Form 10-Q

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

10-Q 1 d338406d10q.htm FORM 10-Q Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012.

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission File Number 333-133319

LIFECARE HOLDINGS, INC.

(Exact name of registrant as specified in its charter)


Delaware		51-0372090
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification Number)

5560 Tennyson Parkway Plano, Texas		75024
(Address of Principal Executive Offices)		(Zip Code)

(469) 241-2100

(Registrant’s telephone number, including area code)

None

(Former name, former address and former fiscal year, if changes since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

As of May 10, 2012, the registrant had 100 shares of Common Stock, par value $0.01 per share, outstanding.

LIFECARE HOLDINGS, INC.

TABLE OF CONTENTS


	PART I: FINANCIAL INFORMATION

ITEM 1.	CONSOLIDATED FINANCIAL STATEMENTS	3
	CONDENSED CONSOLIDATED BALANCE SHEETS	3
	CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS	4
	CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDER’S DEFICIT	5
	CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS	6
	NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS	7
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	20
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	31
ITEM 4.	CONTROLS AND PROCEDURES	31
	PART II: OTHER INFORMATION	32
ITEM 1.	LEGAL PROCEEDINGS	32
ITEM 1A.	RISK FACTORS	32
ITEM 6.	EXHIBITS	32
SIGNATURES		33

PART 1: FINANCIAL INFORMATION

ITEM 1:

CONSOLIDATED FINANCIAL STATEMENTS

LIFECARE HOLDINGS, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

March 31, 2012 and December 31, 2011

(In thousands, except share data)

(unaudited)


	March 31, 2012			December 31, 2011
Assets
Current assets:
Cash and cash equivalents	$	4,127		$	11,569
Accounts receivable, net of allowance for doubtful accounts of $6,841 and $8,477, respectively		85,919			91,364
Other current assets		10,707			10,244

Total current assets		100,753			113,177
Property and equipment, net		72,396			73,767
Other assets, net		20,076			22,706
Identifiable intangibles, net		38,258			38,323
Goodwill		264,512			264,512

	$	495,995		$	512,485

Liabilities and Stockholder’s Deficit
Current liabilities:
Current installments of long-term debt	$	6,047		$	5,912
Current installments of obligations under capital leases		297			414
Current installment of lease financing obligation		530			519
Estimated third party payor settlements		3,312			9,287
Accounts payable		29,396			30,991
Accrued payroll		5,100			9,806
Accrued vacation		7,531			6,589
Accrued interest		11,079			13,705
Accrued other		7,209			9,772
Income taxes payable		863			663

Total current liabilities		71,364			87,658
Long-term debt, excluding current installments		433,891			431,073
Obligations under capital leases, excluding current installments		72			89
Lease financing obligation, excluding current installments		18,902			19,038
Accrued insurance		5,019			4,102
Other noncurrent liabilities		17,659			16,841

Total liabilities		546,907			558,801

Commitments and contingencies
Stockholder’s deficit:
Common stock, $0.01 par value, 100 shares authorized, issued and outstanding		—			—
Additional paid-in capital		175,441			175,441
Accumulated deficit		(226,353	)		(221,757	)

Total stockholder’s deficit		(50,912	)		(46,316	)

	$	495,995		$	512,485

See accompanying notes to condensed consolidated financial statements.

LIFECARE HOLDINGS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

For the three ended March 31, 2012 and 2011

(In thousands)

(Unaudited)


	2012			2011
Net patient service revenue	$	126,409		$	94,919

Salaries, wages and benefits		58,544			44,400
Supplies		12,305			9,291
Rent		10,574			6,473
Other operating expenses		27,304			20,756
Provision for doubtful accounts		1,599			1,345
Loss on early extinguishment of debt		—			2,772
Depreciation and amortization		2,433			2,116
Interest expense, net		17,418			11,335

Total expenses		130,177			98,488

Operating loss		(3,768	)		(3,569	)
Equity in income (loss) of joint venture		(101	)		193

Loss before income taxes		(3,869	)		(3,376	)
Provision for income taxes		727			225

Net loss	$	(4,596	)	$	(3,601	)

See accompanying notes to condensed consolidated financial statements.

LIFECARE HOLDINGS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Stockholder’s Deficit

For the three months ended March 31, 2012

(In thousands)

(Unaudited)


	Common Stock		Additional Paid-in Capital		Accumulated Deficit			Total Stockholder’s Deficit
Balance, December 31, 2011	$	—	$	175,441	$	(221,757	)	$	(46,316	)
Net loss		—		—		(4,596	)		(4,596	)

Balance, March 31, 2012	$	—	$	175,441	$	(226,353	)	$	(50,912	)

See accompanying notes to condensed consolidated financial statements.

LIFECARE HOLDINGS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

For the three months ended March 31, 2012 and 2011

(In thousands)

(Unaudited)


	2012			2011
Cash flows from operating activities:
Net loss	$	(4,596	)	$	(3,601	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization (including amortization of debt issuance cost)		5,017			3,451
Provision for doubtful accounts		1,599			1,345
Paid in kind interest		4,404			551
Loss on early extinguishment of debt		—			2,772
Equity in (income) loss of joint venture		101			(193	)
Deferred income taxes		527			—
Amortization of debt discount		144			—
Changes in operating assets and liabilities:
Accounts receivable		3,846			(5,029	)
Income taxes		200			422
Other current assets		(463	)		(955	)
Other assets		(55	)		(164	)
Estimated third party payor settlements		(5,975	)		875
Accounts payable and accrued expenses		(10,548	)		(3,098	)
Other noncurrent liabilities		1,208			1,345

Net cash used in operating activities		(4,591	)		(2,279	)

Cash flows from investing activities:
Purchases of property and equipment		(997	)		(816	)

Net cash used in investing activities		(997	)		(816	)

Cash flows from financing activities:
Deferred financing cost		—			(17,655	)
Borrowings on revolving credit facility		15,000			—
Payments on revolving credit facility		(15,000	)		(35,000	)
Proceeds from long-term debt		—			257,500
Payments of long-term debt		(1,595	)		(241,613	)
Payments on obligations under capital leases		(134	)		(290	)
Payments on lease financing obligation		(125	)		(116	)

Net cash used in financing activities		(1,854	)		(37,174	)

Net decrease in cash and cash equivalents		(7,442	)		(40,269	)
Cash and cash equivalents, beginning of period		11,569			54,570

Cash and cash equivalents, end of period	$	4,127		$	14,301

Supplemental disclosure of cash flow information:
Cash:
Interest paid	$	17,508		$	10,683
Net income taxes received		—			(197	)

See accompanying notes to condensed consolidated financial statements.

LifeCare Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

(1) Basis of Presentation

LifeCare Holdings, Inc. (the “Company”) is a wholly owned subsidiary of LCI Holdco, LLC (“Holdco”). Holdco is a wholly owned subsidiary of LCI Intermediate Holdco, Inc. (“Intermediate Holdco”). Intermediate Holdco is a wholly owned subsidiary of LCI Holding Company, Inc. (“Holdings”), which is owned by an investor group that includes affiliates of The Carlyle Group and members of our senior management and board of directors. The investor group acquired Holdings pursuant to a merger that occurred on August 11, 2005 (the “Merger”).

The accompanying unaudited condensed consolidated financial statements and financial information have been prepared in accordance with generally accepted accounting principles, and reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results of the interim periods. The accompanying financial statements for the three month periods ended March 31, 2012 and 2011, are not necessarily indicative of annualized financial results.

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated audited financial statements and notes thereto for the year ended December 31, 2011, included in the Form 10-K we filed on March 30, 2012, with the Securities and Exchange Commission. Certain information and disclosures normally included in the notes to consolidated financial statements have been condensed or omitted as permitted by the rules and regulations of the Securities and Exchange Commission, although we believe the disclosure is adequate to make the information presented not misleading.

(2) Liquidity and Uncertainties Related to Going Concern

As of March 31, 2012, we had $439.9 million of long-term debt outstanding consisting of our senior secured term loan credit facility in an outstanding principal amount of $316.8 million, which matures on February 1, 2016, our senior subordinated notes in an outstanding principal amount of $119.3 million, which mature on August 11, 2013, and our note payable to Vibra in an outstanding principal amount of $3.8 million, which matures on June 1, 2013. Additionally we have a $30.0 million senior secured revolving credit facility, which matures on February 1, 2015, of which there is no outstanding balance as of March 31, 2 012. The scheduled maturity dates of the senior secured term loan and revolving credit facility may accelerate to May 15, 2013, if the senior subordinated notes are not refinanced, purchased or defeased in full by May 15, 2013. Although we are highly leveraged, we believe that our cash on hand, expected cash flows from operations, and potential availability of borrowings under our senior secured revolving credit facility will be sufficient to finance our operations and meet our scheduled debt service requirements for at least the next twelve months, absent certain actions of lenders in the case of an event of default under our senior secured credit facility as discussed below.

We are required to comply on a quarterly basis with certain financial and other covenants under our senior secured credit facility, including a minimum consolidated cash interest expense coverage ratio test and a maximum senior secured leverage ratio test which are tested quarterly. We were required to meet a leverage ratio of 6.00x at March 31, 2012, which reduces to 5.75x at June 30, 2012. Our leverage ratio at March 31, 2012 was 5.72x. We were required to meet an interest coverage ratio of 1.25x at March 31, 2012 and throughout 2012, which increases to 1.30x on March 31, 2013. Our interest coverage ratio was 1.44x at March 31, 2012. We are currently in compliance with the covenants under our senior secured credit facility for the quarterly period ended March 31, 2012. We expect to maintain compliance under the covenants of our senior secured credit facility for the next twelve months. See more discussion in note 5.

We may not be able to continue to satisfy the covenant requirements in subsequent periods. In the event we are unable to comply with the covenants under our senior secured credit facility, an event of default may occur. If we are unable to obtain waivers or amendments to cure such event of default, the lenders would be entitled to take various actions, including the acceleration of amounts due under our senior secured credit facility, terminating our access to our revolving credit facility and all actions permitted to be taken by a secured creditor. Acceleration under our senior secured credit facility would further create a cross-default under our senior subordinated notes indenture. Such acceleration would have a material adverse effect on our financial position, results of operations and cash flow.

We are continuing to pursue operational and strategic objectives that may result in profitability and lower total indebtedness in order to remain in compliance with the financial covenants under our senior secured credit facility. These objectives include, among other items, increasing the occupancy levels of our hospitals, reducing administrative and operating expenses, and reducing days of net patient service revenue in accounts receivable. We also continue to seek opportunities to refinance our senior subordinated notes and explore various strategic transactions, such as an acquisition, as a means to reduce our leverage and strengthen our operating and financial conditions.

There can be no assurance, however, that we will be able to refinance our senior subordinated notes on commercially reasonable terms or at all, achieve profitability or be able to successfully execute strategic transactions. In that case, we may be required to consider all of our alternatives in restructuring our business and our capital structure.

(3) Summary of Significant Accounting Policies

Use of Estimates

The preparation of the financial statements requires us to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual amounts could differ from those estimates.

Goodwill

We review our goodwill annually, or more frequently if circumstances warrant a more timely review, to determine if there has been an impairment. We review goodwill based upon one reporting unit, as our company is managed as one operating segment. In calculating the fair value of the reporting unit, we use various assumptions including estimated cash flows and discount rates. If estimated future cash flows decline from the current amounts projected by management, an impairment charge may be recorded.

Income Taxes

For the three months ended March 31, 2012, income tax expense recorded represents the estimated income tax liability for certain state income taxes and deferred federal income tax expense associated with goodwill and other non-amortizable identifiable intangible assets that are amortizable and deductible for federal income tax purposes. We believe that it is more likely than not that no benefit or expense will be realized during 2012 for federal income taxes based on estimated federal taxable losses for 2012, other than the recurring deferred federal income tax expense associated with the goodwill and other non-amortizable identifiable intangible assets. We anticipate that federal net operating losses generated during 2012 will be offset by an increase in the valuation allowance against net deferred tax assets.

We follow the threshold of more-likely-than-not for recognition of tax benefits of uncertain tax positions taken or expected to be taken in a tax return. We record accrued interest and penalties associated with uncertain tax positions, if any, as income tax expense in the condensed consolidated statement of operations.

The federal statute of limitations remains open for original tax returns filed for 2008 through 2010. State jurisdictions generally have statutes of limitations ranging from three to five years. The state income tax impact of federal income tax changes remains subject to examination by various states for a period up to one year after formal notification to the states.

Stock Compensation

We estimate the fair value of our equity-based compensation awards on the date of grant, or the date of award modification if applicable, using the Black-Scholes option pricing model. There were no options granted during the three months ended March 31, 2012 (see note 6).

Reclassifications

Certain reclassifications have been made to the consolidated financial statements for prior periods to conform to the presentation of the 2012 condensed consolidated financial statements. Such reclassifications had no impact on net income or stockholder’s deficit.

(4) Net Patient Service Revenue

We recognize in our consolidated financial statements the impact of adjustments, if any, to Medicare reimbursement when the amounts can be reasonably determined. Net revenues for the three months ended March 31, 2012 and 2011, include a decrease of $0.1 million and an increase of $0.2 million, respectively, related to changes in estimates and settlements on prior year cost reports filed with the Medicare program. Approximately 64.6% and 59.8% of our total net patient service revenue for the three months ended March 31, 2012 and 2011, respectively, came from Medicare reimbursement.

(5) Long-Term Debt

Long-term debt consists of the following (in thousands):


	March 31, 2012			December 31, 2011
Senior secured credit facility—term loan	$	316,824		$	313,182
9 ¹/4% senior subordinated notes		119,299			119,299
Revolving credit facility		—			—
Note payable		3,815			4,504

Total long-term debt		439,938			436,985
Current installments of long-term debt		(6,047	)		(5,912	)

Long-term debt, excluding current installments	$	433,891		$	431,073

New Senior Secured Credit Facility

As a result of the impending maturities and increasingly more restrictive covenant requirements under our previous senior secured credit facility, we entered into a new senior secured credit facility on February 1, 2011, that consisted of (a) an initial $257.5 million senior secured term loan (subject to paid in kind interest options as discussed below) and (b) a senior secured revolving credit facility providing for borrowings of up to $30.0 million (the “Credit Agreement”). Availability of borrowings under the revolving credit facility are reduced by outstanding letters of credit, which were $6.4 million as of March 31, 2012. The proceeds of this new Credit Agreement along with available cash on hand were utilized to pay off our previous senior secured credit facility, revolving credit facility and the fees and expenses associated with the new Credit Agreement.

The terms of the Credit Agreement also provided that we had the right to request additional term loan commitments of up to $50.0 million. On August 1, 2011, in connection with the completion of the acquisition of five long-term acute care hospitals, which operate at seven locations, from HealthSouth Corporation, we borrowed $47.2 million of the available $50.0 million.

Borrowings under the term loan facility of the Credit Agreement bear interest at a rate per annum equal to an applicable margin plus, at our option, either (a) an alternate base rate determined by reference to the highest of (1) the prime rate of JPMorgan Chase Bank, N.A., (2) the federal funds rate in effect on such date plus 1/2 of 1% and (3) the LIBOR rate for a one month interest period plus 1% or (b) a LIBOR rate determined by reference to the cost of funds for U.S. dollar deposits for the relevant interest period adjusted for certain additional costs. The applicable margin percentage is 12.25% for term loans that are alternate base rate loans and 13.25% for term loans based on the LIBOR rate. For the term loans, we may, in our discretion, elect for the relevant interest period (a) to pay the entire amount of interest in cash or (b) to pay 5.50% of such interest “in-kind” by adding such interest to the outstanding principal of the term loans as of the applicable interest payment date. The average interest rate for the term loan facility for the three months ended March 31, 2012 and 2011, was 13.80% and 10.43%, respectively. At March 31, 2012 and December 31, 2011, the weighted average interest rate applicable to the outstanding amounts under our term loan facility was 13.83% and 13.65%, respectively.

The applicable margin percentage is 6.75% for revolving loans that are alternate base loans and 7.75% for revolving loans that are based on the LIBOR rate, subject to quarterly adjustments based on our leverage ratio (as defined in the new senior secured credit agreement). In addition to paying interest on outstanding principal under the senior secured credit agreement, we are required to pay a commitment fee of 0.50% per annum in respect of the unutilized commitments under the revolving credit facility, subject to quarterly adjustment based on our leverage ratio (as defined in the Credit Agreement). We are also required to pay annual customary agency fees.

We are required to make scheduled quarterly payments under the senior secured term loan facility equal to 0.25% of the original principal amount of the term loan and the additional principal amount borrowed on August 1, 2011, with the balance payable on February 1, 2016. Additionally, we are required to prepay outstanding term loans under this agreement with (a) 100% of the net cash proceeds of any debt or equity issued by us or our restricted subsidiaries (with exceptions for certain debt permitted to be incurred or equity permitted to be issued under the agreement), (b) 75% (which percentage will be reduced to 50% if our senior secured leverage ratio (as defined in the Credit Agreement) is less than 4:00 to 1:00) of our annual excess cash flow (as defined in the Credit Agreement), and (c) 100% of the net cash proceeds of certain asset sales or other dispositions of property by us or our restricted subsidiaries, subject to reinvestment rights and certain other exceptions specified in the Credit Agreement. Mandatory prepayments of the term loans, subject to certain exceptions, are subject to a prepayment fee of 2% if such repayment occurs after February 1, 2012 and on or prior to February 1, 2013, and 1% if such prepayment occurs after February 1, 2013 and on or prior to February 1, 2014.

and 1% if such prepayment occurs after February 1, 2013 and on or prior to February 1, 2014. Other than as described above, prepayments are not subject to any premium or penalty other than customary “breakage” costs with respect to loans based on the LIBOR rate.

The term loan and revolving credit facility under the Credit Agreement have scheduled maturity dates of February 1, 2016, and February 1, 2015, respectively. However, if our outstanding senior subordinated notes are not refinanced, purchased or defeased in full by May 15, 2013, then the term loan and the then outstanding balance under the revolving credit facility will be due in full on May 15, 2013.

The Credit Agreement also imposes certain financial covenants on us including: a maximum ratio of 6.0x consolidated EBITDA to total senior secured indebtedness tested quarterly, beginning on the last day of the fourth quarter of 2011; and a minimum ratio of 1.25x consolidated EBITDA to consolidated cash interest expense, tested quarterly beginning on the last day of the fourth fiscal quarter of 2011. The maximum leverage ratio is scheduled to adjust to 5.75x beginning with the trailing four quarter period ending June 30, 2012. The minimum interest coverage ratio is scheduled to adjust to 1.30x beginning with the trailing four quarter period ending March 31, 2013. We are currently in compliance with the covenants of our senior secured credit facility.

The Credit Agreement is secured by substantially all of our tangible and intangible assets, except for assets held by subsidiaries that have been designated as nonguarantor subsidiaries. The Credit Agreement also contains certain customary representations and warranties, affirmative covenants and events of default, including payment defaults, breach of representations and warranties, covenant defaults, cross defaults to certain material indebtedness, certain events of bankruptcy, certain events under ERISA, change of control, material judgments, failure of certain guaranty documents to be in full force and effect and failure of a lien to have the priority or otherwise be valid and perfected with respect to material collateral.

If we are unable to maintain compliance with the covenants and requirements contained in the Credit Agreement, an event of default could occur, unless we are able to obtain a waiver or enter into an amendment with the senior lenders to revise the covenants and requirements. If any such event of default occurs, the lenders under the Credit Agreement would be entitled to take various actions, including the acceleration of amounts due under the Credit Agreement, terminating access to our revolving credit facility, and all actions permitted to be taken by a secured creditor. If we are required to obtain a waiver or execute an amendment to the Credit Agreement, it is likely we will incur additional fees and expenses, and will be required to pay a higher interest margin on our outstanding indebtedness in subsequent periods. An event of default would have a material adverse effect on our financial position, results of operations and cash flow.

(6) Stock Options

At March 31, 2012, there were 2.9 million shares of common stock of Holdings available under the 2005 Equity Incentive Plan (“Plan”) for stock option grants and other incentive awards, including restricted stock units. Options granted generally have an exercise price equal to the fair market value of the shares on the date of grant and expire 10 years from the date of grant. A restricted stock unit is a contractual right to receive one share of Holdings common stock in the future. Options typically vest one-quarter on each of the first four anniversary dates of the grant and restricted stock units typically vest in three equal annual installments.

For the three months ended March 31, 2012 and 2011, there was no pre-tax compensation costs related to our stock-based compensation arrangements.

The following table summarizes stock option activity during the three months ended March 31, 2012:


	Number of Shares			Weighted average exercise price
Balance at December 31, 2011		1,691,250		$	2.50
Granted		—			—
Exercised		—			—
Forfeited		—			—
Expired		(47,250	)		2.50

Balance at March 31, 2012		1,644,000		$	2.50

At March 31, 2012, the weighted average remaining contractual life of outstanding options was 6.4 years. There were 1.3 million stock options exercisable at March 31, 2012. At March 31, 2012, the weighted average exercise price of the vested stock options was $2.50, the remaining weighted average contractual life was 5.8 years and they had no intrinsic value. As of March 31, 2012, there was no unrecognized compensation costs related to stock options.

Restricted Stock Awards

There have been no restricted stock awards issued during the three months ended March 31, 2012. As of March 31, 2012, there was no unrecognized compensation costs related to restricted stock awards.

Warrants

In connection with the acquisition of the long-term acute care hospitals from HealthSouth Corporation, we granted warrants to purchase 1.3 million shares, or 6.25%, of Holdings’ common stock, with an exercise price of $0.01 per share to HealthCare REIT, Inc. The warrants expire on the later of December 31, 2026 or the termination of the lease agreement. These warrants were determined to have no value on the grant date.

(7) Regulatory Matters

All healthcare providers are required to comply with a significant number of laws and regulations at the federal and state government levels. These laws are extremely complex, and in many instances, providers do not have the benefit of significant regulatory or judicial interpretation as to how to interpret and/or apply these laws and regulations. The U.S. Department of Justice and other federal and state agencies are increasing resources dedicated to regulatory investigations and compliance audits of healthcare providers. As a healthcare provider, we are subject to these regulatory efforts. Healthcare providers that do not comply with these laws and regulations may be subject to civil or criminal penalties, the loss of their licenses, or restriction in their ability to participate in various federal and state healthcare programs. We endeavor to conduct our business in compliance with applicable laws and regulations, including healthcare fraud and abuse laws.

As a result of our hospital’s state licensures and certifications under the Medicare and various Medicaid programs, we are subject to regular reviews, surveys, audits and investigations conducted by, or on the behalf of, the federal and state agencies, including the Centers for Medicare & Medicaid Services (“CMS”), that are responsible for the oversight of these programs. These agencies’ reviews may include reviews or surveys of our compliance with required conditions of participation regulations. The purpose of these surveys is to ensure that healthcare providers are in compliance with governmental requirements, including requirements such as adequacy of medical care, equipment, personnel, operating policies and procedures, maintenance of adequate records, compliance with building codes and environmental protection and healthcare fraud and abuse. These surveys may identify deficiencies with conditions of participation which require corrective actions to be made by the hospital within a given timeline. If a hospital is not successful in addressing the deficiencies and conditions in a timely manner, then CMS reserves the right to deem the hospital to be out of compliance with Medicare conditions of participation and may terminate the hospital from participation in the Medicare program.

(8) Commitments and Contingencies

We have certain pending and threatened litigation and claims incurred in the ordinary course of business. We believe (based, in part, on the advice of legal counsel) that the probable resolution of such contingencies will not exceed our insurance coverage and will not materially affect our consolidated financial position, results of operations or liquidity.

(9) Fair Value of Financial Instruments

The carrying amount of cash and cash equivalents, accounts receivable, third-party payor settlements, and accounts payable and accrued expenses approximates fair value because of the short-term maturity of these instruments. The carrying amount of these obligations is a reasonable estimate of fair value.

We follow the guidance for the fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of subjective inputs when measuring fair value. The guidance describes three levels of inputs that may be used to measure fair value:

Level 1—Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

Level 2—Inputs (other than prices included in Level 1) are either directly or indirectly observable, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3—Inputs are unobservable and reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

The Senior Secured Credit Facility and the Senior Subordinated Notes are traded in private institutional markets. The carrying amounts of the Senior Secured Credit Facility and the Senior Subordinated Notes were $316.8 million and $119.3 million, respectively, at March 31, 2012. Using available quoted market prices, the fair values of the Senior Secured Credit Facility and the Senior Subordinated Notes were approximately $264.5 million and $81.4 million, respectively, at March 31 2012. The carrying amount of the Senior Secured Credit Facility and the Senior Subordinated Notes was $313.2 million and $119.3 million, respectively, at December 31, 2011. Using available quoted market prices, the fair values of the Senior Secured Credit Facility and the Senior Subordinated Notes were approximately $261.5 million and $92.5 million, respectively, at December 31, 2011. The fair values are based on quoted market prices at each balance sheet date; however, these quoted market prices represent Level 2 inputs as the markets in which the Senior Secured Credit Facility and the Senior Subordinated Notes trade are not active. The carrying value of the note payable to Vibra, was $3.8 million at March 31, 2012. Using available quoted market prices for our other debt as a basis, we estimated the fair market value of the note payable at $3.8 million at March 31, 2012. The carrying value of the note payable related to the Vibra acquisition was $4.5 million at December 31, 2011. Using available quoted market prices for our other debt as a basis, we estimated the fair market value of the note payable at $4.5 million at December 31, 2011. This valuation is categorized as a Level 2 in the valuation hierocracy.

(10) Exit Cost

On December 1, 2011, we purchased selected assets of a long-term acute care hospital from Vibra Specialty Hospital (“Vibra”), pursuant to an Asset Purchase Agreement. In connection with the acquisition, we relocated and merged our existing operations into the operating location formerly utilized by Vibra. In addition, we entered into an early termination agreement with the landlord for the lease of our former operating location whereby we will pay an early termination fee of $1.8 million, payable over an 18 month period, ending June 30, 2013. This fee, along with other costs associated with the abandonment of the facility, was accrued as exit cost as of December 31, 2011.

The following table summarizes the activity of the accrued exit cost for the three months ended March 31, 2012 (in thousands):


Accrued exit cost at December 31, 2011	$	2,296
Payments made		(625	)

Accrued exit cost at March 31, 2012	$	1,671

(11) Acquisitions

On August 1, 2011, we purchased five long-term acute care hospitals, which operate at seven locations, from HealthSouth Corporation and certain affiliates of HealthSouth Corporation, pursuant to an Asset Purchase Agreement.

On December 1, 2011, we purchased selected assets of a long-term acute care hospital from Vibra, pursuant to an Asset Purchase Agreement. According to the agreement, we acquired substantially all of the inventory and equipment, along with some indentified liabilities.

The following pro forma information assumes the acquisitions had occurred at the beginning of the earliest period presented. Such results have been prepared by adjusting our historical results to include the results of operations, exit cost, depreciation, amortization of acquired definite-lived intangibles and incremental interest related to acquisition debt related to the entities acquired during the year. The pro forma results do not include any cost savings that may result from the combination of the Company and facilities acquired. The pro forma results may not necessarily reflect the consolidated operations that would have existed had the acquisition been completed at the beginning of such period nor are they necessarily indicative of future results. Amounts are in thousands of dollars.


	Three months ended March 31, 2011
	Pro Forma
Net patient service revenues	$	125,731
Net loss	$	(2,807	)

(12) Financial Information for Subsidiary Guarantors and Nonguarantor Subsidiaries under the Senior Subordinated Notes

The senior subordinated notes are fully and unconditionally guaranteed by substantially all of our wholly-owned subsidiaries (the “Subsidiary Guarantors”), however, certain of our subsidiaries did not guarantee the senior subordinated notes (the Nonguarantor Subsidiaries”).

Presented below is condensed consolidating financial information for LifeCare Holdings, Inc., the Subsidiary Guarantors, and the Nonguarantor Subsidiaries for the three months ended at March 30, 2012 and 2011. The equity method has been used with respect to investments in subsidiaries. Separate financial statements of the Subsidiary Guarantors are not presented.

LifeCare Holdings, Inc.

Condensed Consolidating Balance Sheet

March 31, 2012

(in thousands)


	Parent			Guarantor Subsidiaries			Nonguarantor Subsidiaries			Eliminations			Consolidated Totals
Assets
Current assets:
Cash and cash equivalents	$	—		$	4,126		$	1		$	—		$	4,127
Accounts receivable, net of allowance for doubtful accounts		—			83,403			2,516			—			85,919
Due to/from related parties		28,415			(25,076	)		(3,339	)		—			—
Other current assets		—			9,912			795			—			10,707

Total current assets		28,415			72,365			(27	)		—			100,753
Investment in subsidiaries		360,297			—			—			(360,297	)		—
Property and equipment, net		—			52,350			20,046			—			72,396
Other assets, net		13,919			4,598			1,559			—			20,076
Identifiable intangibles, net		—			38,258			—			—			38,258
Goodwill		—			264,512			—			—			264,512

Total assets	$	402,631		$	432,083		$	21,578		$	(360,297	)	$	495,995

Liabilities and Stockholder’s Equity (Deficit)
Current liabilities:
Current installments of long-term debt	$	3,047		$	3,000		$	—		$	—		$	6,047
Current installments of obligations under capital leases		—			282			15			—			297
Current installments of lease financing obligation		—			—			530			—			530
Estimated third party payor settlements		—			191			3,121			—			3,312
Accounts payable		314			28,072			1,010			—			29,396
Accrued payroll		—			4,960			140			—			5,100
Accrued vacation		—			7,321			210			—			7,531
Accrued interest		11,079			—			—			—			11,079
Accrued other		—			7,011			198			—			7,209
Income taxes payable		—			863			—			—			863

Total current liabilities		14,440			51,700			5,224			—			71,364

Long-term debt, excluding current installments		433,076			815			—			—			433,891
Obligations under capital leases, excluding current installments		—			72			—			—			72
Lease financing obligation, excluding current installments		—			—			18,902			—			18,902
Accrued insurance		—			5,019			—			—			5,019
Other noncurrent liabilities		6,027			11,632			—			—			17,659

Total liabilities		453,543			69,238			24,126			—			546,907

Stockholder’s equity (deficit):
Common stock		—			—			—			—			—
Additional paid-in capital		175,441			63			12,580			(12,643	)		175,441
Retained earnings (accumulated deficit)		(226,353	)		362,782			(15,128	)		(347,654	)		(226,353	)

Total stockholder’s equity (deficit)		(50,912	)		362,845			(2,548	)		(360,297	)		(50,912	)

	$	402,631		$	432,083		$	21,578		$	(360,297	)	$	495,995

LifeCare Holdings, Inc.

