Encompass Health Corp (EHC) 2002 Q1 法說會逐字稿

This is an unedited realtime transcript. An edited version with proper case and full speaker names will be available shortly.

ladies and gentlemen your conference will begin momentarily. Please continue to hold. Thank you.

ladies and gentlemen, good morning. Thank you for standing by. Welcome to the healthsouth corporation first quarter earnings release conference call. At this time, all participants are in a listen-only mode. Later, we'll conduct our question-and-answer session. Instructions will be given at that time. If you should require assistance during the conference, please press zero followed by star and an operator will assist you off line. Today's conference call is being recorded. I'll now turn the conference call over to chairman and ceo, Mr. Richard scrushy. Please go ahead, sir.

Thank you very much. Healthsouth this morning announced its operating results for the quarter ended march 31, 2002. Revenues were $1,130,000, an increase of 3.6% as compared to the $1,090,000 for the first quarter of 2001. If you look at that and adjust both periods for the divestitures that we made last year, it was almost a 9% increase in revenues. Net income for the 2002 quarter was $107.7 million, an increase of 43% compared to net income of 75.3 million for the 2001 quarter and earnings per share semidilution were 27 cents for the 2002 quarter consist extent with the wall street estimates and increase of 42% as compared to earnings per share of 19 cents in the 2001 quarter. For the quarter the company's earnings before interest taxes, depreciation, amortization or ebitda margin was 29.1% compared to 27.3 in the first quarter. We had very strong operational performance in the first quarter of this year. Our first wave of inpatient rehabilitation facilities moved into the new inpatient rehabilitation prospective payment system which began january 1 and just as we had projected pps had a positive impact on our bottom line. We have spent years preparing for this change, lowering our costs and increasing our efficiencies. And our initial pps payments have continued to come in on target with our preliminary estimates. In addition, we saw strong same store growth in all of our ambulatory lines and in our inpatient rehabilitation facilities. We are especially pleased to report the 7th consecutive quarter of increases in same store volume and our surgery centers, given these positive trends we are actively pursuing additional strategic growth and development opportunities across our product lines. After a very successful 2001, the first quarter has positioned us well to move forward with a new level in 2002. So I'll go ahead and start walking through some of the information. Again, 27 cents eps we met the consensus estimate up 42 cents -- 42% over the first quarter of 2000 of '01. Record quarterly revenues, 1 billion, 130 million, that's up 9% excluding the divestitures over the first quarter of last year. We continue the ebitda margin improvement, 29.1% versus 27.3% in the first quarter of last year. Strong same store volume growth, pps reimbursement rates, exactly as projected. And inpatient revenue up 12% from the first quarter of last year. So again, 9% increase in the net revenues over prior year excluded divestitures, ebitda margin from 27.3% moved to 29.1 and that was from 297 million ebitda in first quarter of last year to 320 million in the first quarter of this year. First quarter net income comparison of last year to this year was 75 million last year, 108 million this year and that's a 43% increase. First quarter eps, last year, was 19 cents this year, 27 cents. That's a 42% increase over last year. The fiscal highlights, let's take a look at first the outpatient visits, outpatient rehabilitation facilities. Last year we had 2 million 198,000772 visits. This year, 2,373,406, up 8%. So that's an 8% same store increase, as well. Looking at the outpatient revenues, last year, 211 million, this year 235 million. That's 11% increase. Our pricing also eased up from $96 last year to $99. So a slight increase on the per visit basis. So that was -- actually, that's pretty substantial, up $3. First quarter of surgery cases, last year, $219,777. This year, 227,7 85. That's a 4% increase compared to last year and same store growth was 7% in the surgery center area. Surgery center revenues up from last year of 245 million to 254 million this year, pricing basically continues on in the hunt and did 1,-- [ indiscernible ] per surgical visit. Again, this is up from up substantially over where we were as you go back a couple of years ago. And our goal is to move that up to 1200 and we are working diligently to make that happen on a per case basis. So that's a 4% increase compared to last year. First quarter diagnostic procedures and many of you are aware that last quarter we announced divestiture of about 6 diagnostic centers that were not as profitable as the rest of our group. And we didn't see them getting any profitable long term so we did divest ourselves of several so you have to take those out on these statistics. So that would be six diagnostic centers. We went actually this most recent quarter 265,173, and then last year it was 268,645. But if you look at it on a -- that's a 1% decrease, only because of those divestitures. If you look at same store increase, it's up 4%. So we had a very good growth on same store basis. We just had to eliminate those that were dragging us down a little bit. Of course, you can see our margins improving because of that. As far as the diagnostic revenue, same thing. We had a slight decrease there from 86 million to 83. But simply just because of divestitures and that's what is driving that. And we do continue to do more and more procedures that are lower cost procedures in all of our diagnostic centers. As you know, the two most pricey things that we do are our "Ct" scans and our mris. But we do many other things and as we do those things it we begin to bring down our pricing somewhat there so we are about $313 on a per modality versus about 320 last year same quarter. But again, on a same store growth basis, these are doing very, very well. So we are very pleased with where they are and where they are going. We are going to continue to add numerous new diagnostic centers this year and we expect great things out of the ones we have as well as the new once. On the -- ones. On the inpatient discharges, we went from last year of 27,665, this year 29,17. That's a 5% increase -- 29,017 a 5% last year over the last quarter. 4% increase same store. Year-over-year patient revenues very strong up 12% over first quarter of last year so we went from 418 million up to 469 million. In pricing, improved substantially. Last year, 15,120,000. Now we're at 16,1229. Again, very strong growth. Much of this driven by the new reimbursement system. Again, we are marketing to that whole population in the segment that we had never marketed to before. And that is our medicare patients. Because there was -- we were, you know, obviously had no margin so there was no reason to fill up our facilities with those patients. And theoretically, if we had been full of medicare, we would have had zero profit because was all cost based. Under the new pps program, we can actively market for that population and that population is very large in america and is huge and allows us to increase our census. And increase our returns. And it allows to be a much more profitable company. You can see the results in our ebitda margin as that continues to improve. Let's break it down by division in terms of revenue. Outpatient is it 1%, in-- outpatient rehab is 21%. Outpatient surgery now has grown slightly up to 23% as we said it would. Diagnostics are 7, medical center operations are 6%. Inpatient is running 42. And then some of our other investments and what not are running about 2%. So again, that's as we said it would be. Now, a few things I think are very important to bring up and mention here. Managed care and national marketing issues. First of all, we renegotiated 12 national contracts that affected about 15.5 million lives at an average increase of 12% so we had some very good pricing increases. We also completed a renegotiation of one of our large customers that has 120,000 employees. And in that contract we were able to get a 10% increase, again showing you that we are in fact getting some good pricing increases and that we're not only able to renegotiate those contracts, because we have done an outstanding job with those companies, but actually some very healthy price increases such as this one of 10%. We renegotiated our texas outpatient rehab contract at an increase of 26% over our previous rates. Very strong. And again, we have been squeezed over, you know, in the past over many years in that whole texas area so to be able to have those kind of increases again is a very bright future for us and we feel very good about it. And again, I think that, you know, we worked extremely hard to get those increases over the last couple of years and proved ourselves and now we are getting them. We renegotiated our south carolina inpatient rates with an average increase of 28%. Again, extremely strong. And these are just a few that we wanted to bring up to show you sort of the trends that we have and how we have been able to perform in a market that had been mixed over the last few years. But we're now, you know, we are getting those things that we have worked very hard to achieve and so those are just a few and there are many others we could talk about. As far as internal development, we did seven-day no vo projects this past quarter. We had an outstanding development, very good development activity [ 7 de novo ]

We added a diagnostic center and four other outpatient rehabilitation centers. Our facility count then breaks down to about 1419 outpatient rehabilitation locations, 117 inpatient rehabilitation locations, and that's about 7,564 beds. Keep in mind, too we did sell four underperforming rehab hospitals last year so in your comparisons, bed comparisons and also revenue comparisons, you have to take out the fact that we eliminated four hospitals that we didn't believe were in markets that fit with our growth strategy and they were underperforming and we didn't see any future being able to turn those around and to get them to perform at the level the rest of our hospitals. So we eliminated those. We also felt like that, uhm, they would struggle in the pps for a while because of their cost structures. So we again moved those out, sold those to another company. And I understand they are doing a pretty good job of those. But we did move those off our books. Outpatient surgery, 208. Medical centers, we operate 4, 925 beds and we have 134 diagnostic centers. Now, as far as the surgery centers go, we have some great growth initiatives there we did add 111 new physician partners in the first quarter of this year, that brought our new partners, we had a -- a plan to add 1,000 new surgical partners in our facilities. That brings us to a total of 661 under this new initiative at the end of the first quarter and, of course, we have continued to add this quarter, as well. The result of this program is we said we had anticipated this would happen. We have had 7 now consecutive quarters of very strong same store growth in the surgery center area. Now, our 2002 financial outlook, we are very comfortable with a 28 to 30% ebitda margin for '02. We are very comfortable with a cop census eps estimate of $1.14 for this year represented a 39% earnings growth. We are very positive on pps impact, it was realized in the first quarter of this -- the first quarter of this year in terms of its results. [ consensus ]

As far as long term strategic vision we are hosting an investor day in birmingham on may 14. We welcome to you come to birmingham. We will put them in front of -- over in a half day, probably well over 100 people that are in leadership positions in our company. We will have our market managers, our market leaders, senior executives and the middle imaginement. We have numerous presentations that will present our current situation as well as our plans, where we are going, hour we' going to continue to build and grow this company. [ management ] many. Our key physicians will be on staff. We'll talk about some of the other companies that we have been building such as our technology companies, some other kms that we are working with to help again grow our company and move us forward in many ways. So we are real excited about this. And I would request that you please contact tad mcveigh, who is our treasurer, executive vice president, here at healthsouth and he will be glad to set you up for your visit, your hotel room, and make sure that all your plans are made for that. So we do welcome you. We would love to have you here. I think it would be a great day. It would be very informative for all of you that are able to attend. So in sumry. Our first quarter results, uhm, 27 cents eps. We met the estimates again of 42% over first quarter. Had record quarterly revenues of $1,130,000, of 9% if you exclude divestitures over first quarter of last year. Continued ebitda margin improvement of 29.1% versus 27.3 first quarter of last year. Again very strong. Positive pps impact was realized in the first quarter, pps reimbursement rates are exactly as we projected. And again, don't forget the investor day, may 14, in birmingham. We would love to have you here w that I'll be glad to open it for questions. At the end of this, after he is questions, we'll have our general counsel read our forward-looking statements for those that you like to make sure that you don't, you know, you don't Miss that with that we'll go ahead and open up. I do have in the room our president and chief operating officer, bill owens. We have our chief financial officer, weston smith. General counsel, bill horton. We also have our two presidents, larry taylor, who runs our a.M. Boo laer to division and pat foster, who is president of our inpatient division. Of course, tad mcveigh is here as well as jason hurvey, who is senior vice president of our communications and media marketing. a.M. Booer to.

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At this time, if you have a question, ladies and gentlemen, please depress the 1 on your touch tone phone. You'll hear aen to indicating you have been placed in queue. You may remove yourself from queue at any time by pressing the pound key. If you're on a speaker phone, pick up your hand set before pressing a number.

Our first question in queue is from the line of frank morgan from jefferies & company. Please go ahead.

Good morning. Richard, if you look at what has happened with the capacity over the last couple of years, you certainly either slowed down the growth in capacity or in some cases it seems to have shrunk a little bit as you've pruned off weaker performing assets. I think that's probably part of the reason for the strength that you have seen in the same store volume trends. My question is, is how sustainable is the growth specific to just the same store business and how much do you really envision -- how much of growth in the future will be driven off same store volume and it sounds like now even same store pricing, versus what you have alutded to here talking about looking at acquisitions or development in strategic opportunities again? If you could comment on that and if -- if you do accelerate this other part of the business, what are the capital requirements to do that?

I think that's a very good question, frank. And first of all, our capacity is -- we still have tops of capacity. I want to make sure you understand there is a lot of growth opportunity there last year we talked about details of every business segment and we were about 50% capacity in our surgery centers and we're still far from even beginning to fill our surgery centers up. And the reason we have the additional capacity is that many of our surgery centers, you know, it's really driven by how many doctors you have operating there they will run until 2:00 in the afternoon but could you run them to 5:00 or 6:00 at night. It's -- you can start an hour earlier. There is an opportunity for us to, we believe, in the surgery center area, certainly add another 50, 60, 70%, you know, growth there and fill up that capacity that we have. So we think that, you know, we are going to continue to add surgery centers but we can also add ors in those surgery centers. We can expand their day in terms of number of hours that they operate. Then we could add more doctors. Now, another thing that we have done that's really helped our capacity, uhm, in the outpatient surgery area, we now are turning our rooms on an average probably of 8 to 10 minutes, and we have a few that are struggling out there at 15 to 20, but you know, when we bring those turns down to 8 to 10 minutes per facility, we are adding additional capacity. And it's very important that you focus on that a little bit because in many of these 20-minute cases, we are able to go in and do an orthopedic procedure in 20 minutes so if we can just turn the rooms in 8 to 10 minutes, we have added substantial capacity to each surgery center which will allow us to, you know, literally throughout the company generate hundreds of millions of dollars without spending another nickel. And so that's where that is. Now, as far as diagnostics, again, you know, how quick can we get them in and turn them, you know, the technology does play a major role in what your capacity is. Some of the units that we are buying now are, you know, there's -- they're stronger. It takes half the amount of time to do a procedure. And so forth same charge, we are able to do, you know, three or four or five or six more patients a day. And again, hours of operation play a major role. That's the thing -- the difference between an ambulatory business and a fixed bed business where you have x number of beds and you fill the beds and you're done. In the ambulatory business we can expand hours and outpatient rehab. We can bring patients in on saturday if necessary. These types of things. So as far as capacity, we still have substantial capacity. So I would say to you that, you know, our people and our marketing team, you know, two years ago we had, you know, maybe 150, 200 people on our sales and marketing team and 500 people out there every day calling on doctors, working with industry, working with payors, driving patients into our facilities. We have a tremendous marketing effort now and we are trying to fill that capacity. So I would say that you should look for a large amount of growth in same store over many years to come. Again, we are not going to stop at adding 1,000 doctors. That was our plan. Bill owens and I have already had our meetings of adding even another 1,000 doctors because as we look at the opportunities we have in -- and again, as we turn these rooms quicker, as we expand the days, we add additional personnel, additional o.R.S, we believe that we can -- we have the capacity to even add an extra 1,000 doctors. So we are not really sure where that's going to end but there is a lot of growth there. We will continue to expand the company. We do have beefed up our entire production shop. We have added numerous new people in our development area. There are lots of opportunities in all of our product lines. And we are aggressively pursuing those. So, you know, give you an exact amount, frank, is going to be very hard to do. I do expect that our capital expenditures are going to -- based on where we are today and where we came out first quarter, you are going to look spending about $187 million is where we are first quarter which is right in line with what we thought we would do this year between 4 and 500 million, which really to grow this company, you have a large company, we have to put some money into it to grow it. But that's right in line with where we thought we would be. And, yeah, we will spend that money but I think you are going to see some very good returns on those investments. So I hope that answers your question.

Just to make sure, so in terms of the volume trends are obviously very good anywhere from 4 to 6 -- 4 to 7 1/2, 8%, depending on the business line. And is it fair to say that the same store pricing trends can start to accelerate like with all these, you know, examples you gave us with these contracts you're renoshlting? We are very positive on the pricing. This is the best pricing quarter we have had. And we have had some good pricing over the last year, but this is very strong. You know, we don't see in the numbers today these renegotiated rates. They are not in the numbers yet. We have just renegotiated many of these contracts. So you are going to start seeing the impact in quarters to come. So if we have the same kind of success, you know, and the trends continue on into this quarter as we can negotiate the last couple of months, so I expect that, yes, the answer is yes, you should see some good positive trends there and we'll start seeing the numbers come in now that we have, you know, brought in these new rates.

Okay.

So....

Thank you very much.

Thank you.

Our next question is from howard capek from ubs warburg. Please go ahead.

Good morning. Two questions. One, if tad could hit the high points on the balance sheet and cash flow dsos, cap-ex, and net debt. And then second, on the surgery partnership rescind occasions, are you -- rescindcasions, are you selling those back out in line with what you had been buying them in terms of an asset value or is there a gain or loss on any of the stuff that you are re syndicating?

No. It's exactly what we're doing. Bill, you may want to comment on that.

Yeah, howard, the partnership agreements dictate the terms on which we buy these guys out. And then that sets the market rate much like buying a house. You have comps and you set a market rate based on cash flow. And then you have that as a benchmark and that's what you're selling for. So that's a wash. And you know, we have said as we were doing this, that we are not using this as a capital raising venture. This is a initiative that we have taken on in order to grow the business. So... The capital from that is pretty much a wash.

And it's good to be getting it back in the door.

Yes, it is. And then along those lines, sort of run rate on the minority interest line this quarter? 27 or so? That would be a good number to start at the base? Tad will cover those balance sheet issues and also talk about that minority interest line. I think, howard, the number of minority interest number that we put out for the first quarter, uhm, it was a good quarter. Really driven by inpatient rehab as opposed to surgery centers. And, you know, for modeling purposes, I think to stay in that 26, $27 million range per quarter is a good range to be in. In terms of the balance sheet for the first quarter, our total debt was $3,019,000. That was down $8 million sequentially. And down $235 million compared to the year ago period. Our cash was $238 million. That was down $40 million sequentially, up 56 million year-over-year. Net debt, $2,781,000. That is up 30 million sequentially, down $291 million year-over-year. In terms of a.R. Days, they were 81 1/2 days. That's up four days sequentially. And cap-ex was $187 million in the quarter as richard said. And richard, you may want to add some color to that cap-ex.

Yeah. Let me do that howard. So you can understand where we spent the money, we had -- as you know, we had several rehabilitation hospital projects going on -- we had 7 new hospitals that we have been working on and we had 5 ex-pantions. We spent about 50 million there we opened one rehab hospital again, a surgery center, diagnostic center and four outpatient centers spending $15 million on that our surgery centers, we had 5 new once that -- ones that we have been working on. We had three expansions that we expended $20 million total an those 8 projects and then diagnostics area, we had 3 new and one that we had to relocate. We spent about $20 million in the diagnostic area. We have begun expanding in the mri -- with mri upgrades and we added a first "Pet" scan where we are beginning to roll out "Pet" scanners in certain markets. We invested about $18 million in that area. On the digital hospital and a.R. Enhancements, we spent about $10 million there. And on our maintenance ada compliance and various issues, there is about a $50 million expenditure. So that's about $183 million there, so you can sort of see how that rolled out. Again, that -- we have a lot of activity, a lot of expansions, a lot of new projects and a lot of new things going on that again, i think we'll see some very strong results. But we feel very good about where we're estimating we are going to come in for the year on cap-ex. And I think everything's pretty much in line.

On the mris, those are new magnets or --?

Upgrades and new, aha.

Thanks very much.

Thank you.

Our next question is from adam feinstein from lehman brothers, please go ahead.

Good morning. Just a couple of quick questions. Tad, I'm sorry, I didn't hear, did you give a cash flow from operations number for the quarter when you just answered the some of the other data you just gave?

Adam, I did not. But the cash from ops is going to be -- we had a very strong quarter. It's going to be approximately, uhm, $175 million. Maybe a little more than that.

Okay. Great. And okay. And, uhm, and just, you know, couple of, uhm, other questions here. Uhm, when you guys broke out the revenue per discharge data here today, the number was a little bit higher than what i would have thought just knowing what you guys get roughly on the medicare business and knowing, you know, that's almost 70 percent of your bills. I just -- if I'm doing this right, it would imply that you're getting almost $30,000 per discharge for a private pay patient? I just wanted to see --

That includes the -- it does include some of the out patient side. It's in that number. When that patient continues to come back for two or three weeks, that's all in -- so you have to throw the outpatient in. So if you go just to the inpatient side, you know, it changes the equation.

And adam, the other thing includes, we have 22 managed units which there are -- which the fees we get from that, and there is no discharge associated with that in that statistic.

So if you look, adam, where are we on a per discharge basis relative to medicare, it's something north -- continues to be north of the 11-2 that we had anticipated. It's actually doing better than 11-2. And that's driven by the acuity, because acuity is very strong.

Okay. And all right. And, uhm --.

You got 3 or 4 fact tomplts you have outpatient, managed care units in there. And then you, you know, you have -- [ factors ]

That plays a major role. So if we broke all that out, which we don't break it out because we're not required to break it out, but we are telling you, we're running north of the 11-2, very strong.

Okay. What's going on with the medical center business just a little bit of volumes were low there. Just wanted to see if there was anything in particular that was causing that.

Adam that really is distorted on the sequential basis. Miami just had a real blowout comparison but the numbers here are so small that the percentage might look high but it's just because it's such a small segment of our business. Overall, it's great.

We did go through a little bit of a down -- you know, in that hospital was in play because there was other people numerous people trying to buy it.

We struggled a little bit with some of the doctors and then people their involvement there that's all behind us and we elected not to do that and the hospital is doing incredibly well. And so, you know, we are -- you know, we're not out running around trying to build medical centers. We are going to build this new hospital here in birmingham. We are moving out of an old hospital that's landlocked and we are building a new hospital that's very high-tech and the building -- in building this hospital, we developed technologies here that really don't exist in healthcare that we are going to be able to use throughout our whole network. So we are real excited about where that's going.

Great. And that, by the way, you will see a substantial revenue increase in that hospital because of the o.R.S, the expansion in outpatient and the ability to fill ought rooms. As we sit today, we have a 219-bed hospital which we only use about 150 rooms because the rest of them are so outdated. Now we'll be able to move our census up to the full 219 so we'll see some substantial revenue increases there.

The new hospital will open when?

June of 2004. Actually, the completion date is june 30. So it will actually open july 1.

Okay. 2004. Great. And then just one more question. Any update on the doj lawsuit?

We are -- yeah, we're still in the 30s chour as we reported in the 10-k of -- 30s -- we are still in the posture as we reported in the 10-k of waiting for the doj to file its complaint. We currently expect that to be filed in cases here in birmingham late next week and to be served with it shortly thereafter but we are still -- if you look at the disclosh u in the 10-k, that's still the posture that we're in. We're still waiting -- waiting to be served with something and continue to feel very good about our ability to deal with it once it's served [ disclosure ]. We feel strongly that our position in this is right and we are looking forward to have a chance to have our day in court and prove that.

I might mention, too that we have brought in, you know, outside legal experts on this and asked them to review our policies, review our -- you know, everything that we are doing here. And they have, uhm, recommended to us that there is nothing that we should change and that all of our policies are intact with laws and reimbursement. We think that we are being abused and mistreated here and we think that, you know, we are will show. We are just waiting to see the complaint. And then we will address that as we go forward. But the outside legal experts recommend that we change nothing we are doing. They see nothing wrong and that we're in full compliance with all the regulations.

Thank you.

Your next question is from the line of scott estes from deutsche banc. Please go ahead.

Thank you. I had one question on the inpatient rehab bills. You guys had given some color on the last call about how same store volumes were running at just 36% or association the facilities that went on the new system. [ rehab business ] kind of a read on the full quarter and could you provide a little more color on the up particular in the ar days and your goals for the year at this point. [ uptick ]

There are two major interimmediate areas that we deal with. One is blue cross, and then there is another intermediary -- and we deal through the blue cross, you know, office out of birmingham here because they are down the street from us. But they worked extremely hard to get themselves linked up to make sure they can process our claims in line with the -- as the rules came on and they worked with us, as a matter of fact, testing all of our data to make sure that we understood what we needed to be doing in terms of filing. They were 100% up to speed. The other organization that we deal with which is very fine organization, they just only -- only have a handful of rehab hospitals, uhm, they slowed to get around -- they actually -- they are now 100% on line and they are doing everything right on schedule. But they actually didn't get that done until the second quarter. And so we -- they actually set well over $40 million worth of our revenue. We are about $10, $11 million a day. And they set on that for about well over three months. It was a -- it drug us through that. And that's really the reflection of days. It's just that one intermediary which that by the way has been corrected and they are now moving along. You may want to make a comment, weston smith our cfo.

No, that's correct. The other intermediary has their systems in place now. There's still time to flush through those claims. And ensure that their systems are up and running. But, you know, the percentage of their business of rehab wasn't significant to them and they were clearly behind in terms of being ready for the pps, unlike blue cross of alabama.

But that's been corrected and they are now paying us right in line with the same kind of days that blue cross is. So... We don't see any problems with that going forward. There was a little bit of slow there. Did you want to make another comment on anything else?

No.

What was the other point?

One thing on that, your goal is this year now that you have that problem corrected?

We said our goal is to bring our days into the 60s and it's been that way '0the last year. We are going -- way over the last year. We are going to continue we think this year to run in the 70s. Hopefully we'll bring it down to the low 70s and hopefully next year we'll break it into the 60s. That's our goal. It's really unfortunate that we're sitting here 100% electronically ready to go. And unfortunately, many. Players out there just do not -- they cannot deal with it. We are still getting 10, you know, to 15% of our payments back electronically, and we are delivering -- we can deliver 100%. So we are up to speed. We put systems in place. We spent the money. And we are just waiting now for the payors to be able to deal with us and that's what drags that out. And as they improve their systems, you are going to see days go down substantially and certainly I think their costs will go down as once they go digital or electronic. So that's all -- that's what we are hoping on. I think our people are doing a great job work our receivables. And, you know, we are -- just going to see it running in the 70s, adam, until we get that moving. And -- but we are working it. I think we are making great progress.

Good. Thanks. The only other question I just wanted to get a read on kind of same store volume, the 36% of the rehab hospitals on the new payment system in the quarter?

You know, the same store overall was up just about 4.5%. 36% were under the pps system and it was probably -- pps and non-pps, were probably equally -- equal contributors to that same store number. We just had a real good quarter overall, all of our hospitals performed very well. And just to remind he, in the second quarter, we are looking at another 7% of our hospitals to come under pps, third quarter 41%. And then the fourth quarter would be the final 16%.

Great. Thanks, guys.

Thank you.

Our next question is from the line of debby lawson from salomon smith barney. Please go ahead.

Hello?

Miss lawson, go ahead.

I'm sorry. I had two questions. I was wondering if you could give us an update on the mixed and the asc division in terms of types of procedures being done and secondly, can you give us any sense of what you're seeing out there as far as the hospital-based rehab units in the wake of pps? Thanks.

Well, it's very positive for us. And basically, we're seeing many of the hospitals that have decided that they are not going to continue on with their units because they have struggling with them. Again, you have to go back just a single hospital that has 15, 20-bed unit. They are running that -- they don't have the vast experience that we have in running a whole nationwide network rehab hospitals. They struggle with developing of their pps plans, you know, clinical treatment protocols and everything that you have to do to move the patients through the system here. And also, give good quality care so you have good outcomes and there are a lot of issues. They are beginning to see under this plan they are going to see losses so they are closing those units. And some of them -- some of the major hospital chains that are out there that have numerous units and literally have told us that they are going to be closing those units, and I know that one of them even made a public statement that they would be closing their units because they didn't see the ability to continue to build profitability in them because of their costs. Now, also, many of those hospitals are in need of med surge beds. They are doing good on that side and they want to use those units for med surge. Overall trends are that units are closing. We have, you know, great relationships, huge number of products in the pipeline and in the works now to create a new rehab hospitals. 40-bed hospitals, 50-bed hospitals. Very efficient hospitals. We just opened just new hospital went to the groundbreaking last week in north memphis with methodist hospital is almost full. Just opened and again, it's a perfect model. It's a 40-bed model and very cost effective. We built the hospital for $6 million. Just really hard to beat that and those are going to run in the 7500 to 8500 range in cost per case. And they are going to be very profitable for medicare. And that's really the model that works. And that's what we are seeing happening, debby. They are searching that out and we are working with the major tesh area care facilities around the country. You are going to see more and more of that.

The second thing that we are seeing is many of the hospitals with units are trying to get the high acuity patient out of their facilities because they have opted to go for the low acuity patient, lower reimbursement to dry to drive their costs down further, with your our strategy is we want the acuity patient because we have already got our cost structure in line. So we are seeing referrals come from sources that we haven't seen referrals in years. So that's the other trend that we are seeing. We are seeing units begin to close. We have been told not -- as richard said, we understand that one of the major companies announced that or mentioned that in their conference -- their earnings conference call that they were converting beds. And we are seeing these referrals come from sources that we haven't received referrals in a long time.

I think that's real important. They are calling and saying, you know, we would like -- we have a patient weed like for you to look at and -- and they have a unit in their hospital but they know they can't make money on that patient and we are glad to take them because we're structured to do that [ we'd ]

Thanks for that color. And any comment on the asc mix?

Yeah. We cab give you some comments on that.

Debby, we're continuing to see a decline [ can ] a decline in opthalmology and gastro, which is what we expected. Those had ticked up, as you'll recall, due to some acquisitions of companies that specialize in gastro and opthalmology. And that's being all set by positive gains in orthopedic, plastics, and ent. So it's moving in light of the upcoming change in reimbursement for surgery centers. It's moving in exactly the way we would like it to move.

And a lot of that's driven by the fact that we added 661 new doctors, you know, in the last 18 months to those o.R. Rooms operating every day. And they are doing multiple cases. That's just going to continue to change as we are out there searching out those new partners. We have also done something else. We have a new television show that we will be on fox sports net that will feature our star doctors that are working, you know, throughout the country with sports teams, doing orthopedics. Many other doctors that are involved in the training programs for athletes and olympic athletes as well as those that play college and professional and we're -- so that will be -- that's going to give us an opportunity from a marketing standpoint to present those doctors and -- as a matter of fact, the name of the show is healthsouth presents behind the game. We are real excited about that fox worked with us on that television show. And you'll be able to dial in on monday afternoon and see what healthsouth is doing in the area of sports and be in the largest operator of orthopedic -- I means of orthopedic treatment facilities, we treat over 70,000 orthopedic patients a day in healthsouth. Many people don't understand that. That's a huge number! We have doctors, you know, automatic over this country that are aligned with sports teams that we work with. [ all ] from the professional bull riders to the pga. Yesterday, we did this week, as a matter of fact, last two days, we spent the last two days doing all the physicals on all the tour professionals on the senior pga tour. That's healthsouth doing that we'll be able to again behind the game, injuries, training, featuring doctors and what they are doing. And so we'll be able to reach out to the consumer and talk more about many of the accomplishments at healthsouth that so many people don't realize and the good that we are bringing to young athletes across this country.

Great. Thanks a lot.

Aha.

.

Our next question is from gary taylor from bank of america. Pleas -- from banc of america securities.

Good morning. Nice quarter. Just a couple questions. Just one for tad, was hoping maybe we could get after the fact, release of discharges since you're going that way on rehab now, maybe a couple of years of quarters of discharges just for historic data?

Gary, you can give me a call and we can talk about that.

Okay.

It's at the very least, on an ongoing basis, next quarter we'll report, you know, last year's second quarter and so on and so forth.

We are doing that now.

Okay. Most of my questions have been answered. The only one I have left, when you look at the out patient rehab business, I think richard had talked about a very sizable outpatient contract being renewed at a higher rate, and you look at the pricing which is up 3% or so, year over year, and i think probably still I am pablgtd somewhat by the divestiture of the occupational health, if I'm not mistaken. [ impacted ] just kind of talk about where you see that pricing going and is there anything that's helping drive that except just renegotiating commercial zplts.

A lot of it is driven by the procedures that we're doing. [ commercial contracts question mark ] procedures that allow to us collect more money. There are certain things that we can do and certainly things we can sell. Expand, add product lines. Take for example many of our -- take a typical small, you know, outpatient rehab center that we are able to now add more sophisticated procedures to. Add again a therapist that can do hand therapy, for example, or add sports injures segment to it and just expand those different departments within those facilities, allows to us increase our charges. Now, to larry. You -- larry taylor, who runs that division, here. Larry. You want to make a comment or two on that?

Richard, you are right on in regards to the procedures and type of patients. We are 52% spine patients who are out there. We have had a big push on our overall educational process for hands on therapy which drives charges, it drives the clinical outcomes and it pushes the patients back into the system quickly as well as our overall push for workmen's compensation. Solution to industry that gives us a leg up to get into the employer as well as on their group side. So it gives us a number of advantages as we move forward. Also, our functional capacity assessments where we rate individuals and assure that they are able to return to work is a very high reimbursement per encounter and then we focus on our ime as well as our overall pesting -- testing that rolls into these programs on the industrial side, as well.

These -- it's a lot more than simple physical therapy visit for $57. So that's sort of -- for $75. That's what's driving that.

Just one other question. I saw the materials you sent out on your ambulater which looks like a pretty neat product. Is that something where you may are not being reimbursed appropriately, that's there is an opportunity to increase rei am bus merit with the approval?

I appreciate you bringing that up. What we have done is been building that auto ambulater is so huge. [ reimbursement ] we now have a device with fda approval that we can manufacture and we are going to build one for -- actually more than one, some of our rehab hospitals will have two or three. But first, several hundred of these that we build will be in healthsouth facilities this means that everyone who has m.S. Has had a stroke or has had a spinal cord injury will go to a healthsouth facility so that they can exercise. So it's more than just -- it is a form of treatment. We will treat them. What we found is that -- and the meeting with the leadership on the spinal cord research and Dr. John mcdonald at washington university and st. Louis which is affiliated with christian hospital, he is one of the very renowned in the whole area of spinal cord regeneration and research, they are saying that every spinal cord injury patient after two weeks of injury should be immediately on this unit. Immediately. Every one of them. So there is therapeutic value. Now, we will be -- with our first 100 units we'll be putting hopefully our plan is 10 patients a day per unit which will be 1,000 patients a day and we'll be able to gather that data and every doctor at every healthsouth facility will be involved in the research working with john mcdonald and a neurosurgeon, very renowned neurosurgeon, Dr. Suede. And they will be gathering the data and documenting the improvements. Now, the improvements that we have seen which we can talk about under our fda approval now, which you know we eliminate the whole bedsores situation, the breakdown of skin. We increase broad flow in the abdominal area. And we are seeing, you know, the bladder function eliminating infections and getting these patients to have more normal bladder function, at the same time we are seeing the muscles begin to tone back up in the legs where you have this waisting away of leg muscle -- wasting away of leg muscle. It's toning up. The most important two things that are most important is that the patients now are actually sensing their legs again. They are actually feel -- they can touch their legs and feel their legs where before -- and they couldn't do that and the blood flow and obviously some impact from the oughtnomic nervous system and the weight bearing. They are actually walking on that auto ambulater and their feet are weight bearing and we have weights in the treadmill customized and built to the actual robotic device that they're n and what happens is we begin to have some dramatic impacts there with -- being able to touch their legs and feel them but also the mental impact of it the fact that they can stand now. We have patients that haven't stood for 20 years, 15 years, they are standing up and walking. And so we're little naturing all sorts of things. Now, we believe that there is a -- an opportunity for some very substantial reimbursement. We will be charging but until the insurance companies start paying and we obviously will go through the whole process of getting medicare reimbursement and everything else but right now we will charge for the exercise and it's been suggested that these individuals could do this every day. But obviously, that's almost not practical but at least two to three times a week is practical. So this is a huge revenue generator for us in the future. It's a major breakthrough in, you know, technology for patients who have some type of paralysis, whether it be through disease or injury. And it prepares those patients, hopefully in the future, if there is a success in the regeneration of spinal cord injuries, that we will in fact have a mechanism to make sure that we -- these patients are appropriately strengthened and that their muscle tone in their legs are such that it will allow them to walk. We are real excited about this as you know, literally hundreds and hundreds of thousands of people out there in the country today that are candidates to use this equipment our phones are ringing off the hook. Everyone is in line. They are wanting -- if you went to a center where we have one of these units, and you could see the patients in wheelchairs wanting to get on this unit and the excitement and the glow in their eyes, now they can stand up and they can walk and exercise, and then talk to them after they get off this unit, you get pretty excited about what is the potential impact of this and what is the potential future of this technology. So we have had a paenlt on that technology. We spent the last two years building it. And [ baenlt ] and again we are starting our manufacturing process now. patent ]

We have two units built and we'll build more. We'll leave them within the healthsouth network so patients will be able to use those units at our facilities. So that's where it is today. And then over time, we obviously will expand that throughout the world. We expect we have a request to put it in our hospital in saudi arabia now. We see that happening. And the physicians over there are very interested in this. And so we see a lot of expansion opportunities.

The goal is 100 in what time frame. Well, it's going to take us, we believe we can build, you know, once we go into full manufacturing process, we hopefully can build several a week and we hope that we have them all rolled out certainly within the next, you know, six to nine months we ought to have them out there, have all the doctors trained, the therapists trained and -- you know, this is a very sophisticated software program that's tied to the treadmill and the robotic device. It costs us about $57,000 to build one of these and once we begin our manufacturing, we are hoping we can bring that down a little below the $75,000 cost. There is, you know, again, we started out from spending about $300,000 to now down to $75 and I think what's important is had we been done this within a university system or government backed grant that would have been millions and millions of dollars involved but we were able to hire brilliant engineers and software developers to build this and now we have it available and we did it quickly, inexpensively and we have a very fine product that's tested and proven and through fda approval.

Thank you.

Next question is from j.P. Morgan. Please go ahead.

Thank you. Just a few questions on your inpatient rehappen business. First of all, I just wanted to see if you could comment on the length of stay that you have seen in that business year-over-year. And where you expected that to go, you know, by year end. And then the second question is, just if you could comment on the medicare patient mix in the inpatient rehab business i know that you're more proactively marketing the medical business segment, where you see that going.

Pat foster, press of our inpatient operation wants to make some comments: [ president ]

As far as our length of stay, we have had a small downtick in the length of stay. We have expanded our therapist because of the prospective payment system. We are getting the patient out sooner. Our discharge to community, which is a key clinical factor, continues to improve. So we have shortened the length of stay about one day for our medicare population. That was planned. And again, the impact is we continue to have the increase in clinical gains and discharge to the community. And the other, as far as the mixed medicare patients, we have a major focus on developing other stroke mix which has a high acuity level, a high case mix indecks and the auto ambulater is a great example. That's going to help us build our volume. There is a huge underserved population of stroke patients out there and we have a major campaign going on right now that will be -- that we'll be introducing and jason is working with us on that and we'll be introducing that here the first of the month. And there is a major focus to build our stroke patient. The reasons -- the patient population. The reason is the case mix index which impacts your pps payments is higher because of the acuity level being higher and we have been able to maintain our costs per discharge and actually with the increase in volumes, our cost per discharge for the medicare patients continues to go down.

25789, we have a strong effort to maintain our current -- at the same time, we have a strong effort to maintain our current commercial volume so that we're not sacrificing that good paying non-medicare patient in order to add medicare census. We have, you know, as within the last year, we have about 20% capacity available to us because we're running about 80% of capacity. Our goal is to tray to get that overtime up to about 90% utilization and that 10% growth will primarily be in the medicare arena, which we want to make sure that we protect and continue to push that non-medicare volume because even under pps, the non-medicare patient is still a more profitable patient for us. It's just now we're able to augment that profit with profit from the medicare patient, as well.

But keep in mind, too, that the medicare population is growing. And and again patients as we add new rehab hospitals like the one we added in north memphis and men of the -- many of the others, the project in nevada that we just opened, they -- these hospitals didn't exist in those areas and so many times those patients were kept in acute care costly hospitals. They are pleased to shift them into our hospitals and allow to us treat them. We do have designated stroke programs. We have excellent people that can move them through the system quickly and ultimately it's bringing down healthcare costs in america. That's a very, very important point. That even though we are being reimbursed I think at a good rate on the medicare patients, this is actually good for bringing down the medicare costs. Were our -- with our results and clinical outcomes, which are out standing, we are doing a real good service here in terms of what we do.

Thank you.

Next question is from joel ray from wachovia securities. Please go ahead.

Good morning. Congratulations, guys.

Thank you.

I want to focus on two points. First, related to your whole rehab moving to pps, could you elaborate about where you get the average rates that you get reimbursed versus your earlier expectations? And I have heard you mention that you think your cost per discharge is coming down. Didn't know if you could elaborate on those aspects. Secondly, I wanted you to reconfirm that you had suggested that dso rose 4 days due to payment, you know, cycle here as you went into pps and that without that, you probably would have been, i guess it sounds like, relatively flat at 77 1/2 days. What I'm wondering is, where are we on our goals to reduce dso two days per quarter? And finally, have you changed your objectives on deleveraging the balance sheet overtime? Do you now want to change the strategy and next on investment to expand capacity?

Well, that's -- let's go back. What was the first point?

First point is, having to do with if you have more detail can elaborate on what you are getting paid and what your costs are on the medicare pps.

We run in line with what we thought we would do. Maybe slightly higher than what we thought we would get, a little north of what we thought we would get on the pps. We had anticipated around 11-2 and we are exceeding that that's again driven simply by the acuity level. We did not plan on existing rehab units in hospitals calling us and sending us their higher acuity patients. We just didn't -- that's sort of a surprise. And that's driven that acuity up a little higher than we had anticipated because the overall average of our acuity came up when they sent us more higher acuity patients. So that's basically where that is. It's a little higher than we anticipated.

Cost is still in line at about 9600, you know, we're -- we believe that we'll get that down to about $9,000 a case. We are doing that by increasing our number of discharges as well as continuing to control our cost. You know, we have a primarily fixed cost base and if we can increase our utilization up from 80 do 90% spread, it over more discharges, we'll continue to drive that cost down.

We have as you know, the model that was built on many of these rehab hospitals that we bought. Unfortunately, as they were built at a higher cost, we are building them today. It's amazing, our model today, we can build a 40 to 50-bed rehab hospital in the $6 million to $7 million range. We can manage it in the way we can get our costs down to $8,000 a case. Now, unfortunately, there were many other hospitals that were built for $16 million. Same number of beds. We acquired those companies and we're stuck with some of that fixed cost. But we have done an incredible job as bill says, you know, getting the capacity up and we have done all the things in terms of managing supplies and personnel and putting in the appropriate clinical programs. We still have those very propt -- profitable but they are going to run at $9600 or $9500 and we can only manage them. Filling them up will have an impact. On the dso front, joel, you're right, if we had not had the issue with the medicare, we would have had flat dso days this quarter. We do, as we have said on a previous question, have a target of getting that down in the lower 70s this year and getting also into the 60s. I'm not sure where the two days per quarter came from because we have said time and time again that the big things that we can do that are going to shave big chunks of dsos off are done. What we're doing now is blocking and tackling, you know, focusing on turnover, focusing on training, working with the payors to increase their utilization of edi. All those things -- and there's -- the list is 100 different items that we are doing to bring dsos down. None of which individually are going to, you know, have a major impact. But all of which collectively will ultimately get us into the 60s.

We have an outstanding team developed that works that every day. And we're going to get that -- it's just going to happen. Everybody's focused on it. We look at it every monday morning, not a single monday goes by that we don't talk about it. Actually, bill has a conference call with all the market managers every friday afternoon where they talk about it. Cash is king. It always will be. And that's how you running your business. And we're very focused on that and we're doing all the right things to make that happen and as you know, as we add these new facilities, and you build new things, you have to get all the systems in place and get that going, as well. And you -- so you have a little a bit of lag on that but overall we are doing an outstanding job. We feel good about it. There was a time when we were 120 days and we have it in the 70s. We want it in the 60s. We are not going to stop until we get it there and hopefully someday it will be in the oos. We are doing everything that we think is humanly possible. We have outstanding people working on it [ 50s ] all I can say is keep tracking us on that and I think you are going to see good performance.

What about on your objectives on leverage? A year or so ago we were -- the objective was to try to deliver the balance sheet by about 800 miami. From what I'm hearing it sounds like we are going to be maybe shifting our focus into expanding our capacity with newtives.

We --

Versus the deleveraging -- what are your objectives today?

We are still on top of that. We made a decision not to sell a hospital that would have brought in substantial amount of money because that hospital is -- has such and is doing so well and after meeting with our doctors and our expansion situation. So we took that out of the equation. So you have to net that out. But we'll do 200 million this year. We'll net debt reduction this year 200 million. We had a good year last year in terms of net debt reduction and we are still very focused on continuing to delever and, you know, you have to look at your priorities. When you have 5% debt and opportunities to get 30%, you know, 20%, 25% return on doing a new surgery center, or building a new rehab hospital, we have to manage that because I think ultimately I'm going to be measured -- we can keep debt flat to reduction and continue to build, now, growth in our margins and build new facilities, allow us to grow our earnings, you know, with tremendous growth which you see here, you know, I think it's a balance of all of those items. If we can go hog wild and say, look, let's just pay down debt and don't do anything else, it wouldn't take very long to get rid of all of it but our earnings would suffer on that it's a balance and challenge that we have. We have done a good job managing that balance. We'll do a good job in the future.

I have no problem with it. I just wanted to make sure i understood what the objective was. I agree, if you have cheap borough, you borrow and you expand the capacity and you build your business [ borrowing ]

That's the gold.

-- goal.

We got beat up so bad. I don't understand this we have studied it and, you know, I can go to wall street and everybody, you know, it's like every one of us has got a nose, we all have an opinion. Every meeting I have ever been in I could go around the room and we break out into our one on ones and we have one group saying pay down debt, another said grow your earnings, the other says why aren't you paying down debt, are you stupid? Another group says, my god, the sky is falling, you need to be paying down debt. So what we have would do is satisfy everybody. It's a challenge. You're right. I appreciate your comment. What we are going to do is we are going to manage this company and we are going to keep the debt -- we are going to be very focused on the balance sheet and we are going to protect than a telling grit of that balance sheet. We are going to grow this company successfully, build earnings and we are not going to be pushed into a cave to where, you know, no one has any interest in buying the stock. We are not going to let that happen. So our strategy has brought us over the last two years to where we are today where we're able to announce to you incredible margin growth, incredible earnings growth, great same store growth, all the results are there. Everything that anybody could possibly want out of us is there. And we're doing it. We have a great team of people working very, very hard and we are going to continue to do that. And people just have to make a decision whether they want to open it or sell it and right now, at today's price, it's an outstandingby. If you look at anything else out there, you look at a company with an ebitda margin almost 30% with the kind of growth we have trading at where we are, you ought to own this stock and that's where we are. And we are going to do the right things, and we're very focused.

Thank you.

Thank you.

We have a to do some television things. So we are going to have to end this we appreciate all of your interest and but in order for me to be able to get to do the cnbc thing and other things we have scud -- scheduled for today, I have to end the conference call. I'm sorry, feel free to contact our investment relations department with tad mcveigh and his team. They will be glad toer carry on w that I'd like to ask our general counsel to read our forward-looking statements and then we'll adjourn. Thank you very much.

Thank you, richard. Certain of the matters discussed inist conference call are in the company press release may constitute forward-looking statements within the meaning of section 27 a of the securities act of 1933 and section 21 dp. Of the securities and exchange act of 1934. Certain of such forward-looking statements may be identified by the use of ford looking terminology such as believe, expect, may, will, should, seeks, intends, plans, estimates, or anticipates or other comparable terminology, but decision decision. These forward-looking statements are necessarily estimates reflecting our best judgment based on current information and involve a number of risks and uncertainties. There can be no assurance that other factors won't affect the accuracy of such statements. While it's impossible to identify all such factors factors which could cause actual results to differ materially from those currently estimated by healthsouth include competitive pressures in the healthcare industry and our response, changing in reimbursement policy by governmental and third party players, unanticipated delays in strategies, general conditions in the economy and capital markets and other factors which may be identified from time to time in our sec filings and other pun announcements to which you should refer for further information.

Thank you very much, bill. And again, appreciate everyone being on the call today. Have a nice day. Thank you.

Ladies and gentlemen, this concludes your conference for today. Thank you for your participation and thank you for using at&t executive teleconference.