reviews on our results of operations or cash flows.

We Fraud ~~maintain~~and ~~professional~~Abuse ~~malpractice~~Enforcement. Various ~~liability~~federal ~~insurance~~ and ~~general~~state ~~liability~~laws ~~insurance coverage.~~prohibit Asthe asubmission ~~result~~ of ~~unfavorable~~false ~~pricing~~or ~~and~~fraudulent ~~availability~~claims, ~~trends~~including inclaims ~~the~~to obtain ~~professional liability~~payment ~~insurance~~under ~~market and the insurance market in general~~Medicare, ~~the~~Medicaid ~~cost~~ and ~~risk~~other ~~sharing~~government ~~components~~healthcare ~~of professional liability coverage have changed dramatically~~programs. ~~Many~~Penalties ~~insurance~~for ~~underwriters~~violation ~~have~~of ~~become more~~these ~~selective~~laws ininclude ~~the~~civil ~~insurance limits~~ and ~~types~~criminal offines, ~~coverage~~imprisonment ~~they~~and ~~will~~exclusion ~~provide~~from asparticipation ain ~~result~~federal ofand ~~rising~~state ~~settlement~~healthcare ~~costs and the significant failures of some nationally known insurance underwriters~~programs. In ~~some~~recent ~~instances~~years, ~~insurance~~federal ~~underwriters~~and ~~will~~state nogovernment ~~longer~~agencies ~~issue~~have ~~new~~increased ~~policies~~the ~~in certain~~level ~~states~~of ~~that~~enforcement ~~have~~resources aand ~~history~~activities oftargeted ~~high~~at ~~medical~~the ~~malpractice~~healthcare ~~awards~~industry. AsIn ~~a result~~addition, ~~we have~~the ~~experienced~~federal ~~substantial~~False ~~changes~~Claims inAct ~~our medical~~ and ~~professional~~similar ~~malpractice~~state ~~insurance~~statutes ~~program. Among~~allow ~~other~~individuals ~~things, in order~~ to ~~obtain~~bring ~~malpractice~~lawsuits ~~insurance~~on atbehalf aof ~~reasonable~~the ~~cost~~government, wein what are ~~required to~~known ~~assume~~as ~~substantial~~qui ~~self-insured~~tam ~~retentions~~or ~~for~~"whistleblower" ~~our~~actions, ~~professional~~alleging ~~liability~~false ~~claims. A self-insured~~or ~~retention~~fraudulent isMedicare aor ~~minimum~~Medicaid ~~amount~~claims ofor ~~damages~~other ~~and~~violations ~~expenses~~of ~~(including~~the ~~legal fees) that we must pay for each claim~~statute. WeThe use ~~actuarial methods to determine the value~~ of ~~the~~these ~~losses~~private ~~that~~enforcement ~~may~~actions ~~occur~~against ~~within this~~healthcare ~~self-insured~~providers ~~retention~~has ~~level.~~increased ~~Our~~dramatically ~~insurance agreements require us to post letters of credit or set aside cash~~ in arecent ~~trust~~years, ~~arrangement~~ in anpart because ~~amount equal to~~ the ~~estimated~~individual ~~losses~~filing ~~that we assumed for previous policy years. Because of~~ the ~~high~~initial ~~retention~~complaint ~~levels,~~is weentitled ~~cannot~~to ~~predict~~share ~~with~~in ~~certainty the~~a ~~actual~~portion ~~amount~~ of ~~the~~any ~~losses~~settlement weor ~~will assume and pay~~judgment. ToRevisions ~~the~~to ~~extent that subsequent claims information varies from loss estimates,~~ the ~~liabilities~~False ~~will~~Claims beAct ~~adjusted~~enacted toin ~~reflect~~2009 ~~current~~expanded ~~loss data.~~significantly ~~There can be no assurance that in~~ the ~~future malpractice insurance will be available at a~~scope ~~reasonable price or that we will not have to further increase our levels~~ of ~~self-insurance. In addition~~liability, ~~our~~provided ~~insurance~~for ~~coverage~~new ~~does~~investigative ~~not~~tools, ~~cover punitive damages~~ and ~~may~~made ~~not~~it ~~cover~~easier ~~all~~for ~~claims against~~whistleblowers ~~us.~~to ~~See~~bring ~~“Business~~and —maintain ~~Government~~False ~~Regulations~~Claims —Act ~~Other~~suits ~~Healthcare~~on ~~Regulations”~~behalf ~~and “Management’s Discussion and Analysis~~ of ~~Financial~~the ~~Condition~~government. ~~and~~See ~~Results of Operations~~ "— ~~Medical~~Legal ~~and Professional Malpractice Insurance~~Proceedings.” "

From time to time, various federal and state agencies, such as the Office of Inspector General of the Department of Health and Human Services, or "OIG," issue a variety of pronouncements, including fraud alerts, the OIG's Annual Work Plan and other reports, identifying practices that may be subject to heightened scrutiny. These pronouncements can identify issues relating to LTCHs, IRFs or outpatient rehabilitation services or providers. For example, in the OIG's 2013 Work Plan, the OIG indicated that it would study appropriateness of admissions to IRFs, the level of therapy provided in IRFs and whether IRFs received reduced payments for claims with patient assessment instruments that were transmitted to CMS outside defined time limits. The OIG stated in its 2014 Work Plan that it would study (1) readmission patterns in LTCHs to determine whether LTCHs are billing Medicare for higher paying new stays instead of interrupted stays and (2) the extent to which co-located 27LTCHs readmit patients from the providers with which they are co-located. The OIG issued a corresponding report in June of 2014 in which it recommended that CMS (1) review existing safeguards to determine whether additional action is needed to prevent inappropriate payments for interrupted stays, (2) conduct additional analysis to determine the extent to which financial incentives influence LTCHs' readmission decisions, (3) develop a system to enforce the 5-percent readmission threshold, (4) take appropriate action regarding LTCHs exhibiting certain readmission patterns, and (5) take appropriate action on inappropriate payments and overpayments to co-located LTCHs that exceed the 5-percent readmission threshold. Of these recommendations, CMS concurred with the OIG's recommendation that CMS (1) review existing safeguards to determine whether additional action is needed to prevent inappropriate payments for interrupted stays and (2) take appropriate action on inappropriate payments and overpayments to co-located LTCHs that exceed the 5-percent readmission threshold. . In the OIG's 2015 Work Plan, the OIG announced its intent to estimate the national incidence of adverse and temporary harm events for Medicare beneficiaries receiving post-acute care in IRFs and LTCHs. As part of this review, the OIG intends to identify factors contributing to these events, determine the extent to which the events were preventable, and estimate the associated costs to Medicare. Our IRFs and LTCHs may be required to provide information related to adverse and temporary harm events in connection with this review. We monitor government publications applicable to us to supplement and enhance our compliance efforts.

~~Table~~ We endeavor ofto ~~Contents~~conduct our operations in compliance with applicable laws, including healthcare fraud and abuse laws. If we identify any practices as being potentially contrary to applicable law, we will take appropriate action to address the matter, including, where appropriate, disclosure to the proper

~~The interests of our principal stockholder may conflict with your interests.~~ 25

AnTable ~~investor group led by our sponsors owns substantially all~~ of the outstanding equity securities of our parent. Welsh Carson controls a majority of the voting power of such outstanding equity securities and therefore ultimately controls all of our affairs and policies, including the election of our board of directors, the approval of certain actions such as amending our charter, commencing bankruptcy proceedings and taking certain corporate actions (including, without limitation, incurring debt, issuing stock, selling assets and engaging in mergers and acquisitions), and appointing members of our management. Welsh Carson’s interests in exercising control over our business may conflict with your interests. Contents

~~ITEM~~authorities, which ~~1B.~~may ~~UNRESOLVED~~result ~~STAFF~~in ~~COMMENTS~~ a voluntary refund of monies to Medicare, Medicaid or other governmental healthcare programs.

~~Not~~ Remuneration ~~applicable~~and Fraud Measures. The federal anti-kickback statute prohibits some business practices and relationships under Medicare, Medicaid and other federal healthcare programs. These practices include the payment, receipt, offer or solicitation of remuneration in connection with, to induce, or to arrange for, the referral of patients covered by a federal or state healthcare program. Violations of the anti-kickback law may be punished by a criminal fine of up to $50,000 or imprisonment for each violation, or both, civil monetary penalties of $50,000 and damages of up to three times the total amount of remuneration, and exclusion from participation in federal or state healthcare programs.

~~ITEM~~ The Stark 2Law prohibits referrals for designated health services by physicians under the Medicare and Medicaid programs to other healthcare providers in which the physicians have an ownership or compensation arrangement unless an exception applies. ~~PROPERTIES~~Sanctions for violating the Stark Law include civil monetary penalties of up to $15,000 per prohibited service provided, assessments equal to three times the dollar value of each such service provided and exclusion from the Medicare and Medicaid programs and other federal and state healthcare programs. The statute also provides a penalty of up to $100,000 for a circumvention scheme. In addition, many states have adopted or may adopt similar anti-kickback or anti-self-referral statutes. Some of these statutes prohibit the payment or receipt of remuneration for the referral of patients, regardless of the source of the payment for the care. While we do not believe our arrangements are in violation of these prohibitions, we cannot assure you that governmental officials charged with the responsibility for enforcing the provisions of these prohibitions will not assert that one or more of our arrangements are in violation of the provisions of such laws and regulations.

We Provider-Based ~~currently~~Status. The ~~lease~~designation ~~most~~"provider-based" refers to circumstances in which a subordinate facility (e.g., a separately certified Medicare provider, a department of ~~our~~a ~~facilities~~provider or a satellite facility) is treated as part of a provider for Medicare payment purposes. In these cases, ~~including~~the ~~clinics~~services of the subordinate facility are included on the "main" provider's cost report and overhead costs of the main provider can be allocated to the subordinate facility, ~~offices~~to the extent that they are shared. As of December 31, 2014, we operated 17 specialty hospitals ~~and our~~that ~~corporate~~were ~~headquarters.~~treated Weas ~~own~~provider-based ~~each~~satellites of certain of our ~~four~~other ~~inpatient~~facilities, 164 of the outpatient rehabilitation ~~facilities~~clinics we operated were provider-based and are ~~two~~operated as departments of ~~our~~ ~~long-term~~the ~~acute~~IRFs ~~care~~we ~~hospitals.~~operated, Weand ~~also~~we ~~own~~provide ~~five~~rehabilitation ~~facilities~~management ~~currently~~and ~~undergoing~~staffing ~~renovations~~ services to hospital rehabilitation departments that ~~will~~may ~~house~~be ~~future~~treated ~~specialty~~as ~~hospitals~~provider-based. These facilities are required to satisfy certain operational standards in order to retain their provider-based status.

We Health ~~lease~~Information ~~all~~Practices. The ofHealth ~~our~~Insurance ~~clinics~~Portability and ~~related~~Accountability ~~offices~~Act of 1996, ~~which~~or "HIPAA," asmandates ofthe ~~December 31,~~adoption ~~2005,~~of standards ~~included~~for ~~717~~the ~~outpatient~~exchange ~~rehabilitation~~of ~~clinics~~electronic ~~throughout~~health ~~the~~information ~~United~~in ~~States~~an effort to encourage overall administrative simplification and ~~Canada.~~enhance Onthe ~~March 1,~~effectiveness ~~2006~~and efficiency of the healthcare industry, wewhile maintaining the ~~completed~~privacy and security of health information. Among the ~~sale~~standards that the Department of ~~our~~Health ~~Canadian~~and ~~business.~~Human ~~See~~Services ~~“Business~~has —adopted ~~Subsequent~~or ~~Event.”~~will ~~The~~adopt ~~outpatient~~pursuant to HIPAA are standards for electronic transactions ~~rehabilitation~~and ~~clinics~~code ~~generally~~sets, ~~have~~unique aidentifiers ~~five-year~~for ~~lease~~providers ~~term~~(referred to as National Provider Identifier), employers, health plans and ~~include~~individuals, ~~options~~security toand ~~renew.~~electronic Wesignatures, ~~also~~privacy and enforcement. If ~~lease~~we fail to comply with the ~~majority~~HIPAA ofrequirements, ~~our~~we ~~long-term~~could ~~acute~~be ~~care~~subject ~~hospital~~to ~~facilities~~criminal ~~except~~penalties ~~for~~and civil sanctions. The privacy, security and enforcement provisions of HIPAA were enhanced by the ~~facilities~~Health ~~described~~Information ~~above.~~Technology Asfor ofEconomic ~~December 31~~and Clinical Health Act, ~~2005~~or "HITECH," wewhich ~~had~~was 93included ~~hospital~~in ~~within~~the aARRA. ~~hospital~~Among ~~leases~~other ~~and~~things, ~~two~~HITECH establishes security breach notification requirements, allows ~~free-standing~~enforcement ~~building~~of ~~leases~~HIPAA by state attorneys general, and increases penalties for HIPAA violations.

~~We generally seek a five-year lease for our long-term acute care hospitals operated as HIHs,~~ The ~~with~~Department anof ~~additional~~Health ~~five-year~~and ~~renewal~~Human atServices ~~our~~has ~~option.~~adopted Westandards ~~lease~~in ~~our~~three ~~corporate~~areas ~~headquarters from companies owned by a related party affiliated with us through common ownership or management. Our corporate headquarters is approximately 92,145 square feet and is located~~ in ~~Mechanicsburg, Pennsylvania.~~which Wewe ~~lease~~are ~~several~~required ~~other administrative spaces related~~ to ~~administrative~~comply ~~and operational~~that ~~support~~affect ~~functions.~~our ~~As of December 31, 2005, this comprised 16 locations throughout the United States with approximately 102,093 square feet in total~~operations.

~~ITEM 3. LEGAL PROCEEDINGS~~ 26

OnTable ~~August 24, 2004, Clifford C. Marsden and Ming Xu filed a purported class action complaint in the United States District Court for the Eastern District~~ of Pennsylvania on behalf of the public stockholders of the Company against Martin F. Jackson, Robert A. Ortenzio, Rocco A. Ortenzio, Patricia A. Rice and the Company. 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”). Contents

On Standards relating ~~April 19,~~to ~~2005,~~the ~~Lead~~privacy ~~Plaintiffs~~of ~~filed~~individually anidentifiable ~~amended~~health ~~complaint,~~information ~~purportedly~~govern onour ~~behalf~~use ofand ~~a class~~disclosure of ~~shareholders~~protected ofhealth ~~Select,~~information ~~against~~and ~~Martin~~require F.us ~~Jackson,~~to ~~Robert~~impose A.those ~~Ortenzio~~rules, ~~Rocco A. Ortenzio,~~by ~~Patricia A. Rice~~contract, ~~and~~on ~~the~~any ~~Company~~business asassociate ~~defendants.~~to ~~The~~whom ~~amended~~such ~~complaint~~information ~~continues~~is todisclosed. ~~allege, among other things,~~

- Standards relating 28to -electronic transactions and code sets require the use of uniform standards for common healthcare transactions, including healthcare claims information, plan eligibility, referral certification and authorization, claims status, plan enrollment and disenrollment, payment and remittance advice, plan premium payments and coordination of benefits.

~~Table~~ Standards for the security of ~~Contents~~electronic health information require us to implement various administrative, physical and technical safeguards to ensure the integrity and confidentiality of electronic protected health information.

~~failure~~ We maintain toa ~~disclose~~HIPAA ~~adverse~~committee ~~information~~that ~~regarding~~is acharged ~~potential~~with ~~regulatory~~evaluating ~~change affecting~~and ~~reimbursement~~monitoring ~~for~~our ~~the~~compliance ~~Company’s~~with ~~services~~HIPAA. ~~applicable~~The toHIPAA ~~long-term~~committee ~~acute~~monitors ~~care~~regulations ~~hospitals operated~~promulgated asunder ~~hospitals~~HIPAA ~~within hospitals,~~as ~~and~~they ~~the~~have ~~issuance~~been adopted ofto ~~false~~date and ~~misleading~~as ~~statements~~additional ~~about~~standards ~~the~~and ~~financial~~modifications ~~outlook~~are ~~of the Company~~adopted. ~~The~~Although ~~amended~~health ~~complaint~~information ~~seeks,~~standards ~~among~~have ~~other~~had ~~things,~~a ~~damages~~significant ineffect anon ~~unspecified amount, interest and attorneys’ fees. The Company believes that~~ the ~~allegations~~manner in ~~the~~which ~~amended~~we ~~complaint are~~handle ~~without~~health ~~merit~~data and communicate ~~intends~~with topayors, ~~vigorously~~the ~~defend~~cost ~~against~~of ~~this~~our ~~action.~~compliance ~~This~~has ~~litigation is in its pre-answer motion phase. The Company does~~ not ~~believe~~had ~~this claim will have~~ a material adverse effect on ~~its~~our business, financial ~~position~~condition or results of operations;. ~~however,~~We ~~due~~cannot toestimate the ~~uncertain~~cost ~~nature~~ of compliance with ~~such~~standards ~~litigation,~~that ~~the~~have ~~Company~~not ~~cannot~~been ~~predict~~issued or finalized by the ~~outcome~~Department of ~~this~~Health ~~matter~~and Human Services.

~~The~~ In addition ~~Company~~to isHIPAA, ~~subject~~there toare ~~legal~~numerous ~~proceedings~~federal and ~~claims~~state ~~that~~laws ~~arise~~and inregulations ~~the~~addressing ~~ordinary~~patient ~~course~~and consumer privacy concerns, including unauthorized access or theft of personal ~~its~~information. ~~business~~State statutes and regulations vary from state to state. Lawsuits, ~~which~~including ~~include~~class ~~malpractice~~actions ~~claims~~and ~~covered~~action ~~under~~by ~~insurance~~state ~~policies~~attorneys general, directed at companies that have experienced a privacy or security breach also can occur. InAlthough our policies and procedures are aimed at complying with privacy and security requirements and minimizing the ~~Company’s opinion~~risks of any breach of privacy or security, ~~the~~there can ~~outcome~~be no assurance that a breach of ~~these~~privacy ~~actions~~or security will not ~~have~~occur. If there is a ~~material~~breach, ~~adverse~~we ~~effect~~may onbe ~~the~~subject ~~financial position~~to orvarious ~~results~~penalties ofand ~~operations~~damages and may be required to incur costs to mitigate the impact of the ~~Company~~breach on affected individuals.

~~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~~ asCompliance ~~the cost and possible lack of available insurance could subject the Company to substantial uninsured liabilities.~~ Program

~~Health~~ ~~care~~Our ~~providers~~Compliance 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 the Company 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 the Company in 2001 and a former employee of the Company’s Florida subsidiary who the Company asked to resign. The Company 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 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 the Company, 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 this qui tam action will not have a material adverse effect on the Company. Program

~~ITEM~~ In 41998, we voluntarily adopted our code of conduct. ~~SUBMISSION~~The OFcode ~~MATTERS~~is TOreviewed Aand ~~VOTE~~amended OFas ~~SECURITY~~necessary ~~HOLDERS~~and is the basis for our company-wide compliance program. Our written code of conduct provides guidelines for principles and regulatory rules that are applicable to our patient care and business activities. These guidelines are implemented by a compliance officer, a compliance and internal audit committee, and employee education and training. We also have established a reporting system, auditing and monitoring programs, and a disciplinary system as a means for enforcing the code's policies.

~~There~~ ~~were~~Compliance noand ~~matters~~Internal ~~submitted~~Audit ~~to a vote of security holders of the Company during the three months ended December 31, 2005.~~ Committee

- Our 29compliance and internal audit committee is made up of members of our senior management and in-house counsel. The compliance and internal audit committee meets on a quarterly basis and reviews the activities, reports and operation of our compliance program. In addition, the HIPAA committee provides reports to the compliance and internal audit committee. The vice president of compliance and audit services meets with the compliance and internal audit committee on a quarterly basis to provide an overview of the activities and operation of our compliance program.

~~Table~~ ofOperating ~~Contents~~Our Compliance Program

~~PART~~ We IIfocus on integrating compliance responsibilities with operational functions. We recognize that our compliance with applicable laws and regulations depends upon individual employee actions as well as company operations. As a result, we have adopted an operations team approach to compliance. Our corporate executives, with the assistance of corporate experts, designed the programs of the compliance

~~ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES~~27

WeTable ~~are wholly-owned by Holdings, a privately owned corporation. There is no public trading market for our equity securities or for those~~ of ~~Holdings. As of March 17, 2006, there were 134 holders of Holdings’ common stock.~~ Contents

~~Our~~and internal ~~senior~~audit ~~secured~~committee. ~~credit~~We utilize facility ~~contains~~leaders ~~customary~~for ~~restrictions~~employee-level onimplementation ~~our ability, Holdings’ ability and the ability~~ of ~~certain of~~ our ~~subsidiaries~~code toof ~~declare or pay any dividends~~conduct. ~~The indenture~~This ~~governing~~approach ~~our~~is ~~7⅝%~~intended ~~senior~~to ~~subordinated~~reinforce ~~notes due 2015 contains customary terms restricting~~ our ~~ability~~company-wide ~~and~~commitment ~~the ability of certain of our subsidiaries~~ to ~~declare or~~operate ~~pay any dividends. The indenture governing Holdings’ senior floating rate notes due 2015~~in ~~contains~~accordance ~~customary~~with ~~restrictions~~the onlaws ~~Holdings’ ability, our ability~~ and ~~the~~regulations ~~ability~~that ofgovern ~~certain of~~ our ~~subsidiaries~~ ~~to declare or pay any dividends~~business.

~~ITEM~~ 6.Compliance ~~SELECTED~~Issue ~~FINANCIAL DATA~~ Reporting

~~You~~ In ~~should~~order ~~read~~to ~~the~~facilitate ~~following~~our ~~selected~~employees' ~~consolidated~~ability ~~historical~~to ~~financial~~report ~~data~~known, insuspected ~~conjunction with~~or ~~our~~potential ~~consolidated~~violations ~~financial~~of ~~statements~~our ~~and~~code ~~the~~of ~~accompanying~~conduct, ~~notes.~~we ~~You should also read~~have ~~“Management’s~~developed ~~Discussion~~a ~~and~~system ~~Analysis~~ of ~~Financial~~reporting. ~~Condition~~This ~~and~~reporting, ~~Results~~anonymous ofor ~~Operations.”~~attributable, ~~All~~may ~~of these~~be ~~materials~~accomplished ~~are~~through ~~contained~~our intoll-free ~~this~~compliance ~~report.~~hotline, ~~The~~compliance ~~data~~e-mail ~~for~~address ~~the~~or ~~years~~our ~~ended~~compliance ~~December 31,~~post ~~2001,~~office box. ~~2002,~~The ~~2003~~compliance officer and ~~2004, for~~ the ~~period~~compliance ~~from~~and ~~January~~internal 1audit ~~through~~committee ~~February 24,~~are ~~2005~~responsible ~~(the~~for ~~“Predecessor”),~~ reviewing and ~~for~~investigating ~~the~~each ~~period~~compliance ~~from~~incident ~~February 25~~in ~~through~~accordance ~~December 31,~~with ~~2005 (~~the ~~“Successor”)~~compliance ~~have~~and ~~been~~audit ~~derived~~services ~~from~~department's ~~our~~investigation ~~audited consolidated financial statements~~policy.

	Predecessor															Successor
	Year Ended December 31,												Period from			Period from
													January 1			February 25
													through			through
													February 24,			December 31,
	2001			2002			2003			2004			2005			2005
							(in thousands)
Statement of Operations Data:
Net operating revenues	$	921,692		$	1,086,894		$	1,341,657		$	1,601,524		$	277,736		$	1,580,706
Operating expenses(1)		816,358			966,596			1,165,814			1,340,068			231,205			1,297,303
Stock compensation expense(2)		—			—			—			—			142,213			10,312
Long-term incentive compensation		—			—			—			—			—			14,453
Depreciation and amortization		31,297			25,071			33,663			38,951			5,933			37,922
Income (loss) from operations		74,037			95,227			142,180			222,505			(101,615	)		220,716
Loss on early retirement of debt(3)		(14,223	)		—			—			—			(42,736	)		—
Merger related charges(4)		—			—			—			—			(12,025	)		—
Equity in income from joint ventures		—			—			824			—			—			—
Other income		—			—			—			1,096			267			3,018
Interest expense, net(5)		(27,604	)		(25,293	)		(24,499	)		(30,716	)		(4,128	)		(82,985	)
Income (loss) from continuing operations before minority interests and income taxes		32,210			69,934			118,505			192,885			(160,237	)		140,749
Minority interests(6)		2,135			1,404			1,661			2,608			330			1,776
Income (loss) from continuing operations before income taxes		30,075			68,530			116,844			190,277			(160,567	)		138,973
Income tax provision (benefit)		2,185			26,822			46,238			76,551			(59,794	)		56,470
Income (loss) from continuing operations		27,890			41,708			70,606			113,726			(100,773	)		82,503
Income from discontinued operations, net of tax		1,791			2,523			3,865			4,458			522			3,072
Net income (loss)		29,681			44,231			74,471			118,184			(100,251	)		85,575
Less: Preferred dividends		2,513			—			—			—			—			—
Net income (loss) available to common stockholders	$	27,168		$	44,231		$	74,471		$	118,184		$	(100,251	)	$	85,575

Compliance Monitoring and Auditing / Comprehensive Training and Education

- Monitoring 30reports and the results of compliance for each of our business segments are reported to the compliance and internal audit committee on a quarterly basis. We train and educate our employees regarding the code of conduct, as well as the legal and regulatory requirements relevant to each employee's work environment. New and current employees are required to acknowledge and certify that the employee has read, understood and has agreed to abide by the code of conduct. Additionally, all employees are required to re-certify compliance with the code on an annual basis.

~~Table~~ ofPolicies ~~Contents~~and Procedures Reflecting Compliance Focus Areas

	Predecessor															Successor
	Year Ended December 31,												Period from			Period from
													January 1			February 25
													through			through
													February 24,			December 31,
	2001			2002			2003			2004			2005			2005
							(in thousands)
Other Financial Data:
Capital expenditures	$	24,011		$	43,183		$	35,852		$	32,626		$	2,586		$	107,360
Ratio of earnings to fixed charges(7)		1.5	x		2.3	x		3.1	x		3.9	x		n/a			2.2	x
Cash Flow Data
Net cash provided by operating activities	$	95,770		$	120,812		$	246,248		$	174,276		$	19,056		$	45,072
Net cash used in investing activities		(61,947	)		(54,048	)		(261,452	)		(28,959	)		(110,757	)		(110,054	)
Net cash provided by (used in) financing activities		(26,164	)		(21,423	)		124,318			(63,959	)		94			(55,521	)
Balance Sheet Data (at end of period):
Cash and cash equivalents	$	10,703		$	56,062		$	165,507		$	247,476					$	35,861
Working capital		126,749			130,621			188,380			313,715						88,354
Total assets		650,845			739,059			1,078,998			1,113,721						2,163,369
Total debt		288,423			260,217			367,503			354,590						1,322,280
Total stockholders’ equity		234,284			286,418			419,175			515,943						506,165

We review our policies and procedures for our compliance program from time to time in order to improve operations and to ensure compliance with requirements of standards, laws and regulations and to reflect the ongoing compliance focus areas which have been identified by the compliance and internal audit committee.

(1)		Operating expenses include cost of services, general and administrative expenses, and bad debt expenses.
(2)		Consists of stock compensation expense related to the repurchase of outstanding stock options in the Predecessor period from January 1, 2005 through February 24, 2005 and compensation expense related to restricted stock and stock options that were issued in the Successor period from February 25, 2005 through December 31, 2005.
(3)		In connection with the Merger, we tendered for all of our 91/2% senior subordinated notes due 2009 and all of our 71/2% senior subordinated notes due 2013. The loss in the Predecessor period of January 1, 2005 through February 24, 2005 consists of the tender premium cost of $34.8 million and the remaining write-off of unamortized deferred financing costs of $7.9 million.
(4)		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 the Board of Directors to evaluate the Merger, legal and accounting fees, costs associated with the Hart-Scott-Rodino filing relating to the Merger, cost associated with purchasing a six year extended reporting period under our directors and officers liability insurance policy and other associated expenses.
(5)		Net interest equals interest expense minus interest income.
(6)		Reflects interests held by other parties in subsidiaries, limited liability companies and limited partnerships owned and controlled by us.
(7)		For purposes of computing the ratio of earnings to fixed charges, earnings consist of income (loss) from continuing operations before income taxes, fixed charges, minority interest in income of subsidiaries, and income (loss) from unconsolidated joint ventures. Fixed charges include preferred dividend requirements of subsidiaries, deemed dividends on preferred stock conversion, interest expense, capitalized interest, interest related to discontinued operations, and the portion of operating rents that is deemed representative of an interest factor. For the period January 1, 2005 through February 24, 2005 (Predecessor period), the ratio coverage was less than 1:1. We would have had to generate additional earnings of approximately $160.3 million to achieve a coverage ratio of 1:1.

Internal Audit

- In 31addition -to and in support of the efforts of our compliance and audit department, during 2001 we established an internal audit function. The vice president of compliance and audit services manages the combined compliance and audit department and meets with the audit and compliance committee of the board of directors on a quarterly basis to discuss audit results and provide an overview of the activities and operation of our compliance program.

~~Table~~ Available ~~of Contents~~Information

~~ITEM~~ We 7are subject to the information and periodic reporting requirements of the Securities Exchange Act of 1934, as amended, and, in accordance therewith, file periodic reports, proxy statements and other information with the SEC. ~~MANAGEMENT’S~~Such ~~DISCUSSION~~periodic ~~AND~~reports, ~~ANALYSIS~~proxy OFstatements ~~FINANCIAL~~and ~~CONDITION~~other ~~AND~~information ~~RESULTS~~is OFavailable ~~OPERATIONS~~for inspection and copying at the SEC's Public Reference Room at 100 F Street, NE., Washington, DC 20549, or may be obtained by calling the SEC at 1- 800-SEC-0330. In addition, the SEC maintains a website at www.sec.gov that contains reports, proxy statements and other information regarding issuers that file electronically with the SEC.

~~Overview~~ Our website address is www.selectmedicalholdings.com and can be used to access free of charge, through the investor relations section, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as soon as reasonably practicable after we electronically file such material with or furnish it to the SEC. The information on our website is not incorporated as a part of this annual report.

We are a leading operator of specialty hospitals and outpatient rehabilitation clinics in the United States. As of December 31, 2005, we operated 97 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 717 outpatient rehabilitation clinics in 24 states, the District of Columbia and seven Canadian provinces. On March 1, 2006, we completed the sale of our Canadian business. See “Item 1. Business — Subsequent Event.” 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. 28

OnTable ~~February 24, 2005, we consummated a merger with a wholly-owned subsidiary~~ of ~~Holdings pursuant~~Contents to which we became a wholly-owned subsidiary of Holdings. Holdings is owned by an investor group that includes Welsh Carson, Thoma Cressey Equity Partners, Inc. (“Thoma Cressey”), and members of our senior management. As a result of the Merger, our assets and liabilities have been adjusted to their fair value as of the closing. We have also experienced an increase in our aggregate outstanding indebtedness as a result of the financing transactions associated with the Merger. Accordingly, our amortization expense and interest expense are higher in periods following the Merger. The excess of the total purchase price over the fair value of our tangible and identifiable intangible assets of $1.4 billion has been allocated to goodwill, which will be the subject of an annual impairment test. In determining the total economic consideration to use for financial accounting purposes, we have applied guidance found in Financial Accounting Standards Board Emerging Issues Task Force Issue No. 88-16 “Basis in Leveraged Buyout Transactions.” This has resulted in a portion of the equity related to our continuing stockholders to be recorded at the stockholder’s predecessor basis and a corresponding portion of the acquired assets to be recorded likewise.

~~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, the~~ ~~financial data for the period after the Merger, February 25, 2005 through December 31, 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 year ended December 31,~~ ~~2005. The combined data is referred to herein as the combined year ended December 31, 2005. As a~~ ~~result~~Executive Officers of the Merger, interest expense, loss on early retirement of debt, merger related charges, stock compensation expense, long-term incentive compensation, depreciation and amortization have been impacted. Accordingly, we believe this combined presentation is a reasonable means of presenting our operating results. Registrant

We The ~~manage~~following ~~our~~table ~~company~~sets ~~through~~forth ~~two~~the ~~business segments~~names, ~~our~~ages ~~specialty hospital segment~~ and ~~our outpatient~~titles, ~~rehabilitation~~as ~~segment.~~well Weas ~~had~~a ~~net~~brief ~~operating~~account ~~revenues~~ of ~~$1,858.4 million for~~ the ~~combined~~ ~~year~~business ~~ended December 31~~experience, ~~2005.~~of Ofeach ~~this~~person ~~total,~~who was wean ~~earned~~executive ~~approximately~~officer ~~74%~~ of ~~our net operating revenues from our specialty hospitals and approximately 26% from our outpatient rehabilitation business for~~ the ~~combined~~Company ~~year~~as ~~ended~~of ~~December~~January 311, ~~2005.~~ 2014:

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

Name		Position

Robert A. Ortenzio	57	Executive Chairman and Co-Founder
Rocco A. Ortenzio	82	Vice Chairman and Co-Founder
David S. Chernow	57	President and Chief Executive Officer
Martin F. Jackson	60	Executive Vice President and Chief Financial Officer
John A. Saich	46	Executive Vice President and Chief Human Resources Officer
James J. Talalai	53	Executive Vice President and Chief Operating Officer
Michael E. Tarvin	54	Executive Vice President, General Counsel and Secretary
Scott A. Romberger	54	Senior Vice President, Controller and Chief Accounting Officer
Robert G. Breighner, Jr.	46	Vice President, Compliance and Audit Services and Corporate Compliance Officer

Robert A. Ortenzio was appointed Executive Chairman and Co- 32Founder effective January 1, 2014. Mr. Ortenzio served as our Chief Executive Officer from January 1, 2005 until December 31, 2013 and. Mr. Ortenzio served as our President and Chief Executive Officer from September 2001 to January 1, 2005. Mr. Ortenzio also served as our President and Chief Operating Officer from February 1997 to September 2001. Mr. Ortenzio co-founded the Company and has served as a director since February 1997. He was an Executive Vice President and a director of Horizon/CMS Healthcare Corporation from July 1995 until July 1996. In 1986, Mr. Ortenzio co-founded Continental Medical Systems, Inc., and served in a number of different capacities, including as a Senior Vice President from February 1986 until April 1988, as Chief Operating Officer from April 1988 until July 1995, as President from May 1989 until August 1996 and as Chief Executive Officer from July 1995 until August 1996. Before co-founding Continental Medical Systems, Inc., he was a Vice President of Rehab Hospital Services Corporation. Until August 17, 2010, Mr. Ortenzio served on the board of directors of Odyssey Healthcare, Inc., a hospice healthcare company. Mr. Ortenzio also served on the board of directors of US Oncology, Inc. until December 30, 2010. Mr. Ortenzio is the son of Rocco A. Ortenzio, our Vice Chairman and Co-Founder.

~~Table~~ Rocco A. Ortenzio was appointed Vice Chairman and Co-Founder effective January 1, 2014. Mr. Ortenzio served as our Executive Chairman from September 2001 until December 2013. From February 1997 to September 2001, Mr. Ortenzio served as our Chief Executive Officer. Mr. Ortenzio co-founded the Company and has served as a director since February 1997. In 1986, he co-founded Continental Medical Systems, Inc., and served as its Chairman and Chief Executive Officer until July 1995. In 1979, Mr. Ortenzio founded Rehab Hospital Services Corporation, and served as its Chairman and Chief Executive Officer until June 1986. In 1969, Mr. Ortenzio founded Rehab Corporation and served as its Chairman and Chief Executive Officer until 1974. Mr. Ortenzio is the father of ~~Contents~~Robert A. Ortenzio, our Executive Chairman and Co-Founder.

~~speech~~ David ~~rehabilitation~~S. ~~services~~Chernow has served as our President and Chief Executive Officer since January 1, 2014. ~~Our~~Mr. Chernow ~~outpatient~~has ~~rehabilitation~~served ~~patients~~as our ~~are~~President ~~typically~~and ~~diagnosed~~previously held various additional executive officer titles since September 2010. Mr. Chernow served as a director of the Company from January 2002 until February 2005 and ~~with~~from ~~musculoskeletal~~August ~~impairments~~2005 ~~that~~until ~~restrict~~September ~~their~~2010. ~~ability~~From May 2007 to ~~perform~~February ~~normal~~2010, ~~activities~~Mr. Chernow served as the President and Chief Executive Officer of ~~daily living~~Oncure Medical Corp. , one of the

~~Recent Trends and Events~~ 29

~~CBIL~~Table ~~Sale~~ of Contents

Onlargest providers ~~March 1,~~of ~~2006, we sold our wholly~~free-~~owned~~ ~~subsidiary~~standing ~~Canadian~~radiation ~~Back~~oncology ~~Institute~~care ~~Limited~~in ~~(“CBIL”) for~~the ~~approximately~~United ~~C$89~~States.~~8 million~~ inFrom ~~cash (US$79.0 million).~~July As2001 ofto ~~December 31,~~June ~~2005~~2007, ~~CBIL operated~~Mr. Chernow ~~109~~served ~~outpatient~~as ~~rehabilitation~~the ~~clinics~~President inand ~~seven~~Chief ~~Canadian~~Executive ~~provinces.~~Officer Weof ~~conducted~~JA ~~all~~Worldwide, ~~of our~~a ~~Canadian~~nonprofit ~~operations~~organization ~~through~~dedicated ~~CBIL.~~to ~~The~~the ~~purchase~~education ~~price~~of isyoung ~~subject~~people toabout abusiness ~~post-closing~~(formerly, ~~adjustment~~Junior ~~based on~~Achievement, Inc.). ~~the~~From ~~amount~~1999 ofto ~~net~~2001, ~~working~~he ~~capital~~was ~~and~~the ~~long~~President ~~term liabilities~~ of ~~CBIL~~the ~~and~~Physician ~~its~~Services ~~subsidiaries~~Group ~~on the~~at ~~closing~~US ~~date~~Oncology, Inc. ~~The~~Mr. Chernow ~~financial~~co-founded ~~results~~American ofOncology ~~CBIL~~Resources ~~have~~in ~~been~~1992 ~~reclassified~~and served as ~~discontinued~~its ~~operations~~Chief ~~for all~~Development ~~periods~~Officer ~~presented~~until inthe ~~this~~time ~~report,~~of ~~and~~the ~~its~~merger ~~assets~~with ~~and~~Physician ~~liabilities have been reclassified as held~~Reliance ~~for~~Network, Inc., ~~sale~~which oncreated ~~our~~US ~~December 31~~Oncology, Inc. ~~2005~~in ~~balance sheet~~1999.

~~Holdings~~ Martin ~~Note~~F. ~~Offering~~Jackson has served as our Executive Vice President and Chief Financial Officer since February 2007. He served as our Senior Vice President and Chief Financial Officer from May 1999 to February 2007. Mr. Jackson previously served as a Managing Director in the Health Care Investment Banking Group for CIBC Oppenheimer from January 1997 to May 1999. Prior to that time, he served as Senior Vice President, Health Care Finance with McDonald & Company Securities, Inc. from January 1994 to January 1997. Prior to 1994, Mr. Jackson held senior financial positions with Van Kampen Merritt, Touche Ross, Honeywell and L'Nard Associates.

On John ~~September 29,~~A. ~~2005,~~Saich ~~Holdings,~~has served as our ~~parent~~Executive ~~company,~~Vice ~~sold~~President ~~$175.0 million~~and ofChief ~~senior~~Human ~~floating rate~~Resources ~~notes~~Officer ~~due~~since ~~2015~~December 15, ~~which~~2010. ~~bear~~He ~~interest~~served atas our aSenior ~~rate~~Vice ~~per annum~~President, ~~reset~~Human ~~semi-annually,~~Resources ~~equal~~from toFebruary ~~the 6-month~~2007 ~~LIBOR~~to ~~plus~~December 52010.~~75%.~~ ~~Interest~~He isserved ~~payable~~as ~~semi-annually~~our inVice ~~arrears~~President, onHuman ~~March 15~~Resources ~~and~~from ~~September 15~~November of1999 ~~each~~to ~~year,~~January ~~with~~2007. ~~the~~He ~~principal~~joined ~~due~~the inCompany ~~full~~as ~~on September 15~~Director, ~~2015. The floating notes are~~ ~~general~~Human ~~unsecured~~Resources ~~obligations of Holdings~~ and ~~are~~HRIS ~~not~~in ~~guaranteed~~February by1998. usPreviously, ~~or any of our subsidiaries~~Mr. ~~The~~ Saich ~~net~~served ~~proceeds~~as ofDirector ~~the issuance~~ of ~~the~~Benefits ~~floating~~and ~~rate~~Human ~~notes,~~Resources ~~together~~for ~~with~~Integrated ~~cash~~Health ~~provided~~Services ~~through~~in ~~a dividend~~1997 ~~from~~and ~~us,~~as ~~was~~Director ~~used to reduce the amount~~ of ~~Holdings’~~Human ~~preferred~~Resources ~~stock, to make a payment to~~for ~~participants~~Continental inMedical ~~Holdings’~~Systems, Inc. ~~long-term~~from ~~cash~~August ~~incentive~~1993 ~~plan, and~~ to ~~pay~~January ~~related fees and expenses~~1997.

~~Combined~~ James ~~Year~~J. ~~Ended~~Talalai has served as our Executive Vice President and Chief Operating Officer since January 2012. Prior to this, he served as our Executive Vice President and Chief Information Officer from February 2007 to December 31 2011. He served as our Senior Vice President and Chief Information Officer from August 2001 to February 2007. He joined the Company in May 1997 and served in various leadership capacities within Information Services. Before joining us, ~~2005~~Mr. Talalai was Director of Information Technology for Horizon/ CMS Healthcare Corporation from 1995 to 1997. He also served as Data Center Manager at Continental Medical Systems, Inc. in the mid-1990s.

~~For~~ Michael ~~the~~E. ~~combined~~Tarvin ~~year~~has ~~ended~~served ~~December 31,~~as ~~2005,~~ our ~~net~~Executive ~~operating~~Vice ~~revenues increased 16.0% to $1~~President,~~858.4 million~~ ~~compared~~General toCounsel ~~the~~and ~~year~~Secretary ~~ended~~since ~~December 31,~~February ~~2004~~2007. ~~This~~He ~~increase~~served inas ~~net~~our ~~operating~~Senior ~~revenues~~Vice ~~was principally attributable to our acquisition of SemperCare Inc. on January 1~~President, ~~2005~~General Counsel and ~~the~~ ~~growth~~Secretary infrom ~~net~~November ~~operating~~1999 ~~revenues~~to atFebruary ~~our same store hospitals~~2007. ~~This~~He ~~growth~~served inas ~~net operating revenue was offset by a decline in~~ our ~~outpatient~~Vice ~~rehabilitation~~President, ~~net~~General ~~operating~~Counsel ~~revenues~~and ~~that resulted~~Secretary from aFebruary ~~decline~~1997 into ~~the~~November ~~number~~1999. ofHe ~~clinics~~was weVice President — ~~operate~~Senior ~~and~~Counsel ~~in the volume~~ of ~~visits~~Continental ~~occurring at~~Medical ~~the~~Systems ~~clinics. We had income~~ from ~~operations~~February ~~for~~1993 ~~the~~until ~~combined~~February ~~year ended December 31, 2005 of $119~~1997.~~1 million~~ ~~compared~~Prior to ~~$222.5 million~~that ~~for the year ended December 31~~time, ~~2004.~~he ~~The decline in income from operations~~ was ~~principally~~Associate ~~related~~Counsel toof ~~stock~~Continental ~~compensation~~Medical ~~costs~~Systems offrom March ~~$152~~1992.~~5 million~~ ~~and a long-term incentive compensation payment of $14~~Mr.5 ~~million.~~Tarvin ~~For~~was ~~the~~an ~~combined~~associate ~~year~~at ~~ended~~the ~~December 31,~~Philadelphia ~~2005,~~law wefirm ~~also incurred a loss on early retirement~~ of ~~debt~~Drinker ofBiddle & ~~$42.7~~Reath, ~~million~~LLP ~~related~~from toSeptember ~~the repayment~~1985 ofuntil ~~our~~March ~~7 1/2% and 9 1/2% senior subordinated notes and other expenses related to the Merger of $12~~1992.~~0 million.~~

~~Our~~ Scott ~~cash~~A. ~~flow~~Romberger has served as our Senior Vice President and Controller since February 2007. He served as our Vice President and Controller from ~~operations~~February ~~provided~~1997 ~~$64~~to February 2007.1 In addition, he has served as our Chief Accounting Officer since December 2000. Prior to February 1997, he was Vice President ~~million~~— Controller of ~~cash~~Continental ~~for~~Medical ~~the~~Systems ~~combined~~from ~~year~~January ~~ended~~1991 until January 1997. Prior to that time, he served as Acting Corporate Controller and Assistant Controller of Continental Medical Systems from June 1990 and December ~~31,~~ ~~2005~~1988, ~~which~~respectively. ~~includes $186~~Mr.0 ~~million~~Romberger inis ~~cash~~a ~~expenses~~certified ~~related~~public toaccountant ~~the~~and ~~Merger~~was employed by a national accounting firm from April 1985 until December 1988.

~~SemperCare~~ Robert ~~Acquisition~~G. Breighner, Jr. has served as our Vice President, Compliance and Audit Services since August 2003. He served as our Director of Internal Audit from November 2001 to August 2003. Previously, Mr. Breighner was Director of Internal Audit for Susquehanna Pfaltzgraff Co. from June 1997 until November 2001. Mr. Breighner held other positions with Susquehanna Pfaltzgraff Co. from May 1991 until June 1997.

On January 1, 2005, we acquired SemperCare, Inc., or SemperCare, for approximately $100.0 million in cash. SemperCare operated 17 long-term acute care hospitals in 11 states. All of the SemperCare facilities are HIHs, and we expect to transition these facilities to adapt to the new HIH regulations within a similar time frame and using strategies similar to those that we will use to transition our other HIHs. 30

~~Year~~Table ~~Ended~~of ~~December 31, 2004~~ Contents

- ~~33 -~~ Item 1A. Risk Factors.

~~Table~~ In addition to the factors discussed elsewhere in this Form 10-K, the following are important factors which could cause actual results or events to differ materially from those contained in any forward-looking statements made by or on behalf of ~~Contents~~us.

In ~~2004~~If ~~our~~there ~~net~~are ~~operating~~changes ~~revenues~~in ~~increased 19.4%, income from operations increased 56.5%, net income increased 58.7% over 2003. Our specialty hospital segment was~~ the ~~primary~~rates ~~source~~or ofmethods ~~this growth. In our specialty hospital segment we experienced growth resulting from the addition~~ of ~~four inpatient~~government ~~rehabilitation~~reimbursements ~~facilities~~for ~~acquired through~~ our ~~September 2003 acquisition of Kessler Rehabilitation Corporation~~services, ~~growth from~~ our ~~hospitals~~net ~~opened~~operating inrevenues ~~2003~~ and ~~2004,~~profitability ~~and~~could ~~an increase in our revenue per patient day in our same store hospitals~~decline. Our outpatient segment experienced growth related primarily to the full year effect of the Kessler outpatient clinics in 2004. We also continued to experience significant cash flow from operations resulting from our growth in net income and a continued reduction in accounts receivable days outstanding.

~~Regulatory~~ Approximately ~~Changes~~47% of our net operating revenues for the year ended December 31, 2012, 46% of our net operating revenues for the year ended December 31, 2013 and 45% of our net operating revenues for the year ended December 31, 2014 came from the highly regulated federal Medicare program.

On In recent ~~August 11~~years, ~~2004,~~through ~~the~~legislative ~~Centers~~and ~~for~~regulatory ~~Medicare & Medicaid Services~~actions, ~~also~~the ~~known~~federal asgovernment ~~CMS,~~has ~~published final~~made ~~regulations~~substantial ~~applicable~~changes to ~~long-term~~various ~~acute~~payment ~~care~~systems ~~hospitals~~under ~~that~~the ~~are~~Medicare ~~operated~~program. asPresident ~~“hospitals~~Obama ~~within~~signed ~~hospitals”~~into orlaw ascomprehensive ~~“satellites”~~reforms ~~(collectively referred~~ to asthe ~~“HIHs”).~~healthcare ~~HIHs are separate hospitals located in space leased from~~system, ~~and~~including ~~located~~changes ~~in, general acute care hospitals, known as “host” hospitals. Effective for hospital cost reporting periods beginning on or after October 1, 2004, subject~~ to ~~certain exceptions,~~ the ~~final~~methods ~~regulations provide lower rates of reimbursement to HIHs~~ for, ~~those~~and ~~Medicare~~amounts ~~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%~~reimbursement. ~~For~~Additional ~~HIHs~~reforms ~~that~~or ~~meet~~other ~~specified~~changes ~~criteria~~to ~~and~~these ~~were in existence as of October~~payment 1systems, ~~2004,~~ including ~~all~~modifications ofto ~~our existing HIHs,~~ the ~~Medicare~~conditions ~~admissions thresholds will be phased-in over a four-year period starting with hospital cost reporting periods beginning~~ on orqualification ~~after~~for ~~October 1~~payment, ~~2004,~~bundling aspayments ~~follows:~~to ~~(i) for~~cover ~~discharges~~both ~~during~~acute ~~the~~and ~~cost~~post-acute ~~reporting~~care ~~period beginning on~~ or ~~after October 1, 2004 and before October 1, 2005,~~ the ~~Medicare~~imposition ~~admissions threshold is the Fiscal 2004 Percentage (as defined below)~~ of ~~Medicare~~enrollment ~~discharges~~limitations ~~admitted from the host hospital; (ii) for discharges during the cost reporting period beginning~~ on ornew ~~after October 1~~providers, ~~2005 and before~~ ~~October 1,~~may ~~2006,~~be ~~the~~proposed ~~Medicare admissions threshold is the lesser of the Fiscal 2004 Percentage of Medicare discharges admitted from the host hospital~~ or ~~75%;~~could ~~(iii) for~~be ~~discharges during the cost reporting period beginning on or after October 1~~adopted, ~~2006~~either ~~and~~by ~~before~~Congress ~~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%;~~CMS. ~~and~~If ~~(iv) for~~revised ~~discharges~~regulations ~~during~~are ~~cost reporting periods beginning on or after October 1~~adopted, ~~2007,~~ the ~~Medicare admissions threshold is 25%. As used above~~availability, ~~“Fiscal~~methods ~~2004 Percentage”~~and ~~means,~~rates ~~with respect to any HIH, the percentage~~ of ~~all~~ Medicare ~~patients~~reimbursements ~~discharged~~for ~~by such~~services 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. We have developed a business plan and strategy in each of ~~our markets to adapt to~~ the ~~HIH~~type ~~regulations~~furnished ~~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 tocould ~~alternative~~change. ~~settings,~~Some ~~building~~of ~~or buying~~these ~~free-standing~~changes ~~facilities~~ and ~~closing~~proposed achanges ~~small~~could ~~number~~adversely ofaffect ~~facilities. We currently anticipate that approximately 42% of~~ our ~~hospitals~~business ~~will~~strategy, ~~not~~operations ~~require a move~~ and 8%financial ~~of our hospitals will be closed~~results. If ~~CMS~~In ~~implements~~addition, ~~certain~~there ~~additional~~can ~~regulatory~~be ~~changes~~no ~~that~~assurance ~~it has proposed and discussed and~~ that ~~would affect long-term~~any ~~acute~~increases ~~care~~in ~~hospitals~~Medicare ~~more~~reimbursement ~~generally,~~rates ~~our~~established ~~plan~~by ~~would~~CMS ~~have~~will tofully ~~be further~~reflect ~~modified.~~increases ~~See~~in ~~“Business —~~our ~~Specialty~~operating ~~Hospitals~~costs.”

The BCA ~~new~~of ~~HIH~~2011, ~~regulations~~enacted ~~established~~on ~~exceptions~~August 2, to2011, increased the ~~Medicare~~federal ~~admissions~~debt ~~thresholds~~ceiling in connection with deficit reductions over the next ten years. The BCA of 2011 requires automatic ~~respect~~reductions in federal spending by approximately $1.2 trillion split evenly between domestic and defense spending. Payments to ~~patients~~Medicare ~~who~~providers ~~reach~~are ~~“outlier”~~subject ~~status~~to atthese ~~the~~automatic ~~host~~spending ~~hospital~~reductions, subject ~~HIHs~~to ~~located~~a in2% ~~“MSA-dominant hospitals”~~cap. orOn ~~HIHs~~April 1, ~~located~~2013 ina ~~rural~~2% ~~areas~~reduction to Medicare payments was implemented. AsThe BBA of 2013 extended the automatic spending reductions through 2023. For the years ended December 31, ~~2005~~2014 and 2013, wethis ~~operated~~reduction 97has ~~long-term~~reduced ~~acute care~~our ~~hospitals,~~net 93operating ofrevenues ~~which~~and ~~operated~~income asfrom ~~HIHs~~operations by approximately $30. 0 million and $24.0 million, respectively.

~~On January 27,~~ ~~2006,~~We ~~CMS~~conduct ~~published its~~business ~~proposed~~in ~~annual~~a ~~payment~~heavily ~~rate~~regulated ~~updates for the 2007 LTCH-PPS rate year (affecting cost reporting periods beginning on or after July 1~~industry, ~~2006~~ and ~~before July 1, 2007). The January 2006 proposed rule includes the following proposed~~ changes toin ~~LTCH-PPS~~regulations, ~~payment methodologies: (i) addition of a~~ new ~~payment~~interpretations ~~methodology for Medicare patients with a length~~ of ~~stay~~existing ~~less~~regulations ~~than~~ or ~~equal~~violations ~~to 5/6ths~~ of ~~the~~ ~~geometric~~regulations ~~average~~may length of stay for each LTC-DRG (referred to as “short-stay outlier” or “SSO” cases), so that payment for a significant portion of SSO cases will be reduced to an amount comparable with that paid under the general acute care hospital reimbursement methodology; (ii) a zero-percent update to the LTCH-PPS standard federal rate used as a basis for LTCH-PPS payments; (iii) sunset of the surgical case exception to the three-day or less interruption of stay policy, under which 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 (iv) 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. CMS estimates that the changes it is proposing for the 2007 LTCH-PPS rate year will result in ~~an approximately 11 percent decrease in Medicare payments to~~ ~~long-term~~increased ~~acute~~costs care hospitals as compared to the 2006 rate year. Consistent with its standard process for adopting regulations, CMS has solicited and will consider comments on the January 2006 proposed rule before it publishes a final update for the 2007 LTCH-PPS rate year. As a result, CMS may elect not to adopt certain of its proposals or ~~the~~sanctions ~~agency~~that ~~may adopt the proposals with modifications. If, however, the January 2006 proposals are adopted without modification, these changes in LTCH-PPS reimbursement policy will~~ reduce our net operating revenues and ~~will adversely affect our financial performance~~profitability.

~~Development~~ The healthcare industry is subject to extensive federal, state and local laws and regulations relating to (1) facility and professional licensure, including certificates of ~~New~~need, ~~Specialty~~(2) conduct ~~Hospitals~~of operations, including financial relationships among healthcare providers, Medicare fraud and ~~Clinics~~abuse and physician self-referral, (3) addition of facilities and services and enrollment of newly developed facilities in the Medicare program, (4) payment for services and (5) safeguarding protected health information.

- Both federal 34and -state regulatory agencies inspect, survey and audit our facilities to review our compliance with these laws and regulations. While our facilities intend to comply with existing licensing, Medicare certification requirements and accreditation standards, there can be no assurance that these regulatory authorities will determine that all applicable requirements are fully met at any given time. A determination by any of these regulatory authorities that a facility is not in compliance with these requirements could lead to the imposition of requirements that the facility takes corrective action, assessment of fines and penalties, or loss of licensure, Medicare certification or accreditation. These consequences could have an adverse effect on our company.

~~Table~~ In addition, ofthere ~~Contents~~have been heightened coordinated civil and criminal enforcement efforts by both federal and state government agencies relating to the healthcare industry. The ongoing investigations

We expect to continue evaluating opportunities to develop new long-term acute care hospitals, primarily in settings where the new HIH regulations would have little or no impact, for example, in free-standing buildings. 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. 31

~~Critical~~Table ~~Accounting~~of ~~Matters~~ Contents

~~Sources~~relate to, among other things, various referral practices, cost reporting, billing practices, physician ownership and joint ventures involving hospitals. In the future, different interpretations or enforcement of ~~Revenue~~these laws and regulations could subject us to allegations of impropriety or illegality or could require us to make changes in our facilities, equipment, personnel, services and capital expenditure programs. These changes may increase our operating expenses and reduce our operating revenues. If we fail to comply with these extensive laws and government regulations, we could become ineligible to receive government program reimbursement, suffer civil or criminal penalties or be required to make significant changes to our operations. In addition, we could be forced to expend considerable resources responding to any related investigation or other enforcement action.

~~Our~~ ~~net~~Full ~~operating~~implementation ~~revenues are derived from a number~~ of ~~sources, including commercial, managed care, private and governmental payors. Our net operating revenues include amounts estimated by management to be reimbursable from each of~~ the ~~applicable payors and the federal~~ Medicare ~~program. Amounts~~25 wePercent ~~receive~~Rule ~~for~~applicable ~~treatment~~to ofLTCHs ~~patients~~will ~~are~~have ~~generally~~an ~~less~~adverse ~~than~~effect ~~the~~on ~~standard~~our ~~billing~~future ~~rates.~~net ~~We account~~operating ~~for~~revenues ~~the differences between the estimated reimbursement rates~~ and ~~the standard billing rates as contractual adjustments, which we deduct from gross revenues to arrive at net operating revenues~~profitability.

~~Net~~ Under ~~operating~~the ~~revenues~~25 ~~generated~~Percent ~~directly~~Rule, ~~from~~ the Medicare ~~program~~payment ~~from~~rate ~~all~~for ~~segments represented~~LTCHs ~~approximately~~is ~~56%,~~subject ~~50%,~~to ~~and~~a ~~48%~~downward payment adjustment if the percentage of Medicare ~~net~~patients ~~operating~~discharged ~~revenues~~from ~~for~~an ~~the~~LTCH ~~combined~~who ~~year~~were ~~ended December 31,~~admitted ~~2005~~from ~~and~~an ~~for~~individual ~~the~~referring ~~years~~hospital ~~ended~~exceeds ~~December 31,~~an ~~2004~~applicable ~~and~~percentage ~~2003,~~admissions ~~respectively.~~threshold ~~The~~during ~~increase~~a particular cost reporting period. Cases admitted to an LTCH in excess of the applicable percentage ofadmissions ~~our~~threshold ~~revenues~~are ~~generated~~reimbursed ~~from~~at ~~the~~a ~~Medicare~~rate ~~program~~comparable isto ~~due~~that tounder ~~the~~IPPS. ~~growth~~IPPS inrates ~~the number~~are ofgenerally ~~specialty~~lower ~~hospitals~~than ~~and~~LTCH-PPS ~~their~~rates. ~~higher~~Cases ~~respective~~that reach ~~share~~outlier ofstatus ~~Medicare~~in ~~revenues~~the ~~generated~~discharging ~~in this~~hospital ~~segment~~do ofnot ~~our~~count ~~business~~toward ~~compared~~the tolimit ~~our~~and ~~outpatient~~are ~~rehabilitation~~paid ~~segment~~under LTCH-PPS.

~~Approximately~~ LTCHs that ~~73%,~~are ~~68%,~~operated ~~and~~as ~~69%~~HIHs ofor ~~our~~as ~~specialty~~HIH ~~hospital~~"satellites," ~~revenues~~are ~~for~~subject ~~the~~to ~~combined~~payment ~~year~~reductions ~~ended December 31, 2005 and~~ for ~~the~~those ~~years~~Medicare ~~ended~~patients ~~December 31,~~admitted ~~2004~~from ~~and~~their ~~2003,~~host ~~respectively,~~hospitals ~~were received~~ in ~~respect~~excess of ~~services provided to Medicare patients. For~~ the ~~year~~applicable percentage ~~ended~~admissions threshold ~~December 31, 2004~~ and ~~the combined~~from ~~year~~other ~~ended~~referring ~~December 31,~~hospitals ~~2005,~~in ~~all~~excess of ~~our Medicare payments were paid under a prospective payment system. For~~ the ~~year~~applicable ~~ended~~percentage ~~December 31,~~admissions ~~2003, approximately 23% were paid by Medicare under a full cost-based reimbursement methodology~~threshold. ~~Payments~~LTCHs ~~made~~that ~~under~~are aoperated ~~cost-based~~as ~~reimbursement methodology~~freestanding facilities are subject to ~~final~~a ~~cost~~payment ~~report~~reduction ~~settlements based on administrative review and audit~~for bythose ~~third~~Medicare ~~parties.~~patients Anadmitted ~~annual~~from ~~cost~~other ~~report~~referring ~~was~~hospitals ~~filed~~in ~~for~~excess ~~each provider to report the cost~~ of ~~providing services and to settle~~ the ~~difference~~applicable ~~between~~admissions ~~the interim payments we receive and final costs~~threshold. ~~We record~~Grandfathered ~~adjustments~~HIHs ~~to the original estimates in the periods that such adjustments become known. Historically these adjustments have not been significant. Substantially all of our Medicare cost reports~~ are ~~settled~~excluded ~~through 2002. Because our routine payments~~ from ~~Medicare are different than~~ the ~~final~~ ~~reimbursement~~Medicare ~~due~~percentage toadmissions ~~us under the cost based reimbursement system, we record a receivable or~~threshold ~~payable for the difference~~regulations.

The SCHIP ~~LTCH-PPS~~Extension ~~regulations~~Act, ~~also~~as ~~refined~~amended by the ~~criteria~~ARRA, ~~that~~the ~~must~~ACA beand ~~met~~the inBBA ~~order~~of 2013, postponed the full application of the percentage admissions threshold for aspecific ~~hospital~~classifications toof LTCHs. beFull ~~certified~~implementation asof athe ~~long-term~~Medicare ~~acute~~percentage ~~care~~admissions ~~hospital.~~thresholds ~~For~~under the 25 Percent Rule will not go into effect until cost reporting periods beginning on or after July 1, 2016 or October 1, ~~2002~~2016, adepending ~~long-term~~on ~~acute~~the ~~care~~specific ~~hospital~~classification ~~must have an average inpatient length~~ of ~~stay~~LTCH. ~~for Medicare~~See ~~patients~~"Business — ~~(including~~Government ~~both~~Regulations — ~~Medicare~~Overview ~~covered and non-covered days)~~ of ~~greater than 25 days~~U. ~~Previously,~~S. ~~average~~and ~~lengths~~State ofGovernment Reimbursements — ~~stay~~Long ~~were~~Term ~~measured~~Acute ~~with~~Care ~~respect~~Hospital toMedicare ~~all~~Reimbursement — ~~patients~~25 Percent Rule. "

~~Most~~ As of December 31, 2014, we owned 83 HIHs and satellite facilities of ~~our~~which ~~specialty~~three ~~hospitals~~are ~~receive~~grandfathered ~~bi-weekly~~HIHs ~~periodic~~and ~~interim~~are ~~payments~~excluded ~~(“PIP”)~~from the percentage threshold regulations. Of the remaining 80 HIHs and satellite facilities subject to a percentage admissions threshold for admissions from their host hospital; nine of these HIHs and satellite facilities were subject to a maximum 25% Medicare ~~instead~~percentage ofadmissions ~~being~~threshold ~~paid~~for onadmissions from their host hospital, four HIHs and satellite facilities are co-located with an ~~individual~~MSA ~~claim~~dominant ~~basis.~~hospital ~~Under~~and were subject to a ~~PIP~~Medicare percentage ~~payment~~admissions ~~methodology~~threshold of no more than 50%, ~~Medicare~~ ~~estimates~~nor less than 25%, 19 of these HIHs and satellite facilities were co-located with a MSA dominant hospital’s ~~claim~~or ~~volume~~single ~~based~~urban onhospital ~~historical~~and ~~trends~~were subject to a Medicare percentage admissions threshold of no more than 75%, 46 of these HIHs and ~~periodically~~satellite ~~reconciles~~facilities were subject to a maximum 50% Medicare admissions threshold, and two of these HIHs and ~~the~~satellite ~~differences~~facilities ~~between~~were ~~the~~located ~~actual~~in ~~claim~~a ~~data~~rural area and ~~the~~were ~~estimated~~subject ~~payments~~to a maximum 75% Medicare percentage admissions threshold. AtAs ~~each~~of ~~balance~~December 31, ~~sheet date~~2014, we ~~record~~owned ~~the~~three ~~difference~~grandfathered ~~between~~HIHs, ~~our~~all ~~actual~~of which ~~claims~~are ~~and~~excluded from the ~~PIP~~percentage ~~payments~~admissions asthreshold aregulations. ~~receivable~~As ~~or payable~~of ~~from~~December 31, ~~third~~2014, we owned 29 free-~~party~~standing ~~payors~~LTCHs, which are not subject to the Medicare percentage admissions threshold until cost reporting periods beginning on ~~our~~or ~~balance~~after ~~sheet~~July 1, 2017.

- The BBA 35of -2013 requires CMS to report to Congress before October 2016 on the need for any further extensions or modifications of the extensions of the 25 Percent Rule. In addition, the BBA of 2013 requires MedPAC, an independent federal body that advises Congress on issues affecting the Medicare

~~Table of Contents~~32

~~Contractual~~Table ~~Adjustments~~ of Contents

Net operating revenues include amounts estimated by us to be reimbursable by Medicare and Medicaid under prospective payment systems and provisions of cost-reimbursement and other payment methods. In additionprogram, ~~we are reimbursed by non-governmental payors using a variety of payment~~ ~~methodologies.~~to ~~Amounts~~report weto ~~receive~~Congress ~~for treatment of patients covered~~ by ~~these~~June ~~programs~~2019 ~~are generally~~on ~~less than~~ the ~~standard~~need ~~billing~~to ~~rates.~~continue ~~Contractual~~applying allowances are calculated and recorded through our internally developed systems. Within our hospital segment our billing system automatically calculates estimated Medicare reimbursement and associated contractual allowances. For non-governmental payors, we manually calculate the ~~contractual~~25 ~~allowance~~Percent ~~for each patient based upon the contractual provisions associated with the specific payor. In our outpatient segment~~Rule, ~~we perform provision testing, using internally developed systems, whereby we monitor a payors’ historical paid claims data and compare it against~~ the ~~associated~~effect ~~gross charges. This difference is determined as a percentage~~ of ~~gross~~site-neutral ~~charges~~payment ~~and is applied against gross billing revenue to determine the contractual allowances for the period. Additionally, these contractual percentages are applied against the gross receivables~~ on ~~the~~LTCHs ~~balance~~and ~~sheet~~recommendations ~~to determine that adequate contractual reserves are maintained for the gross accounts receivables reported~~ on ~~the~~how ~~balance sheet. We account for any difference as additional contractual adjustments deducted from gross revenues~~ to ~~arrive~~change ~~at net operating revenues in~~ the ~~period that the difference is determined. The~~site-neutral ~~estimation~~payment ~~processes described above and used in recording our contractual adjustments have historically yielded consistent and reliable results~~policy.

~~Allowance~~ Because these ~~for~~rules ~~Doubtful~~are ~~Accounts~~complex and are based on the volume of Medicare admissions from other referring hospitals as a percent of our overall Medicare admissions, we cannot predict with any certainty the impact on our future net operating revenues and profitability of compliance with these regulations. We expect many of our LTCHs will experience an adverse financial impact when full implementation of the Medicare percentage admissions thresholds goes into effect. Our LTCHs have cost reporting periods that commence on various dates throughout the calendar year. Therefore, the application of the lower percentage admissions thresholds will be staggered and we would not realize the full impact of lower percentage admissions thresholds until 2017.

~~Substantially~~ ~~all~~Expiration of our accounts receivable are related to providing healthcare services to patients. Collection of these accounts receivable is our primary source of cash and is critical to our operating performance. Our primary collection risks relate to non-governmental payors who insure these patients and deductibles, co-payments and self-insured amounts owed by the ~~patient. Deductible,~~moratorium ~~co-payments~~imposed ~~and~~on ~~self-insured amounts are an immaterial portion of our net accounts receivable balance. At December 31, 2005, deductible, co-payments and self-insured amounts owed by~~ the ~~patient~~payment ~~accounted~~adjustment for ~~approximately~~very ~~0.9%~~short-stay ofcases ~~our net accounts receivable balance before doubtful accounts. Our general policy is to verify insurance coverage prior to the date of admission for a patient admitted to our hospitals or~~ in ~~the case of~~ our ~~outpatient~~LTCHs ~~rehabilitation~~has ~~clinics,~~reduced ~~we verify~~and ~~insurance~~will ~~coverage~~continue ~~prior~~ to ~~their~~reduce first therapy visit. Our estimate for the allowance for doubtful accounts is calculated by generally reserving as uncollectible all governmental accounts over 365 days and non-governmental accounts over 180 days from discharge. This method is monitored based on our ~~historical~~future ~~cash~~net ~~collections experience. Collections are impacted by the effectiveness~~operating ofrevenues ~~our collection efforts with non-governmental payors~~ and ~~regulatory or administrative disruptions with the fiscal intermediaries that pay our governmental receivables~~profitability.

We On ~~estimate~~May 1, ~~bad~~2007, ~~debts~~CMS ~~for~~published ~~total~~a ~~accounts~~new ~~receivable~~provision ~~within~~that ~~each~~changed ofthe ~~our~~payment ~~operating~~methodology ~~units.~~for ~~We believe~~Medicare ~~our~~patients ~~policies~~with ~~have~~a ~~resulted~~length inof ~~reasonable~~stay that ~~estimates~~is ~~determined~~less onthan athe ~~consistent~~IPPS ~~basis~~comparable threshold. ~~We believe~~Beginning ~~that~~with wedischarges ~~collect~~on ~~substantially~~or ~~all~~after ofJuly 1, ~~our~~2007, ~~third~~for these very short-~~party~~stay ~~insured~~cases, ~~receivables~~the ~~(net~~rule oflowered ~~contractual~~the ~~allowances)~~LTCH payment to a rate based on the ~~which~~general ~~includes~~acute ~~receivables~~care ~~from~~hospital ~~governmental~~IPPS ~~agencies~~per diem. ToSSO ~~date,~~cases wewith ~~believe~~covered ~~there~~lengths ~~has~~of ~~not~~stay ~~been~~that aexceed ~~material difference~~the ~~between~~IPPS ~~our~~comparable ~~bad~~threshold ~~debt~~would ~~allowances~~continue ~~and~~to be paid under the ~~ultimate~~existing ~~historical~~SSO ~~collection~~payment ~~rates~~policy. onThe ~~accounts~~SCHIP ~~receivables.~~Extension WeAct ~~review~~and ~~our~~ACA ~~overall~~prevented ~~reserve~~CMS ~~adequacy~~from byapplying ~~monitoring~~this ~~historical~~change ~~cash~~to ~~collections~~SSO aspolicy for a ~~percentage~~ period of ~~net~~five ~~revenue~~years ~~less~~through December 28, 2012. The implementation of the ~~provision~~payment methodology for ~~bad~~very short-stay ~~debts~~outliers discharged after December 29, 2012 has reduced and will continue to reduce our future net operating revenues and profitability.

~~Uncollected~~ ~~accounts~~If ~~are~~our ~~written~~LTCHs ~~off~~fail ~~the~~to ~~balance~~maintain ~~sheet~~their ~~when~~certifications ~~they~~as ~~are~~LTCHs ~~turned~~or ~~over~~if toour anfacilities ~~outside collection~~operated ~~agency,~~as orHIHs ~~when~~fail ~~management~~to ~~determines~~qualify ~~that~~as ~~the~~hospitals ~~balance~~separate isfrom ~~uncollectible~~their host hospitals, ~~whichever~~our net ~~occurs~~operating ~~first~~revenues and profitability may decline.

- As 36of December 31, 2014, we operated 113 LTCHs, 108 of which are currently certified by Medicare as LTCHs and five of which are in their demonstration period. LTCHs must meet certain conditions of participation to enroll in, and seek payment from, the Medicare program as an LTCH, including, among other things, maintaining an average length of stay for Medicare patients in excess of 25 days. An LTCH that fails to maintain this average length of stay for Medicare patients in excess of 25 days during a single cost reporting period is generally allowed an opportunity to show that it meets the length of stay criteria during the subsequent cost reporting period. If the LTCH can show that it meets the length of stay criteria during this cure period, it will continue to be paid under the LTCH-PPS. If the LTCH again fails to meet the average length of stay criteria during the cure period, it will be paid under the general acute care IPPS at rates generally lower than the rates under the LTCH-PPS.

~~Table~~ Similarly, our HIHs must meet conditions of ~~Contents~~participation in the Medicare program, which include additional criteria establishing separateness from the hospital with which the HIH shares space. If our LTCHs or HIHs fail to meet or maintain the standards for certification as LTCHs, they will receive payment under the general acute care hospitals IPPS which is generally lower than payment under the system applicable to LTCHs. Payments at rates applicable to general acute care hospitals would result in our LTCHs receiving significantly less Medicare reimbursement than they currently receive for their patient services.

~~The following table is an aging of our net (after allowances for contractual adjustments but before doubtful accounts) accounts receivable (in thousands):~~ 33

	Balance as of December 31,
	2004				2005
	Predecessor				Successor
			Over 90				Over 90
	0-90 Days		Days		0-90 Days		Days
Medicare and Medicaid	$	88,174	$	20,182	$	111,707	$	24,141
Commercial insurance, and other		127,692		75,426		131,087		64,754
Total net accounts receivable	$	215,866	$	95,608	$	242,794	$	88,895

Table of Contents

~~The~~ ~~approximate~~Implementation ~~percentage~~ of ~~total~~additional ~~net~~patient ~~accounts~~or ~~receivable~~facility ~~(after~~criteria ~~allowance~~for LTCHs that limit the population of patients eligible for ~~contractual~~our hospitals' services or change the basis on which ~~adjustments~~we ~~but~~are ~~before~~paid ~~doubtful~~could ~~accounts)~~adversely ~~summarized~~affect byour ~~aging~~net ~~categories~~operating isrevenue asand ~~follows:~~ profitability.

	As of December 31,
	2004			2005
	Predecessor			Successor
0 to 90 days		69.3	%		73.2	%
91 to 180 days		11.2	%		9.7	%
181 to 365 days		9.9	%		7.6	%
Over 365 days		9.6	%		9.5	%
Total		100.0	%		100.0	%

The BBA of 2013 establishes new payment limits for Medicare patients who do not meet specified criteria. Specifically, for Medicare patients discharged in cost reporting periods beginning on or after October 1, 2015, LTCHs will be reimbursed under LTCH-PPS only if, immediately preceding the patient's LTCH admission, the patient was discharged from a general acute care hospital paid under IPPS and the patient's stay included at least three days in an intensive care unit (ICU) or coronary care unit (CCU) or the patient is assigned to an MS-LTC-DRG for cases receiving at least 96 hours of ventilator services in the LTCH. In addition, to be paid under LTCH-PPS the patient's discharge from the LTCH may not include a principal diagnosis relating to psychiatric or rehabilitation services. For any Medicare patient who does not meet the new criteria, the LTCH will be paid a "site-neutral" payment rate, which will be the lower of (1) the IPPS comparable per-diem payment rate including any outlier payments, or (2) 100 percent of the estimated costs for services. For cost reporting periods beginning in fiscal year 2020, payment for all discharges from an LTCH may be subject to the site-neutral payment limitation unless the number of discharges for which payment is made under the LTCH-PPS payment rate is greater than 50% of the total number of discharges for the LTCH. The application of the new site-neutral payment rates under LTCH-PPS may reduce our operating revenues.

~~The~~ CMS requested ~~approximate~~public ~~percentage~~comments in May of ~~total~~2013 ~~net~~on ~~accounts~~adoption ~~receivable~~of a payment adjustment based on whether a particular case qualifies as chronically critically ill/medically complex (~~after~~"CCI/MC"). CMS ~~allowance~~indicated ~~for~~that ~~contractual~~it was considering a change to the LTCH-PPS payment policies that would limit full LTCH-PPS payment to those patients meeting the definition of CCI/MC while they were in an IPPS ~~adjustments~~hospital ~~but~~inpatient ~~before~~setting ~~doubtful~~and ~~accounts)~~subsequently ~~summarized~~directly byadmitted ~~payor~~to an LTCH. Payment for non-CCI/MC patients would be made at an "IPPS comparable amount," that is, asan ~~follows:~~amount comparable to what would have been paid under the IPPS calculated as a per diem rate with total payments capped at the full IPPS MS-DRG payment rate.

	As of December 31,
	2004			2005
	Predecessor			Successor
Insured receivables		98.3	%		99.1	%
Self-pay receivables (including deductible and copayments)		1.7	%		0.9	%
Total		100.0	%		100.0	%

It is unclear how the adoption of the BBA of 2013 will impact regulatory or legislative proposals to change the LTCH-PPS payment policies. We cannot predict whether Congress or CMS will adopt additional patient-level criteria in the future or, if adopted, how such criteria would affect our LTCHs. Implementation of additional patient or facility criteria that may limit the population of patients eligible for our LTCHs' services or change the basis on which we are paid could adversely affect our net operating revenues and profitability. See "Business — Government Regulations — Overview of U.S. and State Government Reimbursements — Long Term Acute Care Hospital Medicare Reimbursement."

~~Insurance~~ Decreases in Medicare reimbursement rates received by our outpatient rehabilitation clinics, implementation of annual caps, and payment reductions applied to the second and subsequent therapy services may reduce our future net operating revenues and profitability.

~~Under~~ Our aoutpatient ~~number~~rehabilitation ofclinics ~~our~~receive ~~insurance~~payments ~~programs,~~from ~~which~~the ~~include~~Medicare ~~our~~program ~~employee~~under ~~health~~a ~~insurance~~fee ~~program and~~schedule. ~~certain~~The ~~components~~Medicare ~~under~~physician ~~our~~fee schedule ~~property~~rates ~~and~~are ~~casualty~~automatically ~~insurance~~updated ~~program,~~annually webased ~~are~~on ~~liable~~the ~~for~~SGR ~~a portion~~formula, ofcontained ~~our~~in ~~losses~~legislation. InCMS ~~these~~estimated ~~cases~~on weNovember 13, ~~accrue~~2014 ~~for~~that ~~our~~beginning ~~losses~~April 1, ~~under~~2015 anthe ~~occurrence based principle~~Medicare ~~whereby~~physician wefee ~~estimate~~schedule ~~the~~payment ~~losses~~rates ~~that~~would ~~will~~ be ~~incurred~~reduced by us21.2% inas a ~~given~~result ~~accounting~~of ~~period~~the ~~and~~SGR ~~accrue that~~formula. ~~estimated~~The ~~liability.~~PAMA ~~Where~~temporarily weblocks ~~have~~the ~~substantial~~payment ~~exposure,~~reduction wecaused ~~utilize~~by ~~actuarial~~the ~~methods~~SGR informula through March 31, 2015 ~~estimating~~and ~~the~~replaces ~~losses~~it with a 0.5% Inpayment ~~cases~~increase ~~where~~for weservices ~~have~~provided ~~minimal~~through ~~exposure~~December 31, we2014 ~~will~~and ~~estimate~~a ~~our~~0% ~~losses~~payment ~~by analyzing~~update ~~historical~~from ~~trends~~January 1, 2015 through March 31, 2015. WeIf ~~monitor~~no ~~these~~further legislation ~~programs~~is ~~quarterly~~passed ~~and~~by ~~revise~~Congress ~~our~~and ~~estimates~~signed ~~as necessary~~by tothe ~~take~~President, ~~into~~the ~~account~~SGR ~~additional~~formula ~~information.~~will Atlikely ~~December 31,~~reduce ~~2005~~our ~~and~~Medicare ~~December 31,~~outpatient ~~2004, we~~rehabilitation ~~have~~payment ~~recorded~~rates abeginning ~~liability~~April 1, of 2015.

- Congress has 37established -annual caps that limit the amount that can be paid (including deductible and coinsurance amounts) for outpatient therapy services rendered to any Medicare beneficiary. As directed by Congress in the DRA, CMS implemented an exception process for therapy expenses incurred in 2006.

~~Table of Contents~~34

~~$55.7 million~~Table ~~and~~of ~~$44.4 million, respectively, for our estimated losses under these insurance programs.~~ Contents

~~Related~~Under this ~~Party~~process, ~~Transactions~~a Medicare enrollee (or person acting on behalf of the Medicare enrollee) was able to request an exception from the therapy caps if the provision of therapy services was deemed to be medically necessary. Therapy cap exceptions were available automatically for certain conditions and on a case by case basis upon submission of documentation of medical necessity. The exception process has been extended by Congress several times. Most recently, the PAMA extends the exceptions process for outpatient therapy caps through March 31, 2015. The exception process will expire on April 1, 2015 unless further extended by Congress. There can be no assurance that Congress will extend it further. To date, the implementation of the therapy caps has not had a material adverse effect on our business. However, if the exception process is not renewed, our future net operating revenues and profitability may decline.

We CMS adopted ~~are~~a ~~party~~multiple procedure payment reduction for therapy services in the final update to ~~various~~the ~~rental~~Medicare ~~and~~physician ~~other~~fee ~~agreements~~schedule ~~with~~for ~~companies~~calendar ~~affiliated~~year ~~with~~2011. usUnder ~~through~~the policy, the Medicare ~~common~~program ~~ownership.~~pays ~~Our~~100% ~~payments~~of tothe ~~these~~practice ~~related~~expense ~~parties~~component ~~amounted~~of tothe ~~$2.0 million~~therapy procedure or unit of service with the highest Relative Value Unit, and ~~$1.9 million~~ then reduces the payment for the ~~combined~~practice ~~year~~expense ~~ended~~component for ~~December 31,~~the ~~2005~~second and subsequent therapy procedures or units of service furnished during the ~~year~~same ~~ended~~day ~~December 31,~~for ~~2004~~the same patient, ~~respectively. Our~~regardless ~~future~~of ~~commitments~~whether those therapy services are ~~related~~furnished toin ~~commercial~~separate sessions. ~~office~~In ~~space~~2011 weand ~~lease~~2012 the second and subsequent therapy service furnished during the same day for ~~our~~the ~~corporate headquarters~~same patient was reduced by 20% in ~~Mechanicsburg,~~office ~~Pennsylvania.~~and ~~These~~other ~~future~~non ~~commitments~~institutional ~~amount~~settings toand ~~$17.1 million~~by 25% in ~~through~~institutional ~~2014~~settings. ~~These~~The ~~transactions~~American ~~and~~Taxpayer ~~commitments~~Relief ~~are~~Act ~~described~~of ~~more~~2012 ~~fully~~increased in the ~~notes~~payment reduction to ~~our consolidated~~50% ~~financial~~effective ~~statements~~April 1, ~~included herein~~2013. ~~See~~Should ~~also~~CMS ~~“Item 13.~~adopt ~~Certain~~further ~~Relationships~~increases ~~and~~in the payment reduction ~~Related~~percentage ~~Transactions~~our future net operating revenues and profitability would decline.”

~~Operating~~ ~~Statistics~~ Regulations limiting the diagnosis codes on the presumptive compliance list could adversely affect our net operating revenue and profitability.

~~The~~ As ~~following~~of ~~table~~December 31, ~~sets~~2014, ~~forth~~we ~~operating~~operated ~~statistics~~16 ~~for~~IRFs, ~~our~~all ~~specialty~~of ~~hospitals~~which ~~and~~are ~~our outpatient~~currently ~~rehabilitation~~certified ~~clinics~~by ~~for~~Medicare ~~each~~as IRFs. IRFs must meet certain conditions of participation to enroll in, and seek payment from, the ~~periods~~Medicare ~~presented~~program as an IRF. ~~The~~Among ~~data~~other inthings, at least 60% of the ~~table~~IRF's ~~reflect~~total inpatient population must require treatment for one or more of 13 conditions specified by regulation. This requirement is now commonly referred to as the ~~changes~~"60% inRule." Compliance with the ~~number~~60% ofRule ~~specialty~~is ~~hospitals~~demonstrated ~~and~~through ~~outpatient~~a ~~rehabilitation~~two ~~clinics~~step weprocess. ~~operate~~The first ~~that~~step ~~resulted~~is ~~from~~the ~~acquisitions~~"presumptive" method, ~~start-up~~in ~~activities,~~which ~~closures~~patient ~~and~~diagnosis ~~consolidations~~codes are compared to a "presumptive compliance" list. ~~The~~IRFs ~~operating statistics~~that ~~reflect~~fail ~~data~~to ~~for~~demonstrate compliance with the ~~period~~60% Rule using this presumptive test may demonstrate compliance through a second step involving an audit of ~~time~~the ~~these~~facility's ~~operations~~medical ~~were~~records ~~managed~~to byassess uscompliance.

							Combined
							Year Ended
	Fiscal Year Ended December 31,						December 31,
	2003			2004			2005
Specialty hospital data(1):
Number of hospitals — start of period		72			83			86
Number of hospital start-ups		8			4			—
Number of hospitals acquired		4			—			17
Number of hospitals closed		(1	)		(1	)		(2	)
Number of hospitals — end of period		83			86			101
Available licensed beds		3,204			3,403			3,829
Admissions		27,620			33,523			39,963
Patient days		722,231			816,898			985,025
Average length of stay (days)		26			24			25
Net revenue per patient day(2)	$	1,173		$	1,306		$	1,357
Occupancy rate		70	%		67	%		70	%
Percent patient days — Medicare		76	%		74	%		75	%
Outpatient rehabilitation data (3):
Number of clinics owned — start of period		578			656			604
Number of clinics acquired		125			4			—
Number of clinic start-ups		27			20			22
Number of clinics closed/sold		(74	)		(76	)		(59	)
Number of clinics owned — end of period		656			604			567
Number of clinics managed — end of period		32			36			41
Total number of clinics (all) — end of period		688			640			608
Number of visits		4,027,768			3,810,284			3,518,740
Net revenue per visit(4)	$	87		$	90		$	90

CMS has announced that it will remove a number of diagnosis codes from the presumptive compliance list including diagnosis codes in the following categories: non-specific diagnosis codes, arthritis diagnosis codes, unilateral upper extremity amputations diagnosis, amputation status codes, prosthetic fitting and adjustment codes, some congenital anomalies diagnosis codes, and other miscellaneous diagnosis codes. According to CMS, these conditions do not demonstrate the need for intensive inpatient rehabilitation services in the absence of additional facts that would have to be pulled from a patient's medical record. These diagnosis codes are scheduled to be removed from the presumptive compliance list beginning October 1, 2015. If an IRF does not demonstrate compliance with the 60% Rule by either the presumptive method or through a review of medical records, then the facility's classification as an IRF may be terminated at the start of its next cost reporting period causing the facility to be paid as a general acute care hospital under IPPS. By removing diagnosis codes from the presumptive compliance list our facilities may be required to demonstrate compliance with the 60% Rule through medical record reviews. If our IRFs fail to demonstrate compliance with the 60% Rule through either method and are classified as general acute care hospitals, our net operating revenue and profitability may be adversely affected.

(1)		Specialty hospitals consist of long-term acute care hospitals and inpatient rehabilitation facilities.
(2)		Net revenue per patient day is calculated by dividing specialty hospital patient service revenues by the total number of patient days.

-Table 38of - Contents

~~Table~~ As a result of ~~Contents~~increased post-payment reviews of claims we submit to Medicare for our services, we may incur additional costs and may be required to repay amounts already paid to us.

(3)		Clinic data has been restated to remove the clinics operated by CBIL, which is being reported as a discontinued operation. CBIL operated 102, 101 and 109 clinics at December 31, 2003, 2004 and 2005, respectively.
(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.

We are subject to regular post-payment inquiries, investigations and audits of the claims we submit to Medicare for payment for our services. These post-payment reviews are increasing as a result of new government cost- containment initiatives, including enhanced medical necessity reviews for Medicare patients admitted to our specialty hospitals, and audits of Medicare claims under the Recovery Audit Contractor program. These additional post-payment reviews may require us to incur additional costs to respond to requests for records and to pursue the reversal of payment denials, and ultimately may require us to refund amounts paid to us by Medicare that are determined to have been overpaid.

~~Results~~ Our facilities are subject to extensive federal and state laws and regulations relating to the privacy of ~~Operations~~ individually identifiable information.

~~The~~ HIPAA ~~following~~required ~~table presents~~ the ~~combined~~United ~~consolidated~~States ~~statement~~Department of ~~operations~~Health ~~for~~and Human Services to adopt standards to protect the ~~year~~privacy and security of ~~ended~~individually ~~December 31,~~identifiable ~~2005~~health-related information. The ~~financial~~department ~~data~~released ~~for~~final regulations containing privacy standards in December of 2000 and published revisions to the ~~period~~final ~~after~~regulations in August 2002. The privacy regulations extensively regulate the ~~Merger,~~use ~~February 25,~~and ~~2005~~disclosure of individually identifiable health-related information. The regulations also provide patients with significant new rights related to understanding and controlling how ~~through~~their ~~December 31,~~health ~~2005~~information ~~(Successor~~is ~~period),~~used ~~has~~or ~~been~~disclosed. ~~added~~The security regulations require healthcare providers to ~~the~~implement ~~financial~~administrative, ~~data~~physical ~~for~~and technical practices to protect the ~~period~~security of ~~from~~individually ~~January~~identifiable 1health information that is maintained or transmitted electronically. HITECH, ~~2005~~which ~~through~~was signed into law in February 24 of 2009, ~~2005~~enhanced ~~(Predecessor~~the ~~period)~~privacy, tosecurity ~~arrive~~and atenforcement provisions ~~the~~of ~~combined~~HIPAA ~~year~~by, ~~ended December 31~~among other things establishing security breach notification requirements, ~~2005.~~allowing enforcement of HIPAA by state attorneys general, and increasing penalties for HIPAA violations. Violations of HIPAA or HITECH could result in civil or criminal penalties.

							Year Ended
							December 31,
							2005
	Predecessor			Successor			Combined
Net operating revenues	$	277,736		$	1,580,706		$	1,858,442
				(in thousands)
Costs and expenses:
Cost of services		217,133			1,244,183			1,461,316
Stock compensation expense		142,213			10,312			152,525
Long-term incentive compensation		—			14,453			14,453
General and administrative		7,484			34,907			42,391
Bad debt expense		6,588			18,213			24,801
Depreciation and amortization		5,933			37,922			43,855
Total costs and expenses		379,351			1,359,990			1,739,341
Income (loss) from operations		(101,615	)		220,716			119,101
Other income and expense:
Loss on early retirement of debt		42,736			—			42,736
Merger related charges		12,025			—			12,025
Other income		(267	)		(3,018	)		(3,285	)
Interest income		(523	)		(767	)		(1,290	)
Interest expense		4,651			83,752			88,403
Income (loss) before minority interests and income taxes		(160,237	)		140,749			(19,488	)
Minority interest in consolidated subsidiary companies		330			1,776			2,106
Income (loss) before income taxes		(160,567	)		138,973			(21,594	)
Income tax expense (benefit)		(59,794	)		56,470			(3,324	)
Income (loss) from continuing operations		(100,773	)		82,503			(18,270	)
Income from discontinued operations, net of tax		522			3,072			3,594
Net income (loss)	$	(100,251	)	$	85,575		$	(14,676	)

In addition to HIPAA, there are numerous federal and state laws and regulations addressing patient and consumer privacy concerns, including unauthorized access or theft of personal information. State statutes and regulations vary from state to state. Lawsuits, including class actions and action by state attorneys general, directed at companies that have experienced a privacy or security breach also can occur.

- We have 39developed -a comprehensive set of policies and procedures in our efforts to comply with HIPAA and other privacy laws. Our compliance officer, privacy officer and information security officer are responsible for implementing and monitoring compliance with our privacy and security policies and procedures at our facilities. We believe that the cost of our compliance with HIPAA and other federal and state privacy laws will not have a material adverse effect on our business, financial condition, results of operations or cash flows. However, there can be no assurance that a breach of privacy or security will not occur. If there is a breach, we may be subject to various penalties and damages and may be required to incur costs to mitigate the impact of the breach on affected individuals.

~~Table~~ We may be adversely affected by a cyber attack that could compromise our information technologies, which may cause a violation of ~~Contents~~HIPAA or HITECH.

~~The~~ In ~~following~~the ~~table~~normal ~~outlines~~course of business, our information technology systems hold sensitive patient information including patient demographic data, eligibility for ~~the~~various ~~periods~~medical ~~indicated~~plans including Medicare and Medicaid and protected health information, ~~selected~~which ~~operating~~is ~~data~~subject asto aHIPAA and HITECH. Additionally, we utilize those same systems to ~~percentage~~perform our day-to-day activities, such as receiving referrals, assigning medical teams to patients, documenting medical information, maintaining an accurate record of ~~net~~all ~~operating~~transactions ~~revenues:~~and processing payments. We maintain our information technology systems with safeguards protecting against cyber-attacks, including passive intrusion protection, firewalls and virus detection software. However, these safeguards do not ensure that a significant cyber attack could not occur. A cyber attack that bypasses our information technology security systems could cause the loss of protected health

	Fiscal Year Ended December 31,						Combined Year EndedDecember 31,
	2003			2004			2005(1)
Net operating revenues		100.0	%		100.0	%		100.0	%
Cost of services(2)		79.8			77.8			78.6
Stock compensation expense		—			—			8.2
Long-term incentive compensation		—			—			0.8
General and administrative		3.3			2.9			2.3
Bad debt expense		3.8			3.0			1.3
Depreciation and amortization		2.5			2.4			2.4
Income from operations		10.6			13.9			6.4
Loss on early retirement of debt		—			—			2.3
Merger related charges		—			—			0.7
Equity in earnings from joint ventures		(0.1	)		—			—
Other income		—			(0.1	)		(0.2	)
Interest expense, net		1.9			1.9			4.7
Income (loss) from continuing operations before minority interests and income taxes		8.8			12.1			(1.1	)
Minority interests		0.1			0.2			0.1
Income (loss) from continuing operations before income taxes		8.7			11.9			(1.2	)
Income tax (benefit)		3.4			4.8			(0.2	)
Income (loss) from continuing operations		5.3			7.1			(1.0	)
Income from discontinued operations, net of tax		0.3			0.3			0.2
Net income (loss)		5.6	%		7.4	%		(0.8	)%

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

							Combined
							Year
							Ended			%			%
	Fiscal Year Ended						December			Change			Change
	December 31,						31,			2003-			2004-
	2003			2004			2005			2004			2005
(in thousands)
Net operating revenues:
Specialty hospitals	$	849,260		$	1,089,538		$	1,370,320			28.3	%		25.8	%
Outpatient rehabilitation		478,553			498,830			480,711			4.2			(3.6	)
Other(4)		13,844			13,156			7,411			(5.0	)		(43.7	)
Total company	$	1,341,657		$	1,601,524		$	1,858,442			19.4	%		16.0	%
Income (loss) from operations:
Specialty hospitals	$	129,861		$	216,803		$	280,206			67.0	%		29.2	%
Outpatient rehabilitation		53,159			57,777			56,052			8.7			(3.0	)
Other(4)		(40,840	)		(52,075	)		(217,157	)		(27.5	)		(317.0	)
Total company	$	142,180		$	222,505		$	119,101			56.5	%		(46.5	)%
Adjusted EBITDA:(3)
Specialty hospitals	$	145,650		$	236,181		$	307,339			62.2	%		30.1	%
Outpatient rehabilitation		66,378			71,562			65,957			7.8			(7.8	)

information, or other data subject to privacy laws, the loss of proprietary business information, or a material disruption to our information technology business systems resulting in a material adverse effect on our business, financial condition, results of operations or cash flows. In addition, our future results could be adversely affected due to the theft, destruction, loss, misappropriation or release of protected health information, other confidential data or proprietary business information, operational or business delays resulting from the disruption of information technology systems and subsequent clean-up and mitigation activities, negative publicity resulting in reputation or brand damage with clients, members, or industry peers, or regulatory action taken as a result of such incident.

- 40We - may be adversely affected by negative publicity which can result in increased governmental and regulatory scrutiny and possibly adverse regulatory changes.

~~Table~~ Negative press coverage can result in increased governmental and regulatory scrutiny and possibly adverse regulatory changes. Adverse publicity and increased governmental scrutiny can have a negative impact on our reputation with referral sources and patients and on the morale and performance of ~~Contents~~our employees, both of which could adversely affect our businesses and results of operations.

							Combined
							Year
							Ended			%			%
	Fiscal Year Ended						December			Change			Change
	December 31,						31,			2003-			2004-
	2003			2004			2005			2004			2005
(in thousands)
Other(4)		(36,185	)		(46,287	)		(43,362	)		(27.9	)		6.3
Adjusted EBITDA margins:(3)
Specialty hospitals		17.2	%		21.7	%		22.4	%		26.2	%		3.2	%
Outpatient rehabilitation		13.9			14.3			13.7			2.9			(4.2	)
Other(4)		N/M			N/M			N/M			N/M			N/M
Total assets:
Specialty hospitals	$	512,956		$	520,572		$	1,652,532
Outpatient rehabilitation		365,534			318,180			293,720
Other		200,508			274,969			217,117
Total company	$	1,078,998		$	1,113,721		$	2,163,369
Purchases of property and equipment, net:
Specialty hospitals	$	22,559		$	23,320		$	102,321
Outpatient rehabilitation		8,514			5,885			3,750
Other		4,779			3,421			3,875
Total company	$	35,852		$	32,626		$	109,946

Future acquisitions may use significant resources, may be unsuccessful and could expose us to unforeseen liabilities.

~~The~~ As ~~following~~part ~~table~~of ~~reconciles~~our ~~net~~growth ~~income~~strategy, towe ~~Adjusted~~may ~~EBITDA~~pursue ~~for~~acquisitions ~~the~~of ~~Company~~specialty hospitals, outpatient rehabilitation clinics and other related ~~provides~~healthcare ~~the~~facilities ~~calculation~~and ofservices. ~~Adjusted~~These ~~EBITDA~~acquisitions ~~margin~~may ~~for~~involve ~~each~~significant ofcash ~~the~~expenditures, ~~periods~~debt ~~presented:~~incurrence, additional operating losses and expenses and compliance risks that could have a material adverse effect on our financial condition and results of operations.

							Combined
							Year
							Ended
	Fiscal Years Ended						December
	December 31,						31,
	2003			2004			2005(1)
				(in thousands)
Net income (loss)	$	74,471		$	118,184		$	(14,676	)
Income from discontinued operations		(3,865	)		(4,458	)		(3,594	)
Minority interest		1,661			2,608			2,106
Merger related charges		—			—			12,025
Loss on early retirement of debt		—			—			42,736
Equity in income from joint ventures		(824	)		—			—
Other income		—			(1,096	)		(3,285	)
Income tax expense (benefit)		46,238			76,551			(3,324	)
Interest expense, net		24,499			30,716			87,113
Depreciation and amortization		33,663			38,951			43,855
Long term incentive compensation		—			—			14,453
Stock compensation expense		—			—			152,525
Adjusted EBITDA(3)	$	175,843		$	261,456		$	329,934
Net revenue	$	1,341,657		$	1,601,524		$	1,858,442
Adjusted EBITDA margin (3)		13.1	%		16.3	%		17.8	%

We may not be able to successfully integrate acquired businesses into ours, and therefore we may not be able to realize the intended benefits from an acquisition. If we fail to successfully integrate acquisitions, our financial condition and results of operations may be materially adversely affected. Acquisitions could result in difficulties integrating acquired operations, technologies and personnel into our business. Such difficulties may divert significant financial, operational and managerial resources from our existing operations and make it more difficult to achieve our operating and strategic objectives. We may fail to retain employees or patients acquired through acquisitions, which may negatively impact the integration efforts. Acquisitions could also have a negative impact on our results of operations if it is subsequently determined that goodwill or other acquired intangible assets are impaired, thus resulting in an impairment charge in a future period.

- In addition, 41acquisitions -involve risks that the acquired businesses will not perform in accordance with expectations; that we may become liable for unforeseen financial or business liabilities of the acquired businesses, including liabilities for failure to comply with healthcare regulations; that the expected synergies associated with acquisitions will not be achieved; and that business judgments concerning the value, strengths and weaknesses of businesses acquired will prove incorrect, which could have an material adverse effect on our financial condition and results of operations.

~~Table~~ ofRisks ~~Contents~~associated with our potential international operations.

We may expand our operations into other countries. International operations are subject to risks that may materially adversely affect our business, results of operations and financial condition. The ~~following~~risks ~~tables~~that ~~reconcile~~our ~~same~~potential ~~hospitals~~international ~~information~~operations would be subject to include, among other things: difficulties and costs relating to staffing and managing foreign operations; fluctuations in the value of foreign currencies; repatriation of cash from our foreign operations to the United States; foreign countries may impose additional withholding taxes or otherwise tax our foreign income; separate operating and financial systems; disaster recovery; and unexpected regulatory, economic and political changes in foreign markets. In addition to the foregoing, our potential international operations will face risks associated with complying

	Twelve Months Ended
	December 31,
	2003			2004
	(in thousands)
Net operating revenue
Specialty hospitals net operating revenue	$	849,260		$	1,089,538
Less: Specialty hospitals opened, acquired or closed after 1/1/03		66,014			222,049
Specialty hospitals same store net operating revenue	$	783,246		$	867,489
Adjusted EBITDA(3)
Specialty hospitals Adjusted EBITDA(3)	$	145,650		$	236,181
Less: Specialty hospitals opened, acquired or closed after 1/1/03		2,897			46,813
Specialty hospitals same store Adjusted EBITDA(3)	$	142,753		$	189,368
All specialty hospitals Adjusted EBITDA margin(3)		17.2	%		21.7	%
Specialty hospitals same store Adjusted EBITDA margin(3)		18.2	%		21.8	%

	Twelve Months Ended
	December 31,
	2004			2005(1)
	(in thousands)
Net operating revenue
Specialty hospitals net operating revenue	$	1,089,538		$	1,370,320
Less: Specialty hospitals opened, acquired or closed after 1/1/04		30,754			218,837
Specialty hospitals same store net operating revenue	$	1,058,784		$	1,151,483
Adjusted EBITDA(3)
Specialty hospitals Adjusted EBITDA(3)	$	236,181		$	307,339
Less: Specialty hospitals opened, acquired or closed after 1/1/04		(4,591	)		34,095
Specialty hospitals same store Adjusted EBITDA(3)	$	240,772		$	273,244
All specialty hospitals Adjusted EBITDA margin(3)		21.7	%		22.4	%
Specialty hospitals same store Adjusted EBITDA margin(3)		22.7	%		23.7	%

Table of Contents

		N/M — Not Meaningful.
(1)		The financial data for the period after the Merger, February 25, 2005 through December 31, 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 year ended December 31, 2005.
(2)		Cost of services includes 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, income from discontinued operations, loss on early retirement of debt, equity in income from joint ventures, merger related charges, stock compensation expense, long-term incentive compensation, other income and minority interest. We believe that the presentation of Adjusted EBITDA is important to investors because Adjusted EBITDA is commonly used as an analytical indicator of performance by investors within the healthcare industry. Adjusted EBITDA is used by management to evaluate financial performance and determine resource allocation for each of our operating units. Adjusted EBITDA is not a measure of financial performance under generally accepted accounting principles. Items excluded from Adjusted EBITDA are significant components in understanding and assessing financial performance. Adjusted EBITDA should not be considered in isolation or as an alternative to, or substitute for, net income, cash flows generated by operations, investing or financing activities, or other financial statement data presented in the consolidated financial statements as indicators of financial performance or liquidity. Because Adjusted EBITDA is not a measurement determined in accordance with generally accepted accounting principles and is thus susceptible to varying calculations, Adjusted EBITDA as presented may not be comparable to other similarly titled measures of other companies. See footnote 13 to our audited consolidated financial statements for a reconciliation of net income to Adjusted EBITDA as utilized by us in reporting our segment performance in accordance with SFAS No. 131.
(4)		Other includes the company’s general and administrative services, as well as businesses associated with the sale of home medical equipment, orthotics, prosthetics, and infusion/intravenous services.

with laws governing our foreign business operations, including the U.S. Foreign Corrupt Practices Act and applicable regulatory requirements.

- 42Future - joint ventures may use significant resources, may be unsuccessful and could expose us to unforeseen liabilities.

~~Table~~ As part of ~~Contents~~our growth strategy, we may partner with large health care systems to provide post acute care services. These joint ventures may involve significant cash expenditures, debt incurrence, additional operating losses and expenses, and compliance risks that could have a material adverse effect on our financial condition and results of operations.

~~Combined~~ A joint ~~Year~~venture ~~Ended~~involves ~~December 31~~the combining of corporate cultures and mission. As a result, ~~2005~~we ~~Compared~~may not be able to ~~Year~~successfully ~~Ended~~operate ~~December 31~~a joint venture, ~~2004~~and therefore we may not be able to realize the intended benefits. If we fail to successfully execute a joint venture relationship, our financial condition and results of operations may be materially adversely affected. A new joint venture could result in difficulties in combining operations, technologies and personnel. Such difficulties may divert significant financial, operational and managerial resources from our existing operations and make it more difficult to achieve our operating and strategic objectives. We may fail to retain employees or patients as a result of the integration efforts.

~~Net~~ A joint ~~Operating~~venture ~~Revenues~~is operated through a board of directors that contains representatives of Select and other parties to the joint venture. We may not control the board or some actions of the board may require supermajority votes. As a result, the joint venture may elect certain actions that could have adverse effects on our financial condition and results of operations.

~~Our~~ ~~net~~Future ~~operating~~cost ~~revenues~~containment ~~increased~~initiatives undertaken by ~~16.0%~~private tothird-party ~~$1,858.4 million~~payors ~~for~~may ~~the~~limit ~~combined~~our ~~year~~future ~~ended December 31,~~net ~~2005~~operating ~~compared~~revenues toand ~~$1,601~~profitability.~~5 million for the year ended December 31, 2004.~~

~~Specialty~~ Initiatives ~~Hospitals.~~undertaken ~~Our~~by ~~specialty~~major ~~hospital~~insurers ~~net~~and ~~operating~~managed ~~revenues~~care ~~increased~~companies ~~25.8%~~ to ~~$1,370.3 million~~ ~~for~~contain ~~the~~healthcare ~~combined~~costs ~~year~~affect ~~ended December 31, 2005 compared to $1,089.5 million for~~ the ~~year~~ ~~ended~~profitability ~~December 31,~~of ~~2004. Net operating revenues for the~~ our specialty hospitals ~~opened before January 1, 2004~~ and ~~operated~~outpatient byrehabilitation usclinics. ~~throughout~~These ~~both~~payors ~~years~~attempt ~~increased~~to ~~8.8%~~control tohealthcare ~~$1,151.5 million~~costs ~~for~~by ~~the combined~~contracting ~~year~~with ~~ended~~hospitals ~~December 31,~~and ~~2005~~other ~~from~~healthcare ~~$1,058.8 million~~providers ~~for~~to ~~the~~obtain ~~year~~services ~~ended~~on ~~December 31,~~a discounted ~~2004~~basis. ~~This~~ ~~increase~~We ~~resulted~~believe ~~from~~that ~~both~~this antrend ~~increase~~may incontinue ~~our patient days~~ and ~~higher~~may ~~net~~limit ~~revenue~~reimbursements ~~per~~for ~~patient day~~healthcare services. ~~Our~~If ~~patient~~insurers ~~days~~or ~~for~~managed ~~these~~care ~~hospitals~~companies ~~increased~~from ~~5.0%~~whom ~~and~~we ~~our~~receive ~~occupancy~~substantial ~~percentage~~payments ~~increased to~~reduce ~~72% for~~ the ~~combined~~amounts ~~year~~they ~~ended~~pay ~~December 31~~for services, ~~2005~~our ~~compared~~profit tomargins ~~69%~~may ~~for the year ended December 31~~decline, ~~2004.~~ ~~The~~or ~~remaining~~we ~~increase~~may oflose ~~$188.1 million~~patients ~~resulted~~if ~~primarily~~we ~~from~~choose ~~the~~not ~~acquisition~~to ofrenew ~~the SemperCare~~our ~~facilities,~~contracts ~~which~~with ~~contributed~~these ~~$172.5 million~~insurers ofat ~~net~~lower ~~revenue growth~~rates.

~~Outpatient~~ ~~Rehabilitation.~~If ~~Our~~we ~~outpatient~~fail ~~rehabilitation net operating revenues declined 3.6%~~ to ~~$480.7 million~~maintain ~~for~~established ~~the~~relationships ~~combined~~with ~~year ended December 31, 2005 compared to $498.8 million for~~ the ~~year~~ ~~ended~~physicians ~~December 31, 2004. The number of patient visits~~ in ~~our outpatient rehabilitation clinics declined 7.7% for~~ the ~~combined~~areas ~~year~~we ~~ended December 31~~serve, ~~2005~~our ~~to 3,518,740 visits compared to 3,810,284 visits for the year ended December 31, 2004. The decrease in~~ net operating revenues ~~and patient~~may ~~visits was principally related to a 6~~decrease.1% decline in the number of clinics we operate and a 1.6% decline in the volume of visits per clinic. Net revenue per visit in these clinics was $90 in both 2005 and 2004. Offsetting the net operating revenue decline in our outpatient rehabilitation clinics were increases in our contract services revenues.

~~Other.~~ Our ~~other~~success ~~revenues~~is ~~were~~partially ~~$7.4 million~~dependent ~~for~~upon the ~~combined~~admissions ~~year~~and ~~ended~~referral ~~December 31,~~practices ~~2005 compared~~of tothe ~~$13.2 million~~physicians ~~for~~in the ~~year~~communities ~~ended~~our ~~December 31~~hospitals and our outpatient rehabilitation clinics serve, ~~2004~~and our ability to maintain good relations with these physicians. ~~These~~Physicians ~~revenues~~referring patients to our hospitals and clinics are ~~principally~~generally not our ~~related~~employees toand, ~~the~~in ~~sales~~many of ~~orthotics,~~the ~~prosthetics,~~local ~~home~~areas ~~medical~~that ~~equipment~~we serve, most physicians have admitting privileges at other hospitals and ~~infusion/intravenous services.~~are Infree ~~May 2005~~to werefer ~~sold~~their ~~the~~patients ~~assets~~to ofother ~~our~~providers. ~~home~~If ~~medical~~we ~~equipment~~are ~~and~~unable ~~infusion/intravenous~~to ~~service~~successfully ~~business~~cultivate and maintain strong relationships with these physicians, ~~which~~our ~~resulted~~hospitals' inadmissions ~~the~~and ~~reduction~~clinics' inbusinesses may decrease, and our ~~other~~net operating revenues may decline.

~~Operating~~ ~~Expenses~~Changes in federal or state law limiting or prohibiting certain physician referrals may preclude physicians from investing in our hospitals or referring to hospitals in which they already own an interest.

Our operating expenses increased by 14.1% to $1,528.5 million for the combined year ended December 31, 2005 compared to $1,340.1 million for the year ended December 31, 2004. Our operating expenses include our cost of services, general and administrative expense and bad debt expense. The ~~increase~~Stark inLaw ~~operating~~prohibits ~~expenses~~a ~~was~~physician ~~principally~~who ~~related~~has toa ~~the~~financial ~~acquisition~~relationship ofwith ~~SemperCare facilities~~an onentity ~~January 1,~~from ~~2005.~~referring Ashis aor ~~percentage~~her ofMedicare ~~our~~or ~~net operating revenues, our operating~~Medicaid ~~expenses~~patients ~~were 82.2% for the combined year ended December 31, 2005 compared~~ to ~~83.7%~~that ~~for~~entity ~~the year ended December 31, 2004. Cost of services as a percentage of operating revenues was 78.6%~~ for ~~the combined~~certain ~~year~~designated ~~ended~~health ~~December 31~~services, ~~2005~~including ~~compared~~inpatient ~~to 77.8% for the year ended December 31, 2004. This increase was due to higher labor~~ and ~~operating costs in our~~ outpatient ~~division~~hospital ~~combined with higher non-labor costs in our hospitals. Another component of cost of~~ services ~~is facility rent expense, which was $81~~.~~6 million~~ ~~for~~Under the ~~combined~~transparency year ended December 31, 2005 compared to $75.6 million for the year ended December 31, 2004. This increase is principally related to the SemperCare hospitals we acquired on January 1, 2005. During the same time period, general and ~~administrative~~ ~~expense~~program asintegrity aprovisions ~~percentage~~ of ~~net operating revenues declined to 2.3% for~~ the ~~combined year ended December 31~~ACA, ~~2005 from 2.9% for~~ the ~~year ended December 31, 2004. This decrease in~~exception ~~general~~to ~~and administrative expenses is~~ the ~~result~~Stark ofLaw athat ~~decline~~previously inpermitted ~~our~~physicians ~~expense~~to ~~for~~refer ~~abandoned hospital~~patients ~~development~~to ~~projects~~hospitals in ~~2005.~~which ~~Our~~they ~~bad~~have ~~debt~~an ~~expense~~ownership asor ainvestment ~~percentage~~interest ofhas ~~net~~been ~~operating revenues~~dramatically ~~was 1~~curtailed.3% ~~for~~Only ~~the combined year ended December 31~~hospitals, ~~2005~~

~~- 43 -~~ 38

Table of Contents

~~compared~~including specialty hospitals, with physician ownership and a provider agreement in place on December 31, 2010 are exempt from the general ban on self-referral. Existing physician- owned hospitals are prohibited from increasing the percentage of physician ownership or investment interests held in the hospital after March 23, 2010. In addition, physician-owned hospitals are prohibited from increasing the number of licensed beds after March 23, 2010, unless meeting specific exceptions related to the hospital's location and patient population. In order to retain their exemption from the general ban on self- referrals, our physician owned hospitals are required to adopt specific measures relating to conflicts of interest, bona fide investments and patient safety. Furthermore, initiatives are underway in some states to restrict physician referrals to physician-owned hospitals. Currently, 11 of our consolidating hospitals have physicians as minority owners. The aggregate net operating revenue of these 11 hospitals was $194.1 million for the year ended December 31, 2014, or approximately 6.3% of our consolidated net operating revenues for the year ended December 31, 2014. The range of physician minority ownership of these 11 hospitals was 2.1% to 49.0% ~~for~~as of the year ended December 31, ~~2004~~2014. ~~This~~There ~~decrease~~can be no assurance that new legislation or regulation prohibiting or limiting physician referrals to physician-owned hospitals will not be successfully enacted in the future. If such federal or state laws are ~~bad~~adopted, ~~debt~~among ~~expense~~other ~~resulted~~outcomes, ~~from~~physicians ~~continued~~who ~~improvement~~have invested in our ~~collection~~hospitals could be precluded from referring to, investing in or continuing to be physician owners of ~~non~~a hospital. In addition, expansion of our physician-~~Medicare~~ ~~accounts~~owned ~~receivable~~hospitals may be limited, and the revenues, profitability and overall financial performance of our hospitals may be negatively affected.

~~Adjusted~~ ~~EBITDA~~ We could experience significant increases to our operating costs due to shortages of healthcare professionals or union activity.

~~Specialty~~ Our ~~Hospitals.~~specialty ~~Adjusted~~hospitals ~~EBITDA~~are ~~increased~~highly bydependent ~~30.1%~~on tonurses, ~~$307.3 million~~and ~~for~~our ~~the~~outpatient ~~combined year~~rehabilitation ~~ended~~division ~~December 31,~~is ~~2005~~highly ~~compared~~dependent toon ~~$236.2 million~~ therapists, for ~~the~~patient ~~year ended December 31, 2004~~care. ~~Our Adjusted~~The ~~EBITDA~~market ~~margins increased to 22.4%~~ for ~~the~~qualified ~~combined~~healthcare ~~year~~professionals ~~ended~~is ~~December 31,~~highly ~~2005 from 21~~competitive.~~7% for~~ ~~the~~We ~~year~~have ~~ended~~sometimes ~~December 31,~~experienced ~~2004.~~difficulties ~~The~~in ~~hospitals~~attracting ~~opened before January 1, 2004~~ and ~~operated throughout~~retaining ~~both~~qualified ~~years~~healthcare ~~had Adjusted EBITDA of $273~~personnel.~~2 million,~~ ~~an increase of 13.5% over the Adjusted~~We ~~EBITDA~~cannot ofassure ~~these~~you ~~hospitals~~we inwill ~~2004.~~be ~~The~~able ~~increase~~to inattract ~~same~~and ~~store~~retain ~~hospitals’~~qualified ~~Adjusted~~healthcare ~~EBITDA~~professionals ~~resulted primarily from an increase~~ in ~~net~~the ~~revenue per patient day and patient days~~future. Additionally, ~~during 2005 we recorded a one-time benefit of $3.8 million due to~~ the ~~reversal~~cost of anattracting ~~accrued~~and ~~patient~~retaining ~~care liability~~qualified ashealthcare apersonnel ~~result~~may ~~of the termination of this obligation. Our Adjusted EBITDA margin in these~~be ~~same~~higher ~~store~~than ~~hospitals~~we ~~increased~~anticipate, toand ~~23.7%~~as ~~for~~a ~~the combined year ended December 31~~result, ~~2005~~our ~~from~~profitability ~~22.7% for~~could ~~the year ended December 31, 2004~~decline.

~~Outpatient~~ In addition, ~~Rehabilitation~~U.S. ~~Adjusted~~healthcare ~~EBITDA~~providers ~~decreased~~are bycontinuing ~~7.8%~~ to ~~$66.0 million~~see ~~for~~an ~~the combined~~increase ~~year~~in ~~ended~~the ~~December 31,~~amount ~~2005~~of ~~compared~~union ~~to $71~~activity.~~6 million~~ ~~for~~Though ~~the~~we ~~year~~cannot ~~ended~~predict ~~December 31, 2004.~~the ~~Our~~degree ~~Adjusted EBITDA margins declined~~ to ~~13.7%~~which ~~for~~we ~~the~~will ~~combined~~be ~~year~~affected ~~ended~~by ~~December 31,~~future ~~2005~~union ~~from~~activity, ~~14.3%~~there ~~for~~are ~~the~~continuing ~~year~~legislative ~~ended~~proposals ~~December 31,~~that ~~2004.~~could ~~The~~result ~~decline~~ in ~~Adjusted~~increased ~~EBITDA~~union ~~was~~activity. ~~the~~We ~~result~~could ~~of the~~experience ~~decline~~an increase in ~~clinic~~labor ~~visit~~and ~~volumes,~~other ~~described under—“Net~~costs ~~Operating~~from ~~Revenue~~such ~~-Outpatient~~union ~~Rehabilitation” above, combined with higher labor costs~~activity.

~~Other.~~ ~~The~~Competition ~~Adjusted~~may ~~EBITDA~~limit ~~loss, which primarily includes~~ our ~~general~~ability ~~and administrative expenses, was $43.4 million for the combined year ended December 31, 2005 compared~~ to aacquire ~~loss~~hospitals ~~of $46.3 million~~and ~~for~~clinics ~~the~~and ~~year~~adversely ~~ended~~affect ~~December 31, 2004. This reduction in the Adjusted EBITDA loss was primarily the result of the decline in~~ our ~~general and administrative expenses~~growth.

~~Stock~~ We ~~Compensation~~have ~~Expense~~historically faced limited competition in acquiring specialty hospitals and outpatient rehabilitation clinics, but we may face heightened competition in the future. Our competitors may acquire or seek to acquire many of the hospitals and clinics that would be suitable acquisition candidates for us. This increased competition could hamper our ability to acquire companies, or such increased competition may cause us to pay a higher price than we would otherwise pay in a less competitive environment. Increased competition from both strategic and financial buyers could limit our ability to grow by acquisitions or make our cost of acquisitions higher and therefore decrease our profitability.

In ~~connection~~If ~~with~~we ~~the~~fail ~~Merger, Holdings, our parent, granted restricted stock awards~~ to ~~certain~~ ~~key~~compete ~~management~~effectively ~~employees.~~with ~~These~~other ~~awards generally vest over five years. Effective at the time of the Merger~~hospitals, ~~Holdings~~clinics ~~also granted stock options to certain other key employees that vest over five years. The fair value of restricted stock awards~~ and ~~stock~~healthcare ~~options~~providers ~~vesting~~in ~~during~~ the ~~Successor~~ ~~period~~local ~~was~~areas ~~$10.3 million.~~we ~~Additionally~~serve, ~~during the Predecessor period of January 1, 2005 through February 25, 2005 all of~~ our ~~then~~net ~~outstanding~~operating ~~stock~~revenues ~~options~~and ~~were~~profitability ~~redeemed in accordance~~may ~~with the Merger agreement~~decline. ~~This resulted in a charge of $142.2 million.~~

~~Long-term~~ The ~~Incentive~~healthcare ~~Compensation~~business is highly competitive, and we compete with other hospitals, rehabilitation clinics and other healthcare providers for patients. If we are unable to compete effectively in the specialty hospital and outpatient rehabilitation businesses, our net operating revenues and profitability may decline. Many of our specialty hospitals operate in geographic areas where we compete with at least one other hospital that provides similar services. Our outpatient rehabilitation clinics face competition from a variety of local and national outpatient rehabilitation providers. Other outpatient rehabilitation clinics in local

As a result of the special dividend of $175.0 million paid to Holdings’ preferred stockholders on September 29, 2005, certain members of senior management of the Company became entitled to a payment of $14.5 million under the terms of Holdings’ long-term incentive compensation plan. 39

~~Income~~Table ~~(Loss)~~of ~~from Operations~~ Contents

~~For the combined year ended December 31, 2005~~ areas we ~~experienced~~serve ~~income~~may ~~from~~have ~~operations~~greater ofname ~~$119.1 million~~recognition ~~compared~~and tolonger ~~income~~operating ~~from~~histories ~~operations~~than ofour ~~$222~~clinics.~~5 million~~ ~~for the year ended December 31, 2004.~~ The ~~lower~~managers ~~income~~of ~~from~~these ~~operations~~clinics ~~experienced~~may ~~for~~also ~~the~~have ~~combined~~stronger ~~year~~relationships ~~ended~~with ~~December 31,~~physicians ~~2005~~in ~~resulted~~their ~~from~~communities, ~~the~~which ~~significant~~could ~~stock~~give ~~compensation~~them ~~costs~~a ~~related~~competitive toadvantage ~~the~~for ~~Merger~~patient ~~of $152~~referrals.~~5 million~~ ~~and an increase in depreciation and amortization of $4.9 million, offset by the Adjusted EBITDA increases~~

-Our 44business - operations could be significantly disrupted if we lose key members of our management team.

~~Table~~ Our success depends to a significant degree upon the continued contributions of ~~Contents~~our senior officers and other key employees, and our ability to retain and motivate these individuals. We currently have employment agreements in place with four executive officers and change in control agreements and/or non-competition agreements with several other officers. Many of these individuals also have significant equity ownership in our company. We do not maintain any key life insurance policies for any of our employees. The loss of the services of any of these individuals could disrupt significant aspects of our business, could prevent us from successfully executing our business strategy and could have a material adverse affect on our results of operations.

~~described~~ ~~above.~~Significant ~~The~~legal ~~stock~~actions ~~compensation~~could ~~expense~~subject ~~was~~us ~~comprised of $142.2 million related~~ to ~~the~~ ~~cancellation~~substantial ofuninsured ~~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 and an additional $10~~liabilities.~~3 million of stock compensation expense related to shares of restricted stock that were issued in the Successor period of February 25, 2005 through December 31, 2005.~~

~~Loss~~ Physicians, onhospitals ~~Early~~and ~~Retirement~~other healthcare providers have become subject to an increasing number of ~~Debt~~legal actions alleging malpractice, product liability or related legal theories. Many of these actions involve large claims and significant defense costs. We are also subject to lawsuits under federal and state whistleblower statutes designed to combat fraud and abuse in the healthcare industry. These whistleblower lawsuits are not covered by insurance and can involve significant monetary damages and award bounties to private plaintiffs who successfully bring the suits. See "Legal Proceedings" and Note 14 in our audited consolidated financial statements.

In We currently ~~connection~~maintain ~~with~~professional ~~the~~malpractice ~~Merger,~~liability weinsurance ~~commenced~~and ~~tender~~general ~~offers~~liability toinsurance ~~acquire~~coverages ~~all~~under a combination of ~~our~~policies ~~91/2%~~with ~~senior~~a total annual aggregate limit of ~~subordinated~~$30.0 million. ~~notes~~Our ~~due~~insurance ~~2009~~for ~~and~~the ~~all~~professional ofliability ~~our~~coverage ~~71/2%~~is ~~senior~~written ~~subordinated~~on ~~notes~~a ~~due~~"claims-made" ~~2013.~~basis ~~Upon~~and ~~completion~~our commercial ofgeneral ~~the~~liability ~~tender~~coverage ~~offers~~is maintained on ~~February 24,~~an ~~2005,~~"occurrence" ~~all $175~~basis.~~0 million~~ ofThese ~~the~~coverages ~~71/2%~~apply ~~senior~~after ~~subordinated~~a ~~notes were~~self-insured ~~tendered~~retention ~~and~~of $~~169~~2.30 million ofper ~~the~~medical incident for professional liability claims and $~~175~~2.0 million ofper ~~91/2%~~occurrence ~~notes~~for ~~were~~general ~~tendered~~liability claims. ~~The~~We ~~loss consists~~review ofour ~~the~~insurance ~~tender~~program ~~premium~~annually ~~cost~~and may make adjustments to the amount of ~~$34~~insurance coverage and self-insured retentions in future years.~~8 million~~ In addition, our insurance coverage does not generally cover punitive damages and ~~the~~may ~~remaining~~not ~~unamortized~~cover ~~deferred financing~~all ~~costs~~claims ofagainst $7us.9 See "Business ~~million.~~— Government Regulations — Other Healthcare Regulations."

~~Merger~~ ~~Related~~Concentration ~~Charges~~ of ownership among our existing executives and directors may prevent new investors from influencing significant corporate decisions.

As Our aexecutives ~~result~~and ofdirectors, ~~the~~beneficially ~~Merger~~own, wein ~~incurred~~the ~~costs~~aggregate, ofapproximately ~~$12~~19.~~0 million~~9% inof ~~the~~Holdings' ~~Predecessor~~outstanding ~~period~~common stock as of ~~January~~February 1, ~~2005~~2015. ~~through~~As ~~February 24~~a result, ~~2005~~these ~~directly~~stockholders ~~related~~have significant control over our management and policies and are able to ~~the~~exercise ~~Merger.~~influence ~~This~~over ~~included~~all ~~the~~matters ~~fees~~requiring stockholder approval, ofincluding the ~~investment~~election ~~advisor~~of ~~hired~~directors, byamendment ~~the~~of ~~Special~~our ~~Committee~~certificate of ~~our~~incorporation ~~Board~~and approval of ~~Directors~~significant tocorporate ~~evaluate~~transactions. ~~the~~The directors elected by these stockholders are able to make ~~Merger~~decisions affecting our capital structure, ~~legal~~including ~~and~~decisions ~~accounting~~to ~~fees~~issue additional capital stock, ~~costs~~implement ~~associated~~stock ~~with~~repurchase ~~the~~programs ~~Hart-Scott-Rodino~~and ~~filing~~incur ~~related~~indebtedness. to This influence may have the ~~Merger~~effect of deterring hostile takeovers, ~~cost~~delaying ~~associated~~or ~~with~~preventing ~~purchasing~~changes ain ~~six~~control ~~year~~or ~~extended~~changes ~~reporting~~in ~~period~~management, ~~under~~or limiting the ability of our ~~directors~~ ~~and~~other ~~officers~~stockholders ~~liability~~to ~~insurance~~approve ~~policy~~transactions ~~and~~that ~~other~~they ~~associated~~may ~~expenses.~~deem to be in their best interest.

~~Interest~~ ~~Expense~~ Our substantial indebtedness may limit the amount of cash flow available to invest in the ongoing needs of our business.

~~Interest~~ We ~~expense~~have ~~increased~~a bysubstantial ~~$55.1 million~~amount toof ~~$88~~indebtedness.~~4 million~~ ~~for~~As ~~the~~of ~~combined year ended~~ December 31, ~~2005~~2014, ~~from~~we had approximately $331,553.30 million ~~for~~of total indebtedness. For the ~~year~~years ended December 31, ~~2004. The increase in interest expense is due to the higher debt levels outstanding in the Successor period of February 25~~2012, ~~2005 through~~ December 31, ~~2005.~~2013 ~~During~~and ~~this Successor period we had approximately $1.0 billion in additional debt compared to the same period in 2004.~~

~~Minority Interests~~ 40

~~Minority~~Table ~~interests~~of ~~in consolidated earnings was $2.1 million for the combined year ended December 31, 2005 compared to $2.6 million for the year ended December 31, 2004.~~ Contents

~~Income Taxes~~December 31, 2014, we paid cash interest of $80.7 million, $89.1 million and $78.8 million, respectively, on our indebtedness.

~~We recorded income tax benefit of $59.8 million for the Predecessor period of January 1, 2005~~ Our ~~through~~indebtedness ~~February 24,~~could ~~2005.~~have ~~The~~important ~~tax~~consequences benefit represented an effective tax benefit rate of 37.2%. This effective tax benefit rate consisted of the statutory federal rate of 35% and a state rate of 2.2%. The federal tax benefit was carried forward and used to ~~offset our federal tax throughout the remainder of 2005~~you. 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 $56.5 million for the Successor period of February 25, 2005 through December 31, 2005. The expense represented an effective tax rate of 40.6%. For ~~the year ended December 31~~example, ~~2004~~ ~~we recorded income tax expense of $76.6 million. This expense represented an effective tax rate of 40.2%.~~ it:

•: requires us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, reducing the availability of our cash flow to fund working capital, capital expenditures, development activity, acquisitions and other general corporate purposes;
•: increases our vulnerability to adverse general economic or industry conditions;
•: limits our flexibility in planning for, or reacting to, changes in our business or the industries in which we operate;
•: makes us more vulnerable to increases in interest rates, as borrowings under our senior secured credit facilities are at variable rates;
•: limits our ability to obtain additional financing in the future for working capital or other purposes; and
•: places us at a competitive disadvantage compared to our competitors that have less indebtedness.

~~Income~~ See "Management's ~~from~~Discussion ~~Discontinued~~and ~~Operations,~~Analysis ~~Net~~of Financial Condition and Results of ~~Tax~~ Operations — Liquidity and Capital Resources."

-Our 45senior -secured credit facilities and the indenture governing Select's 6.375% senior notes require Select to comply with certain financial covenants, the default of which may result in the acceleration of certain of our indebtedness.

~~Table~~ The senior secured credit facilities require Select to maintain a leverage ratio (based upon the ratio of ~~Contents~~indebtedness to consolidated EBITDA as defined in the agreement), which is tested quarterly and becomes more restrictive over time. The senior secured credit facilities also prohibit Select from making capital expenditures in excess of $125.0 million in any fiscal year (subject to a 50% carry-over provision). Failure to comply with these covenants would result in an event of default under the senior secured credit facilities and, absent a waiver or an amendment from the lenders, preclude Select from making further borrowings under the revolving credit facility and permit the lenders to accelerate all outstanding borrowings under the senior secured credit facilities.

~~On March 1~~ In addition, ~~2006,~~the weindenture ~~sold~~governing ~~our~~Select's ~~wholly-owned~~6.375% ~~subsidiary~~senior ~~Canadian~~notes ~~Back~~also ~~Institute~~contains ~~Limited (“CBIL”) for approximately C$89~~covenants.~~8 million~~ inFailure ~~cash (US$79.0 million).~~to Ascomply ofwith ~~December 31,~~those ~~2005,~~covenants ~~CBIL operated~~would ~~109~~result ~~outpatient rehabilitation clinics~~ in ~~seven~~an ~~Canadian~~event ~~provinces. We conducted all~~ of ~~our Canadian~~default ~~operations~~under ~~through CBIL. The purchase price is subject to a post-closing adjustment based on~~ the ~~amount of net working capital~~ indenture and, ~~long~~absent ~~term~~a ~~liabilities~~waiver ofor ~~CBIL~~an ~~and~~amendment, ~~its~~permit ~~subsidiaries on~~ the ~~closing~~ ~~date.~~trustee ~~The~~or ~~financial~~holders ~~results~~ of ~~CBIL~~25% ~~have~~of ~~been~~the ~~reclassified~~notes asto ~~discontinued~~accelerate ~~operations for~~ all ~~periods~~outstanding ~~presented~~6.375% insenior ~~this~~notes ~~report,~~under ~~and~~the ~~its assets and liabilities have been reclassified as held for sale on our December 31, 2005 balance sheet~~indenture.

On As of ~~September~~December 2731, ~~2004~~2014, weSelect ~~sold~~was ~~the~~required ~~land,~~to ~~building~~maintain ~~and~~its ~~certain~~leverage ~~other~~ratio ~~assets~~(its ~~and~~ratio ~~liabilities associated~~of ~~with~~total ~~our~~indebtedness ~~only~~to ~~skilled~~consolidated ~~nursing~~EBITDA ~~facility~~ for ~~$11.6~~the ~~million,~~prior ~~which~~four weconsecutive ~~acquired~~fiscal asquarters) at ~~part~~less ofthan ~~the~~5.00 ~~Kessler acquisition~~to ~~in September 2003~~1.00. ~~The~~For ~~operating~~the ~~results~~four ofquarters ~~the~~ended ~~skilled~~December 31, ~~nursing~~2014, ~~facility~~Select's ~~have~~leverage ~~been reclassified~~ratio ~~and~~was ~~reported~~4.18 asto ~~discontinued operations~~1. 00.

~~Year~~ While Select ~~Ended~~has ~~December 31~~never defaulted on compliance with any of these financial covenants, ~~2004~~its ~~Compared~~ability to ~~Year~~comply ~~Ended~~with ~~December 31~~these ratios in the future may be affected by events beyond its control. Inability to comply with the required financial covenants could result in a default under our senior secured credit facilities and indenture. In the event of any default under our senior secured credit facilities, ~~2003~~the lenders under our senior secured credit facilities could elect to terminate borrowing commitments and declare all borrowings outstanding, together with accrued and unpaid interest and other fees, to be immediately due and payable. In the event of any default under our indenture, the trustee or holders of 25% of the notes could declare all outstanding 6.375% senior notes immediately due and payable.

~~Net Operating Revenues~~ 41

~~Our~~Table ~~net~~of ~~operating revenues increased by 19.4% to $1,601.5 million for the year ended December 31, 2004 compared to $1,341.7 million for the year ended December 31, 2003.~~ Contents

~~Specialty~~ ~~Hospitals.~~Despite ~~Our~~our ~~specialty~~substantial ~~hospital~~level ~~net~~of ~~operating revenues increased 28.3% to $1~~indebtedness,~~089.5 million~~ ~~for~~we ~~the year ended December 31, 2004 compared to $849.3 million for the year ended December 31, 2003. Net operating revenues for the specialty hospitals opened before January 1, 2003~~ and ~~operated~~ byour ussubsidiaries ~~throughout~~may ~~both~~be ~~periods~~able ~~increased 10.8%~~ to ~~$867.5 million~~incur ~~for~~additional ~~the year ended December 31, 2004 from $783~~indebtedness.~~2 million~~ ~~for the year ended December 31, 2003.~~ This ~~increase~~could ~~resulted primarily~~further ~~from~~exacerbate higher net revenue per patient day, offset by a decline in our patient days and occupancy rates. Our patient days and occupancy rates declined primarily as a result of additional admissions criteria implemented in our long-term acute care hospitals. The remaining increase of $155.9 million resulted from the ~~acquisition~~risks ofdescribed ~~the Kessler facilities, which contributed $96~~above.~~3 million of net revenue growth, and the internal development of new specialty hospitals that commenced operations in 2003 and 2004.~~

~~Outpatient~~ We ~~Rehabilitation.~~and ~~Our~~our ~~outpatient~~subsidiaries ~~rehabilitation~~may ~~net~~be ~~operating~~able ~~revenues~~to ~~increased~~incur ~~4.2% to~~additional ~~$498.8 million~~indebtedness ~~for~~in the ~~year~~future. ~~ended~~Although ~~December 31,~~our ~~2004~~senior ~~compared~~secured tocredit ~~$478.6 million for the year~~facilities ~~ended~~contain ~~December 31,~~restrictions ~~2003.~~on ~~The~~the ~~increase~~incurrence inof ~~net~~additional ~~operating~~indebtedness, ~~revenues~~these ~~was~~restrictions ~~principally~~are ~~related~~subject to ~~the acquisition~~a number of ~~the~~qualifications ~~Kessler~~and ~~operations.~~exceptions, ~~The~~and ~~number~~the ofindebtedness ~~patient~~incurred ~~visits~~ in ~~our~~compliance ~~outpatient~~with these ~~rehabilitation~~restrictions ~~clinics~~could ~~declined~~be 5substantial.4% ~~for~~Also, ~~the~~these ~~year~~restrictions ~~ended~~do ~~December 31,~~not ~~2004~~prevent tous ~~3,810,284~~or ~~visits compared~~our tosubsidiaries ~~4,027,768~~from ~~visits~~incurring ~~for~~obligations ~~the~~that ~~year~~do ~~ended~~not ~~December 31,~~constitute ~~2003~~indebtedness. ~~Net~~As ~~revenue~~of ~~per~~December 31, ~~visit~~2014, inwe ~~these~~had ~~clinics was~~ $90249.7 million inof ~~2004~~revolving ~~compared~~loan toavailability ~~$87~~under inour ~~2003.~~senior ~~Excluding~~secured ~~the~~credit ~~effects~~facilities of(after ~~the~~giving ~~Kessler~~effect ~~operations~~to ~~in both periods, visits declined 11~~$40.~~0%.~~3 million ~~The majority~~ of ~~this~~outstanding ~~decline~~letters isof ~~related to clinic closures~~credit). In addition, ~~during~~to the extent ~~first~~new ~~and~~debt ~~second~~is ~~quarters~~added ofto ~~2004~~our ~~various market factors such as elimination of unprofitable contracts~~ and ~~competition~~our ~~from~~subsidiaries' ~~referring~~current ~~physicians~~debt ~~who~~levels, ~~are~~the ~~now~~substantial ~~developing~~leverage ~~their own~~risks ~~rehabilitation~~described ~~therapy~~above ~~practices~~would ~~contributed to the decline~~increase.

~~Other.~~ ~~Our other revenues declined to $13.2 million for the year ended December 31, 2004~~ ~~compared to $13.8~~ Item ~~million for the year ended December 31, 2003~~1B. Unresolved ~~The~~Staff ~~principal reason for the decline is the conversion of our long-term acute care hospitals to LTCH-PPS and the associated changes in how we get reimbursed for the services which was $8~~Comments.7 million in 2003. The decline was offset by revenues related to the Kessler other businesses that are now being reported under this category. These businesses generated approximately $7.9 million of incremental net operating revenues in 2004. See “— Critical Accounting Matters — Sources of Revenue” for a further discussion of this change.

~~Operating Expenses~~ None.

~~- 46 -~~ Item 2. Properties.

~~Table~~ We currently lease most of ~~Contents~~our facilities, including clinics, offices, specialty hospitals and our corporate headquarters. We own 25 of our specialty hospitals.

~~Our operating expenses increased by 15.0% to $1,340.1 million for the year ended December 31,~~ We ~~2004~~lease ~~compared~~all tobut ~~$1,165.8 million~~one ~~for~~of ~~the year ended December 31, 2003. Our operating expenses include~~ our ~~cost~~outpatient ofrehabilitation ~~services,~~clinics ~~general~~ and ~~administrative expense and bad debt expense. The increase in operating expenses was principally~~ related ~~to the acquisition of Kessler and the internal development of new specialty hospitals that commenced operations in 2003 and 2004. As a percentage of our net operating revenues~~offices, ~~our operating expenses were 83.7% for the year ended December 31~~which, ~~2004~~ ~~compared to 86.9% for the year ended December 31, 2003. Cost of services~~ as ~~a percentage~~ of ~~operating~~ ~~revenues decreased to 77.8% for the year ended~~ December 31, ~~2004~~2014 ~~from~~included ~~79.8%~~879 ~~for~~leased ~~the~~outpatient ~~year ended~~rehabilitation ~~December 31,~~clinics ~~2003. These costs primarily reflect our labor expenses. This decrease resulted~~throughout ~~because we experienced a larger rate of growth in our specialty hospital revenues compared to~~ the ~~growth~~ inUnited ~~our specialty hospital cost of services~~States. ~~Another~~We ~~component~~also oflease ~~cost of services is facility rent expense, which was $75.6 million for~~ the ~~year~~majority ~~ended~~of ~~December 31, 2004 compared to $68.0 million for the year ended December 31, 2003. This increase is principally related to~~ our ~~new hospitals~~LTCH ~~that~~facilities ~~opened~~except ~~during 2003 and 2004 and the rent expense~~ for the ~~acquired~~facilities ~~Kessler~~described ~~clinics~~above. ~~During~~ ~~the~~As ~~same time period, general and administrative expense as a percentage~~ of ~~net operating revenues declined to 2.9% for the year ended~~ December 31, ~~2004 from 3.3% for the year ended December 31~~2014, ~~2003. This decrease~~ in ~~general~~our ~~and~~specialty ~~administrative~~hospitals ~~expenses~~we ashad a79 ~~percentage~~HIH ofleases ~~net operating revenue is the result of a growth in net operating revenues that exceeded the growth in our general~~ and ~~administrative costs. Our bad debt expense as a percentage of net operating~~16 ~~revenues~~free-standing ~~was~~building 3leases.0% for the year ended December 31, 2004 compared to 3.8% for the year ended December 31, 2003. This decrease in bad debt expense resulted from an improvement in the composition and aging of our accounts receivable.

~~Adjusted~~ We lease ~~EBITDA~~our corporate headquarters from companies owned by a related party affiliated with us through common ownership or management. Our corporate headquarters is approximately 167,203 square feet and is located in Mechanicsburg, Pennsylvania. We lease several other administrative spaces related to administrative and operational support functions. As of December 31, 2014, this was comprised of eight locations throughout the United States with approximately 45,000 square feet in total.

Specialty Hospitals. Adjusted EBITDA increased by 62.2% to $236.2 million for the year ended December 31, 2004 compared to $145.7 million for the year ended December 31, 2003. Our Adjusted EBITDA margins increased to 21.7% for the year ended December 31, 2004 from 17.2% for the year ended December 31, 2003. The hospitals opened before January 1, 2003 and operated throughout both periods had Adjusted EBITDA of $189.4 million, an increase of 32.7% over the Adjusted EBITDA of these hospitals in 2003. This increase in same store hospitals’ Adjusted EBITDA resulted from an increase in revenue per patient day that exceeded our increase in cost per patient day. Our Adjusted EBITDA margin in these same store hospitals increased to 21.8% for the year ended December 31, 2004 from 18.2% for the year ended December 31, 2003. 42

~~Outpatient~~Table Rehabilitation. Adjusted EBITDA increased by 7.8% to $71.6 million for the year ended December 31, 2004 compared to $66.4 million for the year ended December 31, 2003. Our Adjusted EBITDA margins increased to 14.3% for the year ended December 31, 2004 from 13.9% for the year ended December 31, 2003. This Adjusted EBITDA margin increase was primarily the result of ~~three~~ ~~factors.~~Contents First, the acquired Kessler outpatient operations experienced negative margins in 2003, which had the effect of lowering the overall margins for the segment in 2003. We consolidated or closed many of the underperforming clinics in 2004. Second, we experienced lower bad debt expense in 2004. Third, the increases previously described were offset by an increase in labor costs due to increased competition for hiring therapists.

~~Other.~~ The ~~Adjusted~~following ~~EBITDA~~is ~~loss~~a ~~was~~list ~~$46.3 million~~by ~~for~~state of the ~~year~~number ~~ended~~of ~~December 31,~~facilities ~~2004 compared~~we tooperated aas ~~loss~~ of ~~$36.2 million for the year ended~~ December 31, ~~2003~~2014. This increase in the Adjusted EBITDA loss was primarily the result of the decline in hospital reimbursements for corporate support costs of $8.7 million (See “— Critical Accounting Matters — Sources of Revenue”) and an increase in our general and administrative expenses of $1.4 million.

Income from Operations

	Specialty Hospitals

	Long Term Acute Care		Inpatient Rehabilitation		Outpatient Clinics		Total Facilities
Alabama		1						1
Alaska						6		6
Arizona		3		1		14		18
Arkansas		2				1		3
California						10		10
Colorado		3				17		20
Connecticut						44		44
District of Columbia						2		2
Delaware		1				1		2
Florida		9		1		98		108
Georgia		6		1		24		31
Illinois						44		44
Indiana		5				18		23
Iowa		2						2
Kansas		3				15		18
Kentucky		2				43		45
Louisiana		1				3		4
Maine						12		12
Maryland						21		21
Massachusetts						9		9
Michigan		11				13		24
Minnesota		1				25		26
Mississippi		5						5
Missouri		3		2		66		71
Nebraska		2						2
Nevada						7		7
New Jersey		1		3		153		157
New Mexico						2		2
North Carolina		3				33		36
Ohio		16		1		58		75
Oklahoma		2				20		22
Pennsylvania		9		1		125		135
South Carolina		2				15		17
South Dakota		1						1
Tennessee		5				12		17
Texas		10		6		91		107
Virginia						21		21
West Virginia		1						1
Wisconsin		3						3

Total Company		113		16		1,023		1,152

~~- 47 -~~ Item 3. Legal Proceedings.

~~Table~~ The Company is a party to various legal actions, proceedings and claims (some of ~~Contents~~which are not insured), and regulatory and other governmental audits and investigations in the ordinary course of its business. The Company cannot predict the ultimate outcome of pending litigation, proceedings and regulatory and other governmental audits and investigations. These matters could potentially subject the Company to sanctions, damages, recoupments, fines and other penalties. The Department of Justice, CMS or other federal and state enforcement and regulatory agencies may conduct additional investigations

Income from operations increased 56.5% to $222.5 million for the year ended December 31, 2004 compared to $142.2 million for the year ended December 31, 2003. The increase in income from operations resulted from the Adjusted EBITDA increases described above, and was offset by an increase in depreciation and amortization expense of $5.3 million. The increase in depreciation and amortization expense resulted primarily from the additional depreciation associated with acquired Kessler assets, the amortization of the Kessler non-compete agreement, and increases in depreciation on fixed asset additions that are principally related to new hospital and clinic development. 43

~~Interest~~Table ~~Expense~~ of Contents

~~Interest expense increased by $7.9 million~~ related to ~~$33.3 million for~~ the ~~year~~Company's ~~ended~~businesses ~~December 31, 2004~~in ~~from $25.4 million for~~ the ~~year~~future ~~ended~~that ~~December 31~~may, ~~2003.~~either ~~The~~individually ~~increase~~or in ~~interest expense is due to~~ the ~~higher debt levels outstanding in 2004 compared to 2003 resulting from the issuance of $175.0 million of 7 1/2 % senior subordinated notes due 2013 on August 12~~aggregate, ~~2003,~~have ~~offset by~~ a ~~reduction~~ inmaterial ~~borrowings~~adverse ~~under~~effect ~~our senior credit facility. The lower debt levels~~ on ~~our~~the ~~senior credit~~Company's ~~facility~~business, ~~resulted~~financial ~~from~~position, ~~scheduled~~results ~~term~~of ~~amortization payments~~ operations and ~~principal pre-payments~~liquidity. ~~All repayments have been made with cash flows generated through operations.~~

~~Minority~~ To address ~~Interests~~claims arising out of the operations of the Company's specialty hospitals and outpatient rehabilitation facilities, the Company maintains professional malpractice liability insurance and general liability insurance, subject to self-insured retention of $2.0 million per medical incident for professional liability claims and $2.0 million per occurrence for general liability claims. 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. In the Company's opinion, the outcome of these actions, individually or in the aggregate, will not have a material adverse effect on its financial position, results of operations, or cash flows.

~~Minority~~ Healthcare providers ~~interests~~are insubject ~~consolidated~~to ~~earnings~~lawsuits ~~increased~~under tothe ~~$2.6 million~~qui ~~for~~tam provisions of the ~~year~~federal ~~ended December 31~~False Claims Act. Qui tam lawsuits typically remain under seal (hence, ~~2004~~usually ~~compared~~unknown to ~~$1.7 million~~the defendant) for some time while the ~~year~~government ~~ended~~decides ~~December 31,~~whether ~~2003~~or not to intervene on behalf of a private qui tam plaintiff (known as a relator) and take the lead in the litigation. ~~This~~These ~~increase~~lawsuits iscan ~~the~~involve ~~result~~significant ofmonetary damages and penalties and award bounties to private plaintiffs who successfully bring the ~~improved~~suits. ~~profitability~~The ofCompany has been a defendant in these ~~jointly~~cases ~~owned~~in ~~entities.~~the past, and may be named as a defendant in similar cases from time to time in the future.

~~Income~~ On January 8, ~~Taxes~~2013, a federal magistrate judge unsealed an Amended Complaint in United States of America and the State of Indiana, ex rel. Doe I, Doe II and Doe III v. Select Medical Corporation, Select Specialty Hospital-Evansville, Evansville Physician Investment Corporation, Dr. Richard Sloan and Dr. Jeffrey Selby. The Amended Complaint, which was served on the Company on February 15, 2013, is a civil action filed under seal on September 28, 2012 in the United States District Court for the Southern District of Indiana by private plaintiff-relators on behalf of the United States and the State of Indiana under the federal False Claims Act and Indiana False Claims and Whistleblower Protection Act. Although the Amended Complaint identified the relators by fictitious pseudonyms, on March 28, 2013, the relators filed a Notice identifying themselves as the former CEO at the Company's long term acute care hospital in Evansville, Indiana ("SSH-Evansville") and two former case managers at SSH-Evansville. The named defendants include the Company, SSH-Evansville, and two physicians who have practiced at SSH-Evansville. On March 26, 2013, the defendants, relators and the United States filed a joint motion seeking a stay of the proceedings, in which the United States notified the court that its investigation has not been completed and therefore it is not yet able to decide whether or not to intervene, and on March 29, 2013, the magistrate judge granted the motion and stayed all deadlines in the case for 90 days. The court has subsequently granted additional motions filed by the United States to continue the stay, and the current stay extends through March 16, 2015.

We As previously ~~recorded~~disclosed, ~~income~~the ~~tax~~Company ~~expense~~and ofSSH-Evansville ~~$76.6 million~~produced ~~for~~documents ~~the~~in ~~year~~response ~~ended~~to ~~December 31,~~various ~~2004.~~government ~~The expense~~subpoenas ~~represented~~and andemands ~~effective~~relating ~~tax~~to ~~rate~~SSH-Evansville. In September 2014, representatives of ~~40.2%.~~the WeUnited ~~recorded~~States ~~income~~Attorney's ~~tax~~Office ~~expense~~for the Southern District of ~~$46.2 million for~~Indiana and the ~~year~~Department ~~ended~~of ~~December 31,~~Justice ~~2003.~~informed ~~This~~the ~~expense~~Company ~~represented~~that, anwhile ~~effective~~the ~~tax~~United ~~rate~~States ofhas ~~39.6%.~~not ~~The~~yet decided whether ~~increase~~to intervene in the ~~tax~~case, ~~rate~~its investigation is continuing concerning the ~~result~~allegation ofthat aSSH-Evansville ~~larger~~admitted ~~portion~~patients offor ~~our~~whom ~~net~~long-term ~~income~~acute incare ~~states~~was ~~with~~not ~~higher~~medically necessary. The Company intends ~~tax~~to ~~rates~~fully cooperate with this governmental investigation and is involved in ongoing discussions with the ~~non-deductibility~~government ofregarding ~~certain~~this ~~expenses~~matter. At this time, the Company is unable to predict the timing and outcome of this matter.

~~Liquidity~~ ~~and~~ Item 4. Mine ~~Capital~~Safety ~~Resources~~ Disclosures.

~~Combined~~ None. ~~Year Ended December 31, 2005 and Years Ended December 31, 2004 and 2003~~

Operating activities generated $64.1 million, $174.3 million, and $246.2 million in cash during the combined year ended December 31, 2005 and the years ended December 31, 2004 and 2003, respectively. For 2005, our operating cash flow includes $186.0 million in cash expenses related to the Merger. Our days sales outstanding were 52 days at December 31, 2005. This is an increase of 4 days from December 31, 2004. The increase in days sales outstanding is primarily the result of a change in the way Medicare calculates our Periodic Interim Payments in our Specialty Hospitals. Medicare changed from a per day based calculation to a discharged based calculation to better align the Periodic Interim Payment methodology with the current discharge based reimbursement system. As a result, we are no longer receiving a periodic payment for those patients that have not yet been discharged. The significant cash flow experienced in 2004 and 2003 is attributable to improved operating income and significant reductions in our accounts receivable days outstanding. Our accounts receivable days outstanding were 48 days at December 31, 2004 and 52 days at December 31, 2003. This reduction has resulted from improvements we implemented in our business office operations which includes a focused effort to resolve problematic accounts in a timely manner and improved pre-admission policies to validate insurance coverage. 44

Table -of 48Contents -

~~Table~~ of ~~Contents~~ PART II

~~Investing~~ ~~activities used $220.8 million, $29.0 million and $261.5 million of cash flow for~~ ~~the combined year ended December~~ Item ~~31, 2005 and the years ended December 31, 2004 and 2003, respectively~~5. Market Of this amount, we incurred earnout and acquisition related payments of $111.6 million, $4.9 million and $228.2 million, respectively in 2005, 2004 and 2003. In 2005, the SemperCare acquisition accounted for ~~$105.1 million~~Registrant's ofCommon ~~the $111.6 million acquisition payments. The Kessler acquisition costs~~Equity, ~~net~~Related ofStockholder ~~cash~~Matters acquired, of $223.9 million comprise most of the 2003 expenditures. The remaining acquisition payments relate primarily to small acquisitions of outpatient businesses. The earnout payments related principally to obligations we assumed as part of our 1999 NovaCare acquisition. Investing activities also used cash for the purchases of property and ~~equipment~~Issuer ofPurchases ~~$109.9 million, $32.6 million and $35.9 million in the combined twelve months~~ of ~~2005,~~ ~~2004~~Equity ~~and 2003, respectively, which was related principally to new hospital development and construction~~Securities. ~~During 2005 we purchased five properties that will be used to relocate existing~~ hospitals and one property for a new hospital. Each of these properties require additional improvements to be made before they become operational. Additionally during 2005 we began a major improvement and expansion of our rehabilitation hospital in West Orange, New Jersey. During 2004, we sold our only skilled nursing facility and our non-controlling interest in a rehabilitation hospital for $15.6 million.

~~Financing activities used $55.4 million of cash for the combined year ended December 31, 2005.~~ ~~The principal financing activities were related to the Merger financing discussed below. The~~ ~~excess proceeds from the Transactions were used to pay Merger related costs, which include the~~ ~~cancellation and cash-out of outstanding stock options. Additionally, during 2005 we repaid $115.0~~ ~~million of debt under our revolver and $4.4 million of our term loan. During 2005, we paid~~ ~~dividends of $10.0 million to Holdings which it used to fund interest payments on its debt. Cash~~ ~~overdrafts~~Market ~~of $19.4 have provided additional financing cash.~~ Information

~~Financing~~ Select ~~activities~~Medical ~~used~~Holdings ~~$64.0 million~~Corporation ~~of cash for the year ended December 31, 2004. In 2004, this was principally due to the repurchase of our~~ common stock inis ~~accordance~~quoted ~~with~~on the ~~stock repurchase~~New ~~program~~York weStock ~~announced~~Exchange onunder ~~February 23,~~the ~~2004~~symbol "SEM". ~~During~~The ~~2004,~~following ~~we repurchased a total of~~table 3sets forth,~~399,400~~ ~~shares~~for atthe aperiods ~~cost~~indicated, ~~including~~the ~~fees~~high and ~~commissions,~~low ofsales ~~$48.1 million.~~prices ~~Additionally,~~of ~~during 2004, we repaid all outstanding balances under~~ our ~~credit~~common ~~facility of $8.5 million and repaid $3.9 million of seller and other debt. Cash dividend payments in 2004 were $9.2 million. Additionally~~stock, ~~during~~ ~~2004~~reported weby ~~had $18.6 million of cash flow from~~ the ~~issuance~~New ofYork ~~common~~Stock ~~stock under our stock option plans~~Exchange.

Financing activities provided $124.3 million of cash for the year ended December 31, 2003. During 2003, we sold $175.0 million of 7 1/2 % senior subordinated notes due 2013. The net proceeds from the sale were approximately $169.4 million after deducting discounts, commissions and expenses of the offering, and were used to finance a portion of the Kessler acquisition. Deferred financing costs associated with the offering were $5.9 million. During 2003, we repaid $65.6 million of credit facility debt and $3.7 million of seller and other debt. In December 2003, we declared and paid our company’s first ever common stock cash dividend of $0.03 per share, which resulted in an aggregate payment to our stockholders of $3.1 million. In 2003 we received $28.6 million of proceeds from the issuance of stock related to the exercise of employee stock options and stock warrants.

	Market Prices

Fiscal Year Ended December 31, 2013	High		Low
First Quarter	$	10.00	$	8.38
Second Quarter	$	9.11	$	7.21
Third Quarter	$	9.09	$	7.77
Fourth Quarter	$	11.89	$	8.00

Capital Resources

	Market Prices

Fiscal Year Ended December 31, 2014	High		Low
First Quarter	$	12.45	$	10.15
Second Quarter	$	15.86	$	12.43
Third Quarter	$	16.17	$	12.01
Fourth Quarter	$	15.07	$	11.46

~~Net working capital was $88.4 million at December 31, 2005 compared to $313.7 million at~~ ~~December 31, 2004. This decrease in working capital was principally related to the use of cash to~~ ~~fund Merger costs, offset by an increase in accounts receivable.~~ Holders

~~Net~~ At ~~working~~the ~~capital~~close ~~increased~~of tobusiness ~~$313.7 million~~on ~~at December~~February 311, ~~2004~~2015, ~~compared~~Holdings tohad ~~$188.4 million~~131,228,508 atshares ~~December 31,~~of ~~2003.~~common ~~This~~stock ~~increase~~issued inand ~~working~~outstanding. ~~capital~~As ~~was~~of ~~principally~~that date, ~~related~~there towere ~~an increase~~111 inregistered ~~cash~~holders ~~and~~of arecord. ~~reduction~~This indoes ~~amounts~~not ~~due~~reflect tobeneficial ~~third~~stockholders ~~party~~who ~~payors.~~hold ~~The~~their ~~reduction~~stock in ~~amounts~~nominee ~~due to~~or ~~third-party~~"street" ~~payors~~name ~~was~~through a brokerage firms.

~~- 49 -~~ Dividend Policy

~~Table~~ On May 1, August 7 and October 30, 2013, Holdings declared cash dividends of ~~Contents~~$0.10 per share. Such dividends were paid on May 30, August 30 and November 22, 2013, respectively, to stockholders of record as of the close of business on May 20, August 20 and November 12, 2013, respectively.

~~result~~ On February 19, ofApril 30, ~~filing~~August 6 and ~~settling~~October 29, ~~cost~~2014, ~~reports~~Holdings ~~and~~declared ~~refinements~~cash individends ~~the~~of ~~bi-weekly~~$0.10 ~~payments~~per ~~we receive~~share. ~~from~~Such ~~our~~dividends ~~Medicare~~were ~~fiscal~~paid ~~intermediary~~on ~~related~~March 10, May 28, August 29 and December 1, 2014, respectively, to ~~our~~stockholders ~~Medicare~~of ~~patients.~~record as of the close of business on March 3, May 16, August 20 and November 19, 2014, respectively.

In There is ~~connection~~no ~~with~~assurance ~~the~~that ~~Merger,~~future ondividends ~~February 24,~~will ~~2005~~be wedeclared ~~borrowed~~or ~~$780.0 million~~the ~~under~~timing aor ~~new $880.0 million~~amount ~~senior~~of ~~secured~~any ~~credit~~future ~~facility~~dividends. ~~and~~The ~~issued $660.0 million~~declaration ~~75/8%~~and ~~senior~~payment ~~subordinated notes.~~of ~~Since~~dividends in the ~~Merger~~future onare ~~February 24,~~at ~~2005,~~the wesole discretion ~~have~~of ~~repaid~~our ~~$119.4 million~~board of ~~senior~~directors ~~secured credit~~after ~~facility~~taking ~~debt~~into asaccount ofvarious ~~December 31~~factors, ~~2005. At December 31~~including, ~~2005~~but wenot ~~had~~limited ~~outstanding~~to, ~~$1.3 billion in~~our ~~aggregate~~financial ~~indebtedness~~condition, ~~excluding~~operating ~~$22.0 million~~results, ofavailable ~~letters~~cash ofand ~~credit,~~current ~~with~~and ~~approximately~~anticipated cash ~~$193~~needs.~~0 million~~ ofAdditionally, ~~additional~~certain ~~borrowing~~contractual ~~capacity~~agreements ~~under~~we ~~Select’s~~are ~~existing~~party to, including the senior secured credit facility., ~~As a~~dated ~~result~~as of June 1, ~~our~~2011, ~~liquidity~~as ~~requirements~~amended, ~~are~~and ~~significantly~~the ~~higher~~Indenture ~~than~~governing Select's ~~they~~6.375% ~~were~~senior ~~before~~notes, ~~the~~dated ~~Merger~~as ~~due to~~of May 28, 2013, restrict our ~~increased~~capacity ~~debt~~to ~~service~~pay ~~obligations~~dividends.

~~Our~~ Securities ~~new~~Authorized ~~senior~~For ~~secured~~Issuance ~~credit~~Under ~~facility~~Equity ~~provides~~Compensation ~~for senior secured financing of up to $880.0 million, consisting of:~~ Plans

	•		a $300.0 million revolving loan facility that will terminate on February 24, 2011, including both a letter of credit sub-facility and a swingline loan sub-facility, and
	•		a $580.0 million term loan facility that matures on February 24, 2012.

For information regarding securities authorized for issuance under equity compensation plans, see Part III "Item 12 — Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters."

Proceeds of the term loans and $200.0 million of revolving loans, together with other sources of funds, were used to finance the Merger. Proceeds of the revolving loans borrowed after the closing date of the Merger, swingline loans and letters of credit are used for working capital and general corporate purposes. 45

~~The~~Table interest rates per annum applicable to loans, other than swingline loans, under our new senior secured credit facility are, at our option, equal to either an alternate base rate or an adjusted LIBOR rate for a one, two, three or six month interest period, or a nine or twelve month period if available, in each case, plus an applicable margin percentage. The alternate base rate will be the greater of (1) JPMorgan Chase Bank, N.A.’s prime rate and (2) one-half of 1% over the weighted average of rates on overnight Federal funds as published by the Federal Reserve Bank of New York. The adjusted LIBOR rate will be determined by reference to settlement rates established for deposits in dollars in the London interbank market for a period equal to the interest period of the loan and the maximum reserve percentages established by the Board of Governors of the United States Federal Reserve to which our lenders are subject. The applicable margin percentage for revolving loans is currently (1) 1.25% for alternate base rate loans and (2) 2.25% for adjusted LIBOR loans, subject to change based upon the ratio of our total indebtedness to our consolidated EBITDA (as defined in the credit agreement). The applicable margin percentages for the term loans are (1) 0.75% for alternate base rate loans and (2) 1.75% for adjusted LIBOR loans. On June 13, 2005 we entered into an interest rate swap transaction with an effective date of August 22, 2005. The swap is being designated as a cash flow hedge of forecasted LIBOR based variable rate interest payments. The underlying variable rate debt is $200.0 million and the swap is for a period of five years. Contents

~~On February 24, 2005, EGL Acquisition Corp. issued and sold $660.0 million in aggregate~~ ~~principal amount of 75/8°% senior subordinated notes due 2015, which we assumed in connection with~~ ~~the Merger. The net proceeds of the offering were used to finance a portion of the funds needed to~~ ~~consummate the Merger with EGL Acquisition Corp. The notes were issued under an indenture between~~ ~~EGL Acquisition Corp. and U.S. Bank Trust National Association, as trustee. Interest on the notes~~ ~~is payable semi-annually in arrears on February 1 and August 1 of each year. The notes are~~ ~~guaranteed~~Stock byPerformance all of our wholly-owned subsidiaries, subject to certain exceptions. On or after February 1, 2010, the notes may be redeemed at our option, in whole or in part, at redemption prices that decline annually to 100% on and after February 1, 2013, plus accrued and unpaid interest. Prior to February 1, 2008, we may at our option on one or more occasions with the net cash proceeds from certain equity offerings redeem the Graph

The -graph 50below -compares the cumulative total stockholder return on $100 invested at the close of the market on December 31, 2009, with dividends being reinvested on the date paid through and including the market close on December 31, 2014 with the cumulative total return of the same time period on the same amount invested in the Standard & Poor's 500 Index (S&P 500) and the S&P Health Care Services Select Industry Index (SPSIHP). The chart below the graph sets forth the actual numbers depicted on the graph.

	12/31/09		12/31/10		12/31/11		12/31/12		12/31/13		12/31/14

Select Medical Holdings Corporation (SEM)	$	100.00	$	68.83	$	79.85	$	101.66	$	129.74	$	165.69
S&P Health Care Services Select Industry Index (SPSIHP)	$	100.00	$	112.78	$	112.78	$	127.90	$	165.80	$	184.64
S&P 500	$	100.00	$	115.08	$	118.46	$	145.06	$	198.59	$	248.25

~~outstanding~~ ~~notes in an aggregate principal amount not to exceed 35% of the aggregate~~ ~~principal amount originally issued at a redemption price of 107~~ Item 6.~~625%,~~ Selected ~~plus~~Financial ~~accrued and unpaid interest to the redemption date~~Data.

~~Upon~~ You ashould ~~change~~read ofthe ~~control~~following ofselected historical consolidated financial data in conjunction with our ~~Company,~~consolidated ~~each~~financial ~~holder~~statements and ofthe accompanying notes. ~~may~~You ~~require~~should usalso toread ~~repurchase~~"Management's ~~all or~~Discussion ~~any~~and ~~portion~~Analysis of ~~the~~Financial ~~holder’s~~Condition ~~notes~~and atResults aof ~~purchase~~Operations," ~~price~~which ~~equal~~is tocontained ~~101%~~elsewhere ofherein. ~~the~~The ~~principal~~selected ~~amount~~historical financial ~~plus~~data as of December 31, 2010, ~~accrued~~2011, 2012, 2013 and ~~unpaid~~2014 ~~interest~~and tofor the ~~date~~years ofended ~~purchase.~~ December 31, 2010, 2011, 2012, 2013 and 2014 have been derived from consolidated

Our 91/2% senior subordinated notes due 2009 were issued in June 2001 in an original aggregate principal amount of $175.0 million. We commenced a debt tender offer and redeemed $169.3 million in aggregate principal amount of these notes in connection with the Merger. On June 15, 2005, we redeemed the remaining $5.7 million outstanding principal amount of 91/2% senior subordinated notes due 2009 for a redemption price of 104.750% of the principal amount plus accrued and unpaid interest. 46

OnTable ~~September 29, 2005, Holdings, our parent company, sold $175.0 million~~ of senior floating rate notes due 2015, which bear interest at a rate per annum, reset semi-annually, equal to the 6-month LIBOR plus 5.75%. Interest is payable semi-annually in arrears on March 15 and September 15 of each year, with the principal due in full on September 15, 2015. The floating rate notes are general unsecured obligations of Holdings and are not guaranteed by us or any of our subsidiaries. The net proceeds of the issuance of the floating rate notes, together with cash provided through a dividend from us, was used to reduce the amount of Holdings’ preferred stock, to make a payment to participants in Holdings’ long-term incentive plan, and to pay related fees and expenses. Our parent company is a holding company, and as such, will rely on our cash flow to service this obligation and the $150.0 million of 10% senior subordinated notes Holdings issued to consummate the Merger transaction. Contents

Infinancial statements ~~connection~~audited ~~with this borrowing~~ by ~~Holdings~~PricewaterhouseCoopers LLP, ~~we entered into~~ an ~~amendment~~independent toregistered ~~our~~public ~~senior credit~~accounting ~~facility~~firm. ~~This~~The ~~amendment,~~selected ~~among~~historical ~~other~~consolidated ~~things,~~financial ~~permitted~~data ~~Holdings~~as toof ~~incur~~December 31, ~~this indebtedness~~2013 and ~~permits~~2014, usand tofor ~~make~~the ~~distributions~~years toended ~~Holdings~~December 31, to2012, ~~service~~2013 ~~its~~and ~~indebtedness.~~2014 ~~The~~have ~~amendment~~been ~~also permitted~~derived ~~Holdings~~from toour ~~use~~consolidated ~~the~~financial ~~net~~information ~~proceeds~~included ofelsewhere ~~the~~herein. ~~offering,~~The ~~and~~selected ~~permitted~~historical usconsolidated financial todata ~~make~~as ~~distributions to~~of ~~Holdings~~December 31, to2010, ~~make~~2011 ~~the~~and ~~$175.0 million~~2012 ~~special~~and ~~dividend~~for tothe ~~its~~years ~~preferred~~ended ~~stockholders~~December 31, 2010 and ~~make~~2011 ~~a payment~~have ofbeen ~~$14.5 million~~derived tofrom ~~certain members of~~ our ~~senior~~audited ~~management~~consolidated ~~under~~financial ~~Holdings’~~information ~~long-term~~not ~~incentive~~included ~~compensation~~elsewhere ~~plan~~herein.

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

	Select Medical Holdings Corporation

	Year Ended December 31,
	2010			2011			2012			2013			2014
	(In thousands, except per share data)
Statement of Operations Data:
Net operating revenues	$	2,390,290		$	2,804,507		$	2,948,969		$	2,975,648		$	3,065,017
Operating expenses⁽¹⁾⁽²⁾		2,085,447			2,422,271			2,548,799			2,609,820			2,712,187
Depreciation and amortization		68,706			71,517			63,311			64,392			68,354

Income from operations		236,137			310,719			336,859			301,436			284,476,
Loss on early retirement of debt⁽³⁾		—			(31,018	)		(6,064	)		(18,747	)		(2,277	)
Equity in earnings (losses) of unconsolidated subsidiaries		(440	)		2,923			7,705			2,476			7,044
Other income		632			—			—			—			—
Interest expense, net⁽⁴⁾		(112,337	)		(98,894	)		(94,950	)		(87,364	)		(85,446	)

Income before income taxes		123,992			183,730			243,550			197,801			203,797
Income tax expense		41,628			70,968			89,657			74,792			75,622

Net income		82,364			112,762			153,893			123,009			128,175
Less: Net income attributable to non-controlling interests⁽⁵⁾		4,720			4,916			5,663			8,619			7,548

Net income attributable to Select Medical Holdings Corporation		77,644			107,846			148,230			114,390			120,627
Other comprehensive income:
Unrealized gain on interest rate swap, net of tax		8,914			—			—			—			—

Comprehensive income attributable to Select Medical Holdings Corporation	$	86,558		$	107,846		$	148,230		$	114,390		$	120,627



Income per common share:
Basic	$	0.49		$	0.71		$	1.05		$	0.82		$	0.91
Diluted	$	0.48		$	0.71		$	1.05		$	0.82		$	0.91
Weighted average common shares outstanding:
Basic		159,184			150,501			138,767			136,879			129,026
Diluted		159,442			150,725			139,042			137,047			129,465
Balance Sheet Data (at end of period):
Cash and cash equivalents	$	4,365		$	12,043		$	40,144		$	4,319		$	3,354
Working capital (deficit)		(70,232	)		99,472			80,397			82,878			133,220
Total assets		2,722,086			2,772,147			2,761,361			2,817,622			2,924,809
Total debt		1,430,769			1,396,798			1,470,243			1,445,275			1,522,976
Total Select Medical Holdings Corporation stockholders' equity		780,947			819,679			717,048			786,234			739,515

As a result of the recently enacted HIH regulations, we currently anticipate that we will need to relocate approximately 50% of our long-term acute care hospitals over the next five years, including certain of the hospitals acquired in the SemperCare acquisition. 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 a small number of facilities. We currently anticipate that approximately 42% of our hospitals will not require a move and 8% of our hospitals will be closed. These relocation efforts will require us to make additional capital expenditures above historic levels. We currently expect to spend approximately $390 million on capital expenditures over the next four years, including both our ongoing maintenance capital expenditures and the capital required for hospital relocations. At December 31, 2005, we have commitments under construction contracts related to improvements and renovations at ten of our long-term acute care properties and one of our inpatient rehabilitation facilities totaling $44.0 million. 47

WeTable ~~relocated one~~ of our HIH hospitals to a free-standing building in the fourth quarter of 2005. We also continue to evaluate opportunities to develop new long-term acute care hospitals, primarily in settings where the new HIH regulations would have little or no impact, such as in free-standing Contents

- 51 -

	Select Medical Corporation

	Year Ended December 31,
	2010			2011			2012			2013			2014
	(In thousands)
Statement of Operations Data:
Net operating revenues	$	2,390,290		$	2,804,507		$	2,948,969		$	2,975,648		$	3,065,017
Operating expenses⁽¹⁾⁽²⁾		2,085,447			2,422,271			2,548,799			2,609,820			2,712,187
Depreciation and amortization		68,706			71,517			63,311			64,392			68,354

Income from operations		236,137			310,719			336,859			301,436			284,476
Loss on early retirement of debt⁽³⁾		—			(20,385	)		(6,064	)		(17,788	)		(2,277	)
Equity in earnings (losses) of unconsolidated subsidiaries		(440	)		2,923			7,705			2,476			7,044
Other income

Filing Compare · SELECT MEDICAL CORP