Condensed Consolidating Balance Sheet

December 31, 2011

(in thousands)


	Parent			Guarantor Subsidiaries			Nonguarantor Subsidiaries			Eliminations			Consolidated Totals
Assets
Current assets:
Cash and cash equivalents	$	—		$	11,568		$	1		$	—		$	11,569
Accounts receivable, net of allowance for doubtful accounts		—			87,644			3,720			—			91,364
Due to/from related parties		42,281			(38,735	)		(3,546	)		—			—
Other current assets		—			9,472			772			—			10,244

Total current assets		42,281			69,949			947			—			113,177
Investment in subsidiaries		346,849			—			—			(346,849	)		—
Property and equipment, net		—			53,431			20,336			—			73,767
Other assets, net		16,502			4,545			1,659			—			22,706
Identifiable intangibles, net		—			38,323			—			—			38,323
Goodwill		—			264,512			—			—			264,512

Total assets	$	405,632		$	430,760		$	22,942		$	(346,849	)	$	512,485

Liabilities and Stockholder’s Equity (Deficit)
Current liabilities:
Current installments of long-term debt	$	3,047		$	2,865		$	—		$	—		$	5,912
Current installments of obligations under capital leases		—			389			25			—			414
Current installments of lease financing obligation		—			—			519			—			519
Estimated third party payor settlements		—			6,245			3,042			—			9,287
Accounts payable		262			29,026			1,703			—			30,991
Accrued payroll		—			9,801			5			—			9,806
Accrued vacation		—			6,393			196			—			6,589
Accrued interest		13,705			—			—			—			13,705
Accrued other		—			9,621			151			—			9,772
Income taxes payable		—			663			—			—			663

Total current liabilities		17,014			65,003			5,641			—			87,658

Long-term debt, excluding current installments		429,434			1,639			—			—			431,073
Obligations under capital leases, excluding current installments		—			86			3			—			89
Lease financing obligation, excluding current installments		—			—			19,038			—			19,038
Accrued insurance		—			4,102			—			—			4,102
Deferred income taxes		5,500			—			—			—			5,500
Other noncurrent liabilities		—			11,341			—			—			11,341

Total liabilities		451,948			82,171			24,682			—			558,801

Stockholder’s equity (deficit):

Common stock		—			—			—			—			—
Additional paid-in capital		175,441			63			12,580			(12,643	)		175,441
Retained earnings (accumulated deficit)		(221,757	)		348,526			(14,320	)		(334,206	)		(221,757	)

Total stockholder’s equity (deficit)		(46,316	)		348,589			(1,740	)		(346,849	)		(46,316	)

	$	405,632		$	430,760		$	22,942		$	(346,849	)	$	512,485

LifeCare Holdings, Inc.

Condensed Consolidating Statement of Operations

For the Three Months Ended March 31, 2012

(in thousands)


	Parent			Guarantor Subsidiaries			Nonguarantor Subsidiaries			Eliminations			Consolidated Totals
Net patient service revenue	$	—		$	122,318		$	4,091		$	—		$	126,409

Salaries, wages and benefits		3			56,440			2,101			—			58,544
Supplies		—			11,950			355			—			12,305
Rent		—			10,278			296			—			10,574
Other operating expenses		276			25,952			1,076			—			27,304
Provision for doubtful accounts		—			1,547			52			—			1,599
Depreciation and amortization		—			2,130			303			—			2,433
Intercompany (income) expenses		990			(1,196	)		206			—			—
Interest expense, net		16,776			233			409			—			17,418

Total expenses		18,045			107,334			4,798			—			130,177

Operating income (loss)		(18,045	)		14,984			(707	)		—			(3,768	)
Earnings in investments in subsidiaries		(13,449	)		—			—			13,449			—
Equity in loss of joint venture		—			—			(101	)		—			(101	)

Income (loss) before income taxes		(4,596	)		14,984			(808	)		(13,449	)		(3,869	)
Provision for income taxes		—			727			—			—			727

Net income (loss)	$	(4,596	)	$	14,257		$	(808	)	$	(13,449	)	$	(4,596	)

LifeCare Holdings, Inc.

Condensed Consolidating Statement of Operations

For the Three Months Ended March 31, 2011

(in thousands)


	Parent			Guarantor Subsidiaries			Nonguarantor Subsidiaries		Eliminations			Consolidated Totals
Net patient service revenue	$	—		$	89,662		$	5,257	$	—		$	94,919

Salaries, wages and benefits		3			42,397			2,000		—			44,400
Supplies		—			8,925			366		—			9,291
Rent		—			6,263			210		—			6,473
Other operating expenses		241			19,187			1,328		—			20,756
Provision for doubtful accounts		—			1,261			84		—			1,345
Loss on early extinguishment of debt		2,772			—			—		—			2,772
Depreciation and amortization		—			1,797			319		—			2,116
Intercompany (income) expenses		1,098			(1,457	)		359		—			—
Interest expense, net		10,945			(7	)		397		—			11,335

Total expenses		15,059			78,366			5,063		—			98,488

Operating income (loss)		(15,059	)		11,296			194		—			(3,569	)
Earnings in investments in subsidiaries		(11,458	)		—			—		11,458			—
Equity in income of joint venture		—			—			193		—			193

Income (loss) before income taxes		(3,601	)		11,296			387		(11,458	)		(3,376	)
Provision for income taxes		—			225			—		—			225

Net income (loss)	$	(3,601	)	$	11,071		$	387	$	(11,458	)	$	(3,601	)

LifeCare Holdings, Inc.

Condensed Consolidating Statement of Cash Flows

For the Three Months Ended March 31, 2012

(in thousands)


	Parent			Guarantor Subsidiaries			Nonguarantor Subsidiaries			Eliminations			Consolidated
Cash flows from operating activities:
Net income (loss)	$	(4,596	)	$	14,257		$	(808	)	$	(13,449	)	$	(4,596	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization (including amortization of debt issuance cost)		2,583			2,131			303			—			5,017
Provision for doubtful accounts		—			1,547			52			—			1,599
Paid in kind interest		4,404			—			—			—			4,404
Equity in loss of joint venture		—			—			101			—			101
Deferred income taxes		527			—			—						527
Amortization of debt discount		—			144			—			—			144
Changes in operating assets and liabilities:
Accounts receivable		—			2,694			1,152			—			3,846
Income taxes		—			200			—			—			200
Other current assets		—			(440	)		(23	)		—			(463	)
Change in investments in subsidiaries		(13,449	)		—			—			13,449			—
Other assets		—			(54	)		—			—			(54	)
Due to/from related parties		13,863			(13,656	)		(207	)		—			—
Estimated third party payor settlements		—			(6,053	)		79			—			(5,974	)
Accounts payable and accrued expenses		(2,570	)		(7,483	)		(497	)		—			(10,550	)
Other noncurrent liabilities		—			1,208			—			—			1,208

Net cash provided by (used in) operating activities		762			(5,505	)		152			—			(4,591	)

Cash flows from investing activities:
Purchases of property and equipment		—			(984	)		(13	)		—			(997	)

Net cash used in investing activities		—			(984	)		(13	)		—			(997	)

Cash flows from financing activities:
Borrowings on revolving credit facility		15,000			—			—			—			15,000
Payments on revolving credit facility		(15,000	)		—			—			—			(15,000	)
Payments of long-term debt		(762	)		(833	)		—			—			(1,595	)
Payments on obligations under capital leases		—			(120	)		(13	)		—			(133	)
Payments on lease financing obligation		—			—			(126	)		—			(126	)

Net cash used in financing activities		(762	)		(953	)		(139	)		—			(1,854	)

Net decrease in cash and cash equivalents		—			(7,442	)		—			—			(7,442	)
Cash and cash equivalents, beginning of period		—			11,568			1			—			11,569

Cash and cash equivalents, end of period	$	—		$	4,126		$	1		$	—		$	4,127

LifeCare Holdings, Inc. and Subsidiaries

Condensed Consolidating Statement of Cash Flows

For the Three Months Ended March 31, 2011

(in thousands)


	Parent			Guarantor Subsidiaries			Nonguarantor Subsidiaries			Eliminations			Consolidated
Cash flows from operating activities:
Net income (loss)	$	(3,601	)	$	11,071		$	387		$	(11,458	)	$	(3,601	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		1,335			1,797			319			—			3,451
Provision for doubtful accounts		—			1,261			84			—			1,345
Paid in kind interest		551			—			—			—			551
Loss on early extinguishment of debt		2,772			—			—			—			2,772
Equity in income of joint venture		—			—			(193	)		—			(193	)
Changes in operating assets and liabilities:
Accounts receivable		—			(5,120	)		91			—			(5,029	)
Income taxes		203			219			—			—			422
Prepaid expenses and other current assets		—			(708	)		(247	)		—			(955	)
Change in investments in subsidiaries		(11,458	)		—			—			11,458			—
Other assets		—			(164	)		—			—			(164	)
Due to/from related parties		47,653			(46,825	)		(828	)		—			—
Estimated third party payor settlements		—			650			225			—			875
Accounts payable and accrued expenses		(687	)		(2,725	)		314			—			(3,098	)
Other liabilities		—			1,345			—			—			1,345

Net cash provided by operating activities		36,768			(39,199	)		152			—			(2,279	)

Cash flows from investing activities:
Purchases of property and equipment		—			(812	)		(4	)		—			(816	)

Net cash used in investing activities		—			(812	)		(4	)		—			(816	)

Cash flows from financing activities:
Deferred financing costs		(17,655	)		—			—			—			(17,655	)
Payments under the line of credit		(35,000	)		—			—			—			(35,000	)
Proceeds from long-term debt		257,500			—			—			—			257,500
Payments of long-term debt		(241,613	)		—			—			—			(241,613	)
Payments on obligations under capital leases		—			(258	)		(32	)		—			(290	)
Payments on lease financing obligation		—			—			(116	)		—			(116	)

Net cash used in financing activities		(36,768	)		(258	)		(148	)		—			(37,174	)

Net increase in cash and cash equivalents		—			(40,269	)		—			—			(40,269	)
Cash and cash equivalents, beginning of period		—			54,569			1			—			54,570

Cash and cash equivalents, end of period	$	—		$	14,300		$	1		$	—		$	14,301

ITEM 2:

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion and analysis should be read in conjunction with our condensed consolidated financial statements and the accompanying notes.

Company Overview

We began operations in 1993 and have grown our business through developing and acquiring hospitals to become a leading operator of long-term acute care (“LTAC”) hospitals in the United States. As of March 31, 2012, we operated 27 hospitals located in ten states, consisting of eight “hospital within a hospital” facilities (20% of beds) and 19 freestanding facilities (80% of beds). Through these 27 long-term acute care hospitals, we operate a total of 1,390 licensed beds and employ approximately 4,500 people, the majority of whom are registered or licensed nurses and respiratory therapists. Additionally, we hold a 50% investment in a joint venture for a 51-bed LTAC hospital located in Muskegon, Michigan.

We believe we have developed a reputation for excellence in providing treatment for patients with complex medical needs requiring extended treatment. Our patients have serious medical conditions such as respiratory failure, chronic pulmonary disease, nervous system disorders, infectious diseases and severe wounds. They generally require a high level of monitoring and specialized care, yet may not require the continued services of an intensive care unit. Due to their serious medical conditions, our patients are generally not clinically appropriate for admission to a skilled nursing facility or inpatient rehabilitation facility. By combining general acute care services with a focus on long-term treatment, we believe that our hospitals provide medically complex patients with better and more cost-effective outcomes.

Liquidity and Uncertainties Related to Going Concern

As of March 31, 2012, we had $439.9 million of long-term debt outstanding consisting of our senior secured term loan credit facility in an outstanding principal amount of $316.8 million, which matures on February 1, 2016, our senior subordinated notes in an outstanding principal amount of $119.3 million, which mature on August 11, 2013, and our note payable to Vibra in an outstanding principal amount of $3.8 million, which matures on June 1, 2013. Additionally we have a $30.0 million senior secured revolving credit facility, which matures on February 1, 2015, of which there is no outstanding balance as of March 31, 2012. The scheduled maturity dates of the senior secured term loan and revolving credit facility may accelerate to May 15, 2013, if the senior subordinated notes are not refinanced, purchased or defeased in full by May 15, 2013.Although we are highly leveraged, we believe that our cash on hand, expected cash flows from operations, and potential availability of borrowings under our senior secured revolving credit facility will be sufficient to finance our operations and meet our scheduled debt service requirements for at least the next twelve months, absent certain actions of lenders in the case of an event of default under our senior secured credit facility as discussed below.

We are required to comply on a quarterly basis with certain financial and other covenants under our senior secured credit facility, including a minimum consolidated cash interest expense coverage ratio test and a maximum senior secured leverage ratio test which are tested quarterly. We were required to meet a leverage ratio of 6.00x at March 31, 2012, which reduces to 5.75x at June 30, 2012. Our leverage ratio at March 31, 2012, was 5.72x. We were required to meet an interest coverage ratio of 1.25x at March 31, 2012 and throughout 2012, which increases to 1.30x on March 31, 2013. Our interest coverage ratio was 1.44x at March 31, 2012. We are currently in compliance with the covenants under our senior secured credit facility for the quarterly period ended March 31, 2012. We expect to maintain compliance under the covenants of our senior secured credit facility for the next twelve months. See more discussion in the “Liquidity and Capital Resources” section contained herein.

Recent Trends and Events

Hospital Openings and Closings

On December 1, 2011, we purchased selected assets of a long-term acute care hospital operated by Vibra Specialty Hospital (“Vibra”) located in Dallas, Texas for approximately $10.9 million, less adjustments for certain equipment items and liabilities assumed. We relocated 60 beds from our existing Dallas location into Vibra’s facility and discontinued operations in our existing facility.

On August 1, 2011, we purchased five long-term acute care hospitals (the “Facilities”), which operate at seven locations, from HealthSouth Corporation and certain affiliates of HealthSouth Corporation (collectively, the “Sellers”), pursuant to an Asset Purchase Agreement (the “Purchase Agreement”). According to the Purchase Agreement, we acquired substantially all of the non-real estate assets (excluding accounts receivable and certain other components of working capital) in exchange for a cash purchase price of approximately $42.5 million less the value of working capital associated with the Facilities. We financed the acquisition with a combination of an incremental term loan from our existing senior secured credit facility and cash on hand. In addition, Health Care REIT, Inc. purchased the real estate assets associated with four of these Facilities from the Sellers for $75.0 million. We simultaneously entered into a lease with Health Care REIT, Inc. for these properties as discussed below.

The results of operations of the Facilities are included in our consolidated results of operations beginning August 1, 2011. The assets acquired and liabilities assumed of the Facilities were recognized at their acquisition date fair values. The allocation of the purchase price to the assets acquired and liabilities assumed of the Facilities (and the related estimated lives of depreciable tangible and identifiable intangible assets) required a significant amount of judgment. The allocation of the purchase price has been determined based upon the analysis performed. Any premium paid by us in this transaction is attributable to strategic benefits, including enhanced financial and operational scale, and market diversification. The goodwill associated with this transaction is fully deductible for income tax purposes.

On August 1, 2011, we entered into a Second Amended and Restated Master Lease Agreement (the “Second Amended and Restated Lease”) with Health Care REIT, Inc., which included the real estate properties for two of our existing operations and the four new Facilities discussed previously. The Second Amended and Restated Lease became effective with respect to the hospitals on August 1, 2011 and its initial 15-year term ends on July 31, 2026. The Second Amended and Restated Lease contains an option to renew for one 14-year, 11-month renewal term. The rent for the hospitals under the Second Amended and Restated Lease is computed based upon the Health Care REIT, Inc.’s investment amount multiplied by the greater of (i) a spread over the trading yield on 10-year U.S. Treasury Notes, or (ii) 9.71%, and is subject to an annual inflation adjustment. In addition, on August 1, 2011 we paid a transaction fee of $750,000 to Health Care REIT, Inc., and an indirect parent of the Company granted a warrant to HealthCare REIT, Inc. to purchase 6.25% of the shares of such parent’s common stock on August 1, 2011, with an exercise price of $0.01 per share.

On May 17, 2011, we entered into an amendment, (the “Incremental Amendment”), to our current credit agreement (the “Credit Agreement”), with JPMorgan Chase Bank, N.A., the lenders party thereto, and the other agents named therein. The Incremental Amendment provided for an additional $47.2 million in new senior secured term loans. Proceeds were restricted to (i) payment of consideration for the acquisition of the Facilities, (ii) payment of fees and expenses in connection with the acquisition of the Facilities and (iii) working capital purposes of the Company and its subsidiaries. The new senior secured term loans have the same terms as the outstanding senior secured term loans, including with respect to interest rate, amortization, maturity date and optional and mandatory prepayments. On August 1, 2011, in connection with the completion of the acquisition and the funding of the additional term loan proceeds, we paid a consent fee of $1.4 million to the lenders under the Credit Agreement for consenting to the Incremental Amendment.

On September 6, 2011 we opened a new 40 bed transitional care unit located at one of our Pittsburgh, PA hospital locations. This unit operates as a sub-provider of an existing Pittsburgh, PA operation.

Regulatory Changes

Approximately 64.6% and 59.8% of our total net patient service revenue for the three months ended March 31, 2012 and 2011, respectively, came from Medicare reimbursement. Our industry is subject to extensive government regulation, including regulation of the Medicare reimbursement process. Changes in these regulations can have a material impact on the way we operate our business and on our results of operations. The discussion included herein provides a summary analysis of recent regulatory changes that have had an impact on our results of operations for the three months ended March 31, 2012, and recently proposed regulations that may have an impact on our future results of operations. A more detailed discussion of the regulatory environment in which we operate may be found in Part I – Business – Government Regulations, in our Annual Report filed on Form 10-K on March 30, 2012 with the Securities and Exchange Commission, for the year ended December 31, 2011. The information below should be read in connection with that more detailed discussion.

2012 Proposed Rule

On May 11, 2012, the Centers for Medicare & Medicaid Services (“CMS”) published their proposed annual payment update for LTAC hospitals for the 2013 rate year, which will be effective for all discharges on or after October 1, 2012 (the “2012 Proposed Rule”). The proposed rule includes a net increase in the standard federal rate of $805 to $41,027, or 2.0%, for the period October 1, 2012 through December 28, 2012. For discharges on or after December 29, 2012 through September 30, 2013, the standard federal rate would then decrease by $520 to $40,507, which represents a 0.7% increase from the current rate of $40,222. Both of these proposed standard federal rates include a market basket update of 3.0%, less a 0.097% area wage level budget neutrality factor, and two adjustments required by the Patient Protection and Affordable Care Act: the multifactor productivity (“MFP”) adjustment of 0.8% and a statutory payment rate reduction of 0.1%. The proposed standard federal base rate beginning December 29, 2012, is further reduced by 1.266%, which represents the first year impact of a three-year phase in of a “one-time” 3.75% budget neutrality adjustment. The proposed rule also includes a decrease in the high-cost outlier fixed-loss amount to $15,728 from $17,931, updates to the weighting of Medicare-Severity Diagnosis Related Groups (“MS-LTC-DRG”), and the implementation of reduced Medicare payments for patients with very short stays in LTAC hospitals for discharges occurring on or after December 29, 2012. CMS has estimated that the proposed changes for the 2013 rate year, taken as a whole, will result in an increase of 1.9% in Medicare reimbursement to LTAC hospitals. Individual hospitals, however, may see varying effects of this proposed rule depending upon their Medicare patient population and their specific base rate changes due to geographical location.

As a result of certain federal laws enacted in recent years, including the “Medicare, Medicaid and SCHIP Extension Act of 2007,” the “Patient Protection and Affordable Care Act of 2010,” and the “Health Care and Education Affordability Reconciliation Act of 2010,” CMS had previously been restricted from further implementation of the “25 Percent Rule,” the application of a budget neutrality adjustment and the implementation of very short-stay outlier payment reductions, among other items, until the December 29, 2012, expiration of certain provisions of these laws. These laws also contained a moratorium, subject to certain exceptions, on the development of new LTAC hospital beds until December 29, 2012. The proposed regulations discussed above include the anticipated implementation of the budget neutrality adjustment and the very short-stay outlier policy for discharges on or after December 29, 2012. Additionally, the proposed regulations allow for the expiration of the moratorium on the development of new LTAC hospital beds after December 29, 2012.

However, CMS is proposing a one-year extension on the existing moratorium on the “25 Percent Rule” policy for cost report periods beginning on or after October 1, 2012, pending results of an on-going research initiative to re-define the role of LTAC hospitals in the Medicare program. As a result of various laws and regulations, this extension, however, may create a “gap” period for LTAC hospitals that currently lose relief between July 1, 2012 and October 1, 2012. CMS recognizes this gap period in the proposed rule, but believes that the extension must be prospective commencing with the beginning of the fiscal year, which is October 1, 2012. Under this proposal, LTAC hospitals whose relief expires between July 1, 2012 and October 1, 2012, will fall into the gap period and, therefore, need to wait until the start of their next cost reporting period to benefit from the 1-year extension.

2011 Final Rule

On August 1, 2011, CMS published their annual payment update for LTAC hospitals for the 2012 rate year, which became effective for all discharges on or after October 1, 2011 (the “2011 Final Rule”). The 2011 Final Rule included a net increase in the standard federal rate of $623 to $40,222, or 1.6%, which was based on a market basket update of 2.9% less a 0.22% area wage level budget neutrality factor and the two adjustments required by the PPACA: the multifactor productivity adjustment of 1.0% and statutory payment rate reduction of 0.1%. The 2011 Final Rule also included a decrease in the high-

cost outlier fixed-loss amount to $17,931 from $18,785. Additionally, the 2011 Final Rule included updates to the weighting of MS-LTC-DRG. CMS estimated that the changes outlined above for the 2012 rate year, taken as a whole, would result in an increase of 2.5% in Medicare reimbursement to LTAC hospitals. Individual hospitals, however, may see varying effects of the 2011 Final Rule depending upon their Medicare patient population and their specific base rate changes due to geographical location. The 2011 Final Rule also established a new quality reporting program for LTAC hospitals in accordance with provisions of the Affordable Care Act and clarified CMS’ position that Medicare Advantage days, along with traditional Medicare fee-for-service program days, were to be included in the determination of whether a LTAC hospital meets the greater than 25 day average length of stay requirement. Furthermore, the 2011 Final Rule extended the application of the LTAC bed moratorium to LTAC hospitals developed under exceptions to the LTAC facility moratorium and proposed a rebasing of the market basket used by LTCH hospitals.

The 2010 Final Rule

On July 30, 2010, CMS published their annual payment update for LTAC hospitals for the 2011 rate year, which became effective for all discharges on or after October 1, 2010 (the “2010 Final Rule”). The 2010 Final Rule included a net decrease in the standard federal rate of $195, or 0.5%, to $39,600, which was based on a market basket update of 2.5% less an adjustment of 0.5% as required by the Patient Protection and Affordable Care Act (“PPACA”) of 2010, discussed below, and less an adjustment of 2.5% to account for changes in documentation and coding practices. The 2010 Final Rule also included an increase in the high-cost outlier fixed-loss amount to $18,785 from $18,615. Additionally, the 2010 Final Rule included updates to the weighting of MS-LTC-DRGs, which CMS indicated will be budget neutral for aggregate LTAC hospital payments. CMS also estimated that the changes for the 2011 rate year, taken as a whole, including changes to the area wage adjustments for the 2011 rate year, an increase in high-cost outlier payments and an increase in short-stay outlier payments, would result in an increase of 0.5% in Medicare reimbursement to LTAC hospitals.

2010 Healthcare Reform Law

On March 23, 2010, the President signed into law the PPACA. This act made dramatic changes to the Medicare and Medicaid programs by adopting numerous initiatives intended to improve the quality of healthcare, promote patient safety, reduce the cost of healthcare, increase transparency and reduce fraud and abuse of federal healthcare programs. Additionally, on March 30, 2010, the President signed the Health Care and Education Affordability Reconciliation Act of 2010, which made certain amendments to the law signed by the President on March 23, 2010.

The PPACA, together with the Health Care and Education Affordability Reconciliation Act of 2010, also made changes to the Medicare program relevant to the LTAC industry, including the following key provisions, among other things:

•

a two-year extension of the LTAC provisions originally included in the Medicare, Medicaid and SCHIP Extension Act of 2007 (the “SCHIP Extension Act”),

•

the implementation of quality reporting requirements for LTAC hospitals beginning in rate year 2014,

•

reductions in the annual market basket rate increases of 0.25% for rate year 2010, and ranging from 0.1% to 0.75% for rate years beginning 2011 through 2019,

•

additional reductions in the annual market basket rate increases as the result of productivity adjustments beginning in 2012, which are expected to approximate 1% annually, and

•

the development of a new hospital wage index system to replace the current system of calculating the hospital wage index based on cost report data.

In addition, the PPACA created an “Independent Payment Advisory Board” to develop and submit proposals to the President and Congress designed to reduce Medicare spending, and provided for pilot programs to explore a bundled payment system for an episode of care that includes an inpatient stay in a hospital and post-acute care provided within 30 days after discharge.

Regulatory Matters

Periodically CMS will conduct surveys of hospitals and other health care providers as a condition of participation in the Medicare program. The purpose of these surveys is to ensure that healthcare providers are in compliance with various governmental requirements related to adequacy of medical care, equipment, personnel, operating policies and procedures, maintenance of adequate records, compliance with building codes and environmental protection and healthcare fraud and abuse.

Sources of Revenue

We are reimbursed for our services provided to patients by a number of sources, including the federal Medicare program and commercial payors. Payment arrangements include prospectively determined rates per discharge, reimbursed costs, discounted charges and per diem rates. Our net patient service revenue consists of the amounts that we estimate to be reimbursable from each of the applicable non-governmental payors and the Medicare and Medicaid programs. We account for the differences between the estimated reimbursement rates and our standard billing rates as contractual adjustments, which are deducted from gross revenues to arrive at net revenues. We record accounts receivable resulting from such payment arrangements net of contractual allowances. Net patient service revenues generated directly from the Medicare program approximated 64.6% and 59.8% of total net patient service revenue for the three months ended March 31, 2012 and 2011, respectively. Net patient service revenues generated from non-Medicare payors were substantially from commercial payors.

Laws and regulations governing provider reimbursement pursuant to the Medicare program are complex and subject to interpretation. The Medicare reimbursement amounts reported in our financial statements are based upon estimates and, as such, are subject to adjustment until such time as our billings and cost reports are filed and settled with the appropriate regulatory authorities. Federal regulations require that providers participating in the Medicare program submit annual cost reports associated with services provided to program beneficiaries. In addition, payments under LTAC hospital PPS are subject to review by the regulatory authorities, including enhanced medical necessity reviews pursuant to the SCHIP Extension Act and the Recovery Audit Contractor (“RAC”) program pursuant to the Tax Relief and Health Care Act of 2006. These reviews primarily focus on the accuracy of the MS-LTC-DRG assigned to each discharged patient and normally occur after the completion of the billing process.

The annual cost reports are subject to review and adjustment by CMS through its fiscal intermediaries. These reviews may not occur until several years after a provider files its cost reports and often results in adjustments to amounts reported by providers in their cost reports as a result of the complexity of the regulations and the inherent judgment that is required in the application of certain provisions of provider reimbursement regulations. Since these reviews of filed cost reports occur periodically, there is a possibility that recorded estimated Medicare reimbursement reflected in our consolidated financial statements and previously filed cost reports may change by a material amount in future periods. We recognize in our consolidated financial statements the impact of adjustments, if any, to estimated Medicare reimbursement when the amounts can be reasonably determined.

Total Expenses

Total expenses consist of salaries, wages and benefits, supplies, which includes expenses related to drug and medical supplies, rent, other operating expenses, provision for doubtful accounts, depreciation and amortization and interest expense. Other operating expenses include expenses such as contract labor, legal and accounting fees, insurance and contracted services purchased from host hospitals.

Other Operating Metrics

We use certain operating metrics in the management of our facility operations. These include:

Licensed beds. Licensed beds represent beds for which a facility has been granted approval to operate from the applicable state licensing agency. These licensed beds are used in the determination of average licensed beds and occupancy rates.

Average licensed beds. We compute average licensed beds by computing a weighted average based upon the number of licensed beds in place for each month within the reporting period.

Admissions. Admissions are the total number of patients admitted to our facilities during the reporting period.

Patient days. Patient days are the cumulative number of days that licensed beds are occupied in our facilities for the entire reporting period. We also refer to patient days as our census.

Average length of stay (days). We compute average length of stay in days by dividing patient days for discharged patients by discharges.

Occupancy rates. We compute our occupancy rate by determining the percentage of average licensed beds that are occupied for a 24-hour period during a reporting period. The occupancy rate provides a measure of the utilization of inpatient rooms.

Net patient service revenue per patient day. This measure is determined by dividing our total net patient service revenue by the number of patient days in a reporting period. We use this metric to provide a measure of the net patient service revenue generated for each patient day.

Critical Accounting Matters

This discussion and analysis of our financial condition and results of operation is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of those financial statements requires the use of estimates and judgments that affect the reported amounts and related disclosures. We rely on historical experience and other assumptions that we believe are reasonable at the time in forming the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual amounts may differ from these estimates.

We believe that the following critical accounting policies as more fully described in our annual financial statements as of December 31, 2011 as filed in the Form 10-K, affect the more significant judgments and estimates used in the preparation of our consolidated financial statements.

•

Revenue recognition

•

Accounts receivable and allowance for doubtful accounts

•

Estimated third party payor settlements

•

Insurance risks

•

Impairment of long-lived assets

•

Accounting for income taxes

•

Goodwill

Results of Operations

The following table sets forth operating results for each of the periods presented (in thousands):


	Three Months Ended March 31
	2012			2011
Net patient service revenue	$	126,409		$	94,919
Salaries, wages and benefits		58,544			44,400
Supplies		12,305			9,291
Rent		10,574			6,473
Other operating expenses		27,304			20,756
Provision for doubtful accounts		1,599			1,345
Loss on early extinguishment of debt		—			2,772
Depreciation and amortization		2,433			2,116
Interest expense, net		17,418			11,335

Total expenses		130,177			98,488

Operating loss		(3,768	)		(3,569	)
Equity in income (loss) of joint venture		(101	)		193

Loss before income taxes		(3,869	)		(3,376	)
Provision for income taxes		727			225

Net loss	$	(4,596	)	$	(3,601	)

Operating Statistics

The following table sets forth operating statistics for each of the periods presented.


	Three Months Ended March 31
	2012			2011
Number of hospitals within hospitals (end of period)		8			8
Number of freestanding hospitals (end of period)		19			12
Number of total hospitals (end of period)		27			20
Licensed beds LTAC (end of period)		1,390			1,057
Licensed beds transitional care unit beds (end of period)		40			—
Total licensed beds (end of period)		1,430			1,057
Average of total licensed beds ⁽¹⁾		1,430			1,057
LTAC admissions		2,995			2,108
Transitional care unit admissions		75			—
LTAC patient days		80,096			60,035
Transitional care unit patient days		2,465			—
LTAC occupancy rate		63.3	%		63.1	%
Transitional care unit occupancy rate		67.7	%		—
Percent net patient service revenue from Medicare		64.6	%		59.8	%
Percent net patient service revenue from commercial payors and Medicaid ⁽²⁾		35.4	%		40.2	%
Total net patient service revenue per patient day	$	1,531		$	1,581

(1)	The average licensed beds are only calculated on the beds at locations that were open for operations during the applicable periods.

(2)	The percentage of net patient service revenue from Medicaid is less than two percent for each of the periods presented.

Three Months Ended March 31, 2012 Compared to Three Months Ended March 31, 2011

Net Revenues

Our net patient service revenue of $126.4 million for the three months ended March 31, 2012, increased by $31.5 million, or 33.2%, from the comparable period in 2011. Patient days increased by 22,526, or 37.5%, while admissions increased by 962, or 45.6%, for the three months ended March 31, 2012, as compared to the same period in 2011. On a same store basis, which excludes the hospitals acquired from HealthSouth and the new transitional care unit, patient days increased by 1,779, or 3.0%, and admissions increased by 156, or 7.4%, for the three months ended March 31, 2012, as compared to the same period in 2011.

The increase of $31.5 million in net patient service revenue was attributable to an increase of $28.4 million from the recently acquired hospitals and the new transitional care unit and an increase of $3.1 million on a same store basis. The net increase on a same store basis was comprised of a favorable variance of $2.8 million attributable to an increase in patient days and a net increase of $0.7 million attributable to a decrease in adjustments related to changes in estimates and settlements on cost reports filed with the Medicare program, offset by an unfavorable variance of $0.4 million as the result of the decrease in net patient service revenue on a per patient day basis. During the three months ended March 31, 2012 and 2011, we recorded reductions in net patient service revenue of $0.1 million and $0.8 million, respectively, related to changes in estimates and settlements on cost reports filed with the Medicare program.

Our net patient service revenue per patient day during the three months ended March 31, 2012 and 2011, was $1,531 and $1,581, respectively. However, exclusive of the cost report reimbursement adjustments and results of the new hospitals and the new transitional care unit, net patient service revenue per patient day for the three months ended March 31, 2012 and 2011, was $1,587 and $1,595, respectively.

Total Expenses

Total expenses increased by $31.7 million to $130.2 million for the three months ended March 31, 2012, as compared to the same period in 2011. A portion of this increase was attributable to the addition of the recently acquired hospitals and new transitional care unit. On a same store basis, total expenses increased $6.1 million for the three months ended March 31, 2012, as compared to the same period in 2011.

The same store increase of $6.1 million in expenses was primarily attributable to an increase of $6.1 million in net interest expense, offset by a $2.8 million loss related to the write-off of deferred financing cost as a result of the refinancing of the senior secured credit facility during 2011. The $6.1 million increase in net interest expense was the result of the higher margin rate associated with the new senior secured credit agreement and interest on the additional borrowing related to the purchase of the new hospitals. The principal amount outstanding under our term loan facility at March 31, 2012 and 2011, was $316.8 million and $258.1 million, respectively, and had an average interest rate of 13.80% and 10.43% for the three months ended March 31, 2012 and 2011, respectively.

Income Tax Expense

For the three months ended March 31, 2012, income tax expense recorded represents the estimated income tax liability for certain state income taxes and deferred federal income tax expense associated with goodwill and other non-amortizing identifiable intangible assets that are amortizable and deductible for federal income tax purposes. We believe that it is more likely than not that no benefit or expense will be realized during 2012 for federal income taxes based on estimated federal taxable losses for 2012, other than the recurring deferred federal income tax expense associated with the goodwill and other non-amortizable identifiable intangible assets. We anticipate that federal net operating losses generated during 2012 will be offset by an increase in the valuation allowance against net deferred tax assets.

Liquidity and Capital Resources

Our primary sources of liquidity are cash on hand, expected cash flows generated by operations, and availability of borrowings under a revolving credit facility. Availability of borrowings under our revolving credit facility are generally dependent upon our ability to meet the maximum leverage ratio test included in the senior secured credit facility. Our primary liquidity requirements are for debt service on our senior secured credit facilities and the notes, capital expenditures and working capital.

As a result of impending maturities and increasingly more restrictive covenant requirements under our previous senior secured credit facility, we completed a refinancing of our previous senior secured credit facility with a new senior secured credit facility that consisted of an initial $257.5 million senior secured term loan (subject to paid-in-kind interest options as discussed below) and a new $30.0 million senior secured revolving credit facility on February 1, 2011 (the “Credit Agreement”). The proceeds of this new Credit Agreement along with available cash on hand were utilized to pay off our existing senior secured credit facility and revolving credit facility and the fees and expenses associated with the new Credit Agreement.

The terms of the Credit Agreement also provided that we had the right to request additional term loan commitments of up to $50.0 million. This right was exercised in connection with the HealthSouth acquisition, which occurred on August 1, 2011, as previously discussed.

As of March 31, 2012, we had $439.9 million of long-term debt outstanding consisting of our senior secured term loan credit facility in an outstanding principal amount of $316.8 million, which matures on February 1, 2016, our senior subordinated notes in an outstanding principal amount of $119.3 million, which mature on August 11, 2013, and our note payable to Vibra in an outstanding principal amount of $3.8 million, which matures on June 1, 2013. Additionally, we have a $30.0 million senior secured revolving credit facility, which matures on February 1, 2015, of which there was no outstanding balance as of March 31, 2012. The revolving credit facility includes sub-facilities for letters of credit, of which $6.4 million was outstanding. Availability of borrowings under the revolving credit facility are reduced by outstanding letters of credit. We also had capital lease obligations of $0.4 million with varying maturities. The full amount available under the initial term loan facility was used in connection with the February 1, 2011 refinancing.

interest “in-kind” by adding such interest to the outstanding principal of the term loans as of the applicable interest payment date. At March 31, 2012, the weighted average interest rate applicable to the $316.8 million outstanding under our term loan facility was 13.83%.

The applicable margin percentages for the revolving loans are 6.75% for alternate base loans and 7.75% for loans that are based on the LIBOR rate, subject to quarterly adjustment based on our leverage ratio (as defined in the Credit Agreement). In addition to paying interest on outstanding principal under the senior secured credit agreement, we are required to pay a commitment fee of 0.50% per annum in respect of the unutilized commitments under the revolving credit facility, subject to quarterly adjustment based on our leverage ratio (as defined in the Credit Agreement). We are also required to pay annual customary agency fees.

We may voluntarily prepay outstanding loans under the term loan facility and reduce the unutilized portion of the commitment amount in respect of the senior secured revolving credit facility at any time. Any such voluntary prepayments are subject to a prepayment fee of 2% if such prepayment occurs after February 1, 2012 and on or prior to February 1, 2013, and 1% if such prepayment occurs after February 1, 2013 and on or prior to February 1, 2014. Other than as described above, prepayments are not subject to any premium or penalty other than customary “breakage” costs with respect to loans based on the LIBOR rate.

The Credit Agreement also imposes certain financial covenants on us including: a maximum ratio of 6.0x consolidated EBITDA to total senior secured indebtedness tested quarterly on a trailing 12 month basis, beginning on the last day of the fourth quarter of 2011; and a minimum ratio of 1.25x consolidated EBITDA to consolidated cash interest expense, tested quarterly on a trailing 12 month basis beginning on the last day of the fourth fiscal quarter of 2011. The maximum leverage ratio is scheduled to adjust to 5.75x beginning with the trailing four quarter period ending June 30, 2012.

We believe that our cash on hand, expected cash flows from operations, and potential availability of borrowings under the revolving portion of our senior secured credit facilities will be sufficient to finance our operations, and meet our scheduled debt service requirements for at least the next twelve months, absent an acceleration of repayment due to an event of default as discussed in the previous paragraph.

We actively seek to identify and evaluate potential acquisition candidates and, from time to time, we review potential acquisitions of businesses. Any acquisitions may require us to issue additional equity or incur additional indebtedness, subject to the limitations contained in our senior secured credit facility. We intend to seek opportunities to refinance our senior subordinated notes, subject to financial performance and market conditions, and we continue to explore various strategic transactions, including an acquisition, as a means to reduce our leverage and strengthen our operating and financial condition. However, there is no assurance that we will be able to refinance our senior subordinated notes on commercially reasonable terms or at all, or to complete an acquisition on desirable terms.

We and our subsidiaries, affiliates or significant stockholders may from time to time seek to retire or purchase our outstanding debt through cash purchases and/or exchanges for equity securities, in open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.

Capital Expenditures

We anticipate that we may incur capital expenditures of approximately $5.0 million during the remainder of 2012 based on our current plans of ongoing capital maintenance expenditure requirements at our facilities, including those related to the LTAC hospitals acquired during 2011, as previously discussed. We may enter into lease arrangements to finance a portion of these equipment expenditures.

Historical Cash Flow

For the three months ended March 31, 2012, operating activities used $4.6 million of cash as compared to $2.3 million of cash for the comparable period in 2011. For the three ended March 31, 2012, we had a net loss of $4.6 million as compared to a net loss of $3.6 million for the same period in 2011.

Accounts receivable decreased by $3.8 million for the three months ended March 31, 2012 as compared to an increase of $5.0 million for the same period during 2011. Days of net patient service revenue in accounts receivable at March 31, 2012 had decreased to 61.9 as compared to 69.2 at December 31, 2011. The $3.8 million decrease in accounts receivable and the decrease in days of net patient service revenue in accounts receivable as of March 31, 2012, was primarily the result of improved collections on the accounts receivable of the hospitals acquired during 2011. As of December 31, 2011, we were pending CMS’s approval of the transfer of certain acquired Medicare provider numbers. All of these approvals were received by March 31, 2012.

Estimated third party payor settlements used cash of $6.0 million as compared to providing cash of $0.9 million for the three months ended March 31, 2011. The use of cash during the 2012 period was principally due to the repayment to Medicare of amounts received as interim payments during 2011in excess of revenues ultimately recognized and the net settlement of certain matters on previously filed cost reports.

Accounts payable and accrued expenses used cash of $10.5 million for the three months ended March 31, 2012 as compared to a use of cash of $3.1 million for the same period in 2011. This increase in the use of cash was primarily attributable to the timing of interest payments under our new senior secured credit facility and the timing of our bi-weekly payroll payments.

Cash used in investing activities was $1.0 million for the three months ended March 31, 2012, as compared to $0.8 million in 2011. Cash used in investing activities during the 2012 and 2011 periods was principally for recurring maintenance capital expenditures.

Cash used by financing activities for the three months ended March 31, 2012 was $1.9 million as compared to a use of cash of $37.2 million for the same period in 2011. The three months ended March 31, 2011 included proceeds of $257.5 million from the refinancing of the senior secured credit facility, offset by outflows to pay down the previous senior secured credit facility. We also paid down the $35.0 million for the outstanding balance under the previous revolving line of credit. During 2011 we made payments of $17.7 million for deferred financing cost associated with the debt refinance.

Seasonality

Our business experiences seasonality resulting in variation in census levels, with the highest census historically occurring in the first quarter of the year and the lowest census occurring in the third quarter of the year.

Inflation

We derive a substantial portion of our revenue from the Medicare program. LTAC hospital PPS payments are subject to fixed payments that generally are adjusted annually for inflation. However, there can be no assurance that these adjustments, if received, will reflect the actual increase in our costs for providing healthcare services.

Labor and supply expenses make up a substantial portion of our operating expense structure. The expenses can be subject to increase in periods of rising inflation.

Forward Looking Statements

This quarterly report contains forward-looking statements regarding, among other things, our financial condition, results of operations, plans, objectives, future performance and business. All statements contained in this document other than historical information are forward-looking statements. Forward-looking statements include, but are not limited to, statements that represent our beliefs concerning future operations, strategies, financial results or other developments, and contain words and phrases such as “may,” “expects,” “believes,” “anticipates,” “estimates,” “should,” or similar expressions. Because these forward-looking statements are based on estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond our control or are subject to change, actual results could be materially different. Although we believe that our plans, intentions and expectations reflected in or suggested by these forward-looking statements are reasonable, we cannot assure you that we will achieve or realize these plans, intentions or expectations. Forward-looking statements are inherently subject to risks, uncertainties and assumptions. Important factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to:

•

the failure to maintain compliance with our financial covenants could be costly or have a material adverse effect on us;

•

the amount of outstanding indebtedness, the high interest rates applicable to our indebtedness and the restrictive covenants in the agreements governing our indebtedness increase the difficulty of operating on a profitable basis and may limit our operating and financial flexibility;

•

the condition of the financial markets, including volatility and deterioration in the capital and credit markets, could have a material adverse effect on the availability and terms of financing sources;

•

development or acquisition of new facilities may prove difficult or unsuccessful, use significant resources or expose us to unforeseen liabilities;

•

the failure to comply with the provisions of any of our Master Lease Agreements could materially adversely affect our financial position, results of operations and liquidity;

•

changes in government reimbursement for our services may have an adverse effect on our future revenues and profitability including, for example, the changes described under “Regulatory Changes”;

•

healthcare reform may have an adverse effect on our future revenues and profitability;

•

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

•

periodic reviews, surveys, audits and investigations by federal and state government agencies and private payors could result in adverse findings and may negatively impact our revenues and profitability;

•

actions that may be brought by individuals on the government’s behalf under the False Claims Act’s qui tam or whistleblower provisions may expose us to unforeseen liabilities;

•

the failure of our long-term acute care hospitals to maintain their qualification would cause our revenues and profitability to decline;

•

the failure of our “satellite” facilities to qualify for provider-based status with the applicable “main” facilities may adversely affect our results of operations;

•

private third party payors for our services may merge or undertake future cost containment initiatives that limit our future revenues and profitability;

•

an increase in uninsured and underinsured patients in our hospitals or the deterioration in the collectability of the accounts of such patients could harm our results of operations;

•

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

•

shortages in qualified nurses, therapists and other healthcare professionals or union activity may significantly increase our operating costs;

•

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

•

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

•

the geographic concentration of our facilities in Texas, Pennsylvania and Louisiana makes us sensitive to economic, regulatory, environmental and other developments in these states;

•

adverse changes in individual markets could significantly affect operating results;

•

the effect of legal actions asserted against us or lack of adequate available insurance could subject us to substantial uninsured liabilities;

•

an inability to ensure and maintain an effective system of internal controls over financial reporting could expose us to liability; and,

•

the failure to prevent damage or interruption to our systems and operations or to conform to regulatory standards for electronic health records could result in improper functioning, security breaches of our information systems, additional expenses or penalties.

Consequently, such forward-looking statements should be regarded solely as our current plans, estimates and beliefs. We do not intend, and do not undertake, any obligation to update any forward-looking statements to reflect future events or circumstances after the date of this report.

ITEM 3:

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

At March 31, 2012, we had $316.8 million in senior term loans outstanding and a borrowing availability of $23.6 million under our revolving credit facility, each bearing interest at variable rates. Each 0.125% point change in interest rates would result in a $0.4 million annual change in interest expense on our term loans and revolving credit facility loans, assuming that our revolving credit facility is fully drawn.

ITEM 4:

CONTROLS AND PROCEDURES

We carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934) as of the end of the period covered in this report. The disclosure controls and procedures are designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within required time periods, and include controls and disclosures designed to ensure that this information is accumulated and communicated to the company’s management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosures. Based on this evaluation, our principal executive officer and principal financial officer have concluded that as of March 31, 2012, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be included in our periodic Securities and Exchange Commission reports is recorded accurately, processed, summarized and reported within the time periods specified in the relevant Securities and Exchange Commission rules and forms.

In addition, we reviewed our internal controls, and there have been no changes in our internal controls over financial reporting identified in connection with an evaluation that occurred during the quarter ended March 31, 2012, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II: OTHER INFORMATION

ITEM 1:

LEGAL PROCEEDINGS

We are a party to several legal actions that arose in the ordinary course of business. The majority of these actions are related to malpractice claims that are covered under various insurance policies; however, there may be some actions which are not insured. We are unable to predict the ultimate outcome of pending litigation and government investigations, nor can there be any guarantee that the resolution of any litigation or investigation, either individually or in the aggregate, would not have a material adverse effect on our financial position, results of operations or liquidity. However, in our opinion, the outcome of these actions will not have a material adverse effect on the financial position, results of operations or liquidity of our company.

ITEM 1A:

RISK FACTORS

No changes.

ITEM 6:

EXHIBITS

The exhibits to this report are listed in the Exhibit Index.

SIGNATURES

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


	LifeCare Holdings, Inc

	By:	/s/ Phillip B. Douglas
		Phillip B. Douglas
		Chief Executive Officer

	By:	/s/ CHRIS A. WALKER
		Chris A. Walker
Dated: May 15, 2012		Chief Financial Officer

EXHIBIT INDEX


Exhibit		Description

	31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

	31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

	32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

	32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

	101.INS	XBRL Instance Document*

	101.SCH	XBRL Taxonomy Extension Schema Document*

	101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document*

	101.DEF	XBRL Taxonomy Extension Definition Linkbase Document*

	101.LAB	XBRL Taxonomy Extension Label Linkbase Document*

	101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document*

These interactive data files are being submitted electronically with this report and, in accordance with Rule 406T of Regulation S-T, are not deemed filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, are not deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

Large Accelerated Filer:

Accelerated Filer:

Non-Accelerated Filer:

Smaller Reporting Company: