Encompass Health Corp (EHC) 2002 Q3 法說會逐字稿

Ladies and gentlemen. Thank you for standing by.

Welcome to the HealthSouth Corporation third quarter earnings conference call. At this time all participants are in a listen-only mode. Later we'll have an opportunity for question and answer period with instructions given at that time. If you should require assistance during the conference call please press zero followed by star.

As a reminder your conference call today is being recorded. I'll now turn the confenrence call over to your first speaker, Chairman of the Board, Mr. Richard Scrushy. Please go ahead.

Thank you very much and I'd like to thank everyone for dialing in today for the HealthSouth third quarter conference call.

We'd like to begin by stating that third quarter was a challenging quarter for the company. The introduction of Transmittal 1753 certainly had an impact on the company.

We had the negative press, a lot of bad press on the company which created some problems for us in terms of referrals and so we took a hit in that particular area. The revenue increased by about 3%, that's excluding divestures versus third quarter of last year.

The impact, really where we were hurt the most was in the outpatient area, we had a 14% reduction in volume resulting in about 17% reduction in revenue decline and this, of course, was due to lower reimbursement, the Transmittal 1753 impact and that shows up in the pricing. Bill Owens will talk about that in a moment which is an 11% reduction in pricing. So you had 14% reduction in volume driving a 17% reduction in revenue in that particular area.

There was a lot of good news we'll talk about as well in other divisions. We'll walk you through that in a moment and go through all the statistics.

As we had a lower revenue number, we had an increase in our A/R days, if we were able to keep the revenues flat, we would have shown only a slight increase. We had about an $18.5 million increase in A/R, our reduction if we hadn't had or without the reduction in revenue, an 80.5 days in A/R but with the reduction, it actually drove it up to 86.5. Now there are a lot of positives in this challenging quarter.

Outside of the outpatient rehab, all our business lines had higher revenues versus third quarter of last year. Inpatient revenue was actually up 12% versus third quarter of last year. Same store volume growth in inpatient diagnostic and surgery were at double-digit gross in inpatient revenues. Pricing increased over third quarter of last year in the inpatient and in the surgery area and I think that, something very important here, is that the company had a debt reduction of $111 million in the quarter even after buying back $31 million of our stock. And obviously, we were in the market buying stock back after our price went down. So we would have pushed $140-plus million in debt reduction had we not spent the $31 million on our stock. So, very strong in that respect. So there are very good positives here that I think we need to take a look at.

I'll ask Bill Owens, our President and CEO to walk through the financial highlights at this time.

Thanks, Richard.

Third quarter net revenues were 1 billion 94 million as compared to 1 billion 76 last year. That's an increase of 2% over 3Q of '01 and it's up 3% excluding divestures in the prior period. Our third quarter EBITDA went from $298 million in the prior year to $228 million in this year. Our margin has dropped to 20.8% from 27.7%, that's a 24% decrease in EBITDA. Third quarter net income dropped from $79 million in one period to $54 million in '02 reflecting a 32% decrease and EPS dropped from 20 cents to 13 cents also reflecting a 35% decrease.

As we go product line by product line you'll see that our challenge is in outpatient PT as well as in pricing and a volume issue as Richard discussed in his opening comments. As we go through our statistical highlights you'll see where that hit and we'll start with outpatient visits dropping year over year from 2.2 billion down to-- I'm sorry 2.2 million down to 2 million 58 thousand, that is an 8.3% decrease from third quarter '01 and a 3.8% same store decrease.

Our revenues correspondently dropped 16% from $220 million down to $183 million. The volume also drives that as well as a reduction in pricing from $98 a visit down to $89 which is an 11% reduction in pricing. However, third quarter surgery cases year-over-over increased by 4% with a 5.8% same store increase from 211,570 in the prior year to 220,120 in the current year.

Revenues grew correspondingly from $234 million in '01 to $252 million in '02, an 8% increase compared to the prior year and pricing increased from $1104 a case up to $1146 a case. Diagnostic procedures were relatively flat from the period. Prior year 275,908 to 275,791, however, because of closing the facilities, we did have a 5.3% same store increase in diagnostics. Pricing was flat as well.

So, flat pricing and flat volume you end up with flat revenue, $83 million in both periods. Inpatient discharges. As we've said all along, we're doing very well in inpatient from PPS as well as initiatives that we have going in inpatient. We have a 9.9% increase from third quarter '01. A 10% same store increase, growing our discharges from 27,519 in '01 to 30,231 in the '02 period. That results in very healthy revenue growth from $441 million to $494 million which is a 12% increase over third quarter of '01.

Pricing increase from $16,025 a discharge to $16,342 a discharge.

As you look at the breakdown in our divisional revenue, once again you can see here the decline in outpatient PT revenue. Inpatient represents 45% of our revenues. Outpatient which is traditionally been 21%-22% of our revenue is down to 17%. Surgery is at 23%. Diagnostics at 8% and medical centers at 6%.

Internal development during the quarter, we opened nine new sites, 8 of those were de novo, and 1 was an acquisition. The nine break down, two surgery centers and seven outpatient rehabilitation centers. From a facility count standpoint we now have 1795 facilities, break down as follows: 1331 outpatient rehab, 118 inpatient rehab with 7,643 beds, 206 outpatient surgery locations, four medical centers and 136 diagnostic centers.

It should be noted that, during the quarter we closed or consolidated 103 out patient rehab locations that were primary satellites to host or base facilities. In our surgery center division we're continue to add new physicians. We added 52 new physician partners in third quarter of '02.

Since we started the initiative of bringing in new physician partners we have added a total of 773 and the result of that is our ninth consecutive quarter of same store growth. From a financing standpoint, cash flow from operations is $141 million. As Richard says our A/R days increased 7.5 days but 6.5 days of that -I'm sorry, 6 days of that was driven by the fact that our revenue is down therefore our revenue per day is down and net debt declined by $111 million while we purchased over $30 million of stock during the quarter. We recorded a $25 million gain for early retirement of debt. We repurchased in excess of $440 million of our public debt during the third quarter, we repurchased approximately 214 million of the 3.25% converts that redeem in April 2003. We have approximately 354 million remaining under that issue. Outside of the $354 million converts we have no other maturities until 2005. We presently have over $1 billion in availability under our bank revolver and CAPEX for the quarter was $75 million.

Going product line by product line in talking about the issues we face there, outpatient rehab is very well publicized the challenges that we face in outpatient rehab. Transmittal 1753 resulted in a $23 million revenue hit just simply from pricing with a drop from the previous quarter of $100 per visit down to $89 per visit. Lower volumes which we had not anticipated as part of our $175 million announcement, we had predicted lower volumes but not projected that our volumes would decline by 14%. Resulted in a $34 million loss in revenue quarter to quarter. That's driven by several factors.

We did close or consolidate 103 sites as I said, during the quarter. Our number of referrals fell by almost 11,000. I mean, there was 11,000 fewer new patients we saw in the third quarter as compared to the second quarter. That translates into approximately 100,000 fewer visits. Our visits per referral dropped by one day which is about a 10% reduction in volume there. However, because of the number of sites we have, this really translates into only two less patients per site per day in the third quarter compared to the second quarter.

We're facing many challenges in this division but one of them is our therapists helping to get them trained, overcoming their confusion of all the information that's been out there on how to schedule, how to code and we're working hard to overcome those challenges but that has affected our volume and affected our pricing during the quarter.

Negative press hurt us tremendously in this business. I know of contracts that we lost because of the negative press, and in the negative press is totally unfounded and has not effected the quality of our service.

We are still known and the people that have not sent us business have not ever questioned the quality of our service but the press has hurt us tremendously here and back office PT is continuing to hurt us. However, there is good news on the back office PT. As our physicians are taking PT back into their practice, weakness in our business because of the press, the heat has turned up in this area.

However, in section 513 D of House Rule 4954 known as the Medicare Modernization and Prescription Drug Act, which the House passed in June, the House instructed the Office of Management and Budget to examine the effect of prohibiting a physician from referring patients to physical therapy services owned by the physician and provided in the physician's office. So, we think this is going to turn around.

We know there is a movement in Washington to address this issue, and we are encouraging our elected officials to take a look at that. From an inpatient rehab standpoint revenue grew $8 million in that division despite Transmittal 1753 which had a negative impact on the outpatient business there.

This was driven by PPS and strong same-store growth and would have been a significantly higher number had it not been for our losses under Transmittal 1753.

We had a sequential quarter increase in expenses of about $39 million. The majority of this on the operating level is salary costs related to training. Related to higher contract and nursing contracts, contract labor and nursing costs during the period. Our insurance premiums, as everyone's insurance premiums, are going up and have had a significant impact on our costs.

We've increased recruiting costs for therapists as we face the challenges of 1753 and market initiatives trying to recover the loss volume have driven a sequential increase in cost of $39 million. It should be noted, that part of that increase is that there was one more working day, one more pay roll day in the third quarter as compared to the second quarter and that does translate into a $7 million increase in salaries expense quarter to quarter. So excluding that, we had a $32 million increase in costs driven by the things that we talked about.

At the corporate office. The corporate overhead, we increased cost approximately $12 million driven by what we're going through at the current time, being legal fees, public relation fees, auditor fees that are split-related and various market initiatives that we're once again we are incurring trying to drive net loss volume back into our facility.

Richard, with that I'll turn it back over to you.

Thank you, Bill.

I want to talk just a moment about our corporate governance initiatives.

First of all, this has been a concern of shareholders and companies working towards those concerns and doing the things we think and that they've advised us to do that are most appropriate. For example, we've added two new independent board members. We've also created a special governance committee in which we'll have three independent directors and, of course, four outside advisors and of course, the names of those new advisors will be released soon as they are being confirmed at this point.

Those advisors will be involved and these are people who are well known throughout the country for their expertise in this particular area and they will be advising the Board on several things. The independence of the Board and it's members, as well as governance issues.

It's important to bring up, though, while we're talking about this, the fact if you pull the institutional shareholder service report or ISS on the corporate governance portion, you'll find looking in the S&P index section that HealthSouth has outperformed 78.8% of the companies in the S&P 500 in terms of their governance profile. As far as industry ranking they are 77.7%. That puts us way up the curve and I think what our Board is committed to do and certainly I'm committed to do is to continue to build a blue ribbon company and one that shareholders will be proud of and to own the stock. So we're going to very work hard to move that number up. However, we've got a good start because a lot of companies that are not as far long as we are.

So, our goal is to keep moving that up and get as high as we possibly can and, I think, the advice of these new advisors and this new committee and the work that Bob May is doing as our new, independent Director there as Chairman of that committee, will move the company up the curve here and, again, achieve all the goals we have there and over time people will be very satisfied with the progress we are making in this area and this is moving at a rapid pace, this is not something drug out over a long period of time. We are working on this constantly, weekly and making progress. We also created a special litigation committee that's dealing with the litigation issues and is doing a interim investigation as well, on all of the litigation issues. So, we feel pleased about the progress that committee is making as well. Also released are the results of the Fulbright & Jaworski report.

This is important in the results and the extensive reviews that Fulbright has done and I think that it's important to mention that these reports have all been turned over to the SEC and the company is certainly cooperating with the SEC investigation. The review they sent, the inquiry they started with the company. The company has done all the things we believe that we can do relative to these issues.

We've been straight forward-looking in dealing with the agency as well as going through an incredible investigation from the Fulbright & Jaworski law firm and I think the results are strong. People now understand that the company has been straight forward and that we're working very hard to run a very good business. We've been hit with difficult times and a difficult situation here trying to adjust to this Transmittal 1753 and deal with all of the issues in the press. This has affected us more than we expected on the outpatient side and let me tell you why. We've studied this pretty hard.

As Bill said, we've actually -not only have we lost a couple of contracts but we lost actual opportunities because of the negative press that we were negotiating that would have actually had an improvement in our volume.

On top of that, as you look at patients that go into rehab hospitals, typically what you typically have are sicker patients, many of them have catastrophic injuries and very difficult disease processes and these patients typically come from discharged planners and directly from insurance companies, case managers, managed care organizations and are placed into our facilities. Many times our facility is the only facility in the community, and we have the only beds available or certainly there are limited number of beds so we find that these patients are not -- it's not an elective situation. Were, as you look at the outpatient situation, where we are really dependent upon doctor referrals, we're dependent upon - patients have a choice. They actually can read the newspapers and make a decision about where they go. Where, in the sicker patient, the catastrophic situation we find that we're gonna get those patients into the HealthSouth rehab hospitals and so the HealthSouth rehab hospitals have been less impacted in terms of referrals. We believe it has some impact and we think that our volume would be higher, had this not happened but we are seeing still good growth there.

Our goal is to overcome this negative press and to do the things we need to do to make sure our clinical programs are outstanding and we need to make sure that the physicians that refer patients in continue to know that. If we can get back to business here and look the physicians in the eye and strengthen our marketing programs, work closely day-to-day with all our referral sources, we believe we can overcome this reduction that we've experienced here in the short run.

As Bill said earlier, it's very important to get through the training and deal with the conservative side of what we having to deal with in terms of the coding and issues associated with this. Bill has made great strides in working with the payers and he'll talk about that as well and making sure we are doing all the things to keep the payers happy and provide the services they are expecting out of our company.

I think it's important to note, that we did close and consolidate 300 sites in the third quarter and this will continue into the fourth quarter as well. There will be an evaluation may be necessary impairment charges by year end. Outside of outpatient rehab, other business lines, higher revenue versus third quarter of last year.

Focus on net debt reduction of $111 million in the quarter and repurchase of $31 million of our stock. The company has ample liquidity for its debt obligations and finally as we complete these budgets and as we work our way through all of our operations, we should be in position as we said earlier to announce guidance in mid-December.

So, Bill, you have further comments in closing before we take questions?

No, Richard. I think we've covered it very well, so why don't we open it up for questions. Operator?

Ladies and gentlemen, if you have a question, please press the 1 on your touch tone phone. You'll hear a tone indicating you've been placed in queue and may remove yourself from queue by pressing the pound key. If you are using a speaker phone, we ask that you please lift the handset before pressing any numbers. Our first question will come from the line of Frank Morgan from Jefferies & Company. Go ahead please.

Good morning. Are there any other cost initiatives that you are considering at this point? Clearly, you're trying to retool the clinical model on the outpatient side. But are there any other cost control initiatives you and Pat could talk about that you may be able to implement?

And then secondly, in terms of the timing, I know I think I understood this to be a one-year process of turning the tide and getting the clinical patterns changed over and adapting to the transmittal notice, can you comment on your perspective, do you feel like or look like or do you have any evidence to suggest this may take longer to turn or less time to turn on that front? Thanks.

Frank, those are very good questions.

On the cost initiatives, we are taking a very hard look at every single dollar we spend both at the corporate and the field level. There will be announcements coming out of us in the very near future about our plans to reduce our cost. That is something that we are actively involved in every day.

I'm not ready to put a number out there on that yet, but, yes, there will be meaningful and significant reductions in our cost structure both at the overhead and at the operating unit level to help combat both our loss of volume and loss of pricing.

From a standpoint of how long it's going to take to react and to turn clinical practice, your estimate of a year is fairly accurate. We don't believe it will take quite that long but don't believe it will take anything longer than that, either. I'm actively meeting with other payers.

We've got an active effort going on in Washington to try to work with CMS to come up with a resolution to this issue. We are proposing to payer some revolutionary changes in the way PT will ultimately be priced and paid for in the future.

We're actively out there trying to reengineer not only the way which we schedule and treat patients to deal with this issue but also with the payers so that we protect ourselves from the other payers standpoint and in the long run continue to bring benefit by generating reduced prices but generate higher better clinical outcomes than the competitors do. So, that's our focus and in the time frame that you laid out is a good time frame.

Any comment on were you able to renegotiate contracts in the quarter that might have been linked to the Medicare fee schedule in the past or have you had time to do that yet?

We really haven't had time to do that yet. Our focus at levels are at higher levels of the organizations and we've opened those discussions but not had a lot of success at this point. We have not had any defeats, just the ball is just beginning to roll.

And, Frank, what's important to understand is with the reductions we've had on the outpatient side and some of the other increases, we are very focused on the cost. Obviously the field, our operations and both our corporate operations expect we'll have to make adjustments in order to compensate. I think everybody is there and, as Bill said, a good plan is being worked through right now and you should expect to start to see that happening relatively soon.

Okay, thank you.

Thank you. We have a question in queue from the line of Howard Capek from UBS Warburg.

Thank you. A few questions. If we look at the outpatient clinic at the field level, what is your best guess of a sustainable operating margin going forward? First question.

Our target there is to have our margins in the low to mid-20s.

As we look at the mix of our facilities, we have many facilities that are higher than that. We he a lot that are smaller and some of the strategies that we've deployed in how we place our facilities and the size of our facilities given the change in reimbursement, we're gonna have to revisit. But, we believe we can reengineer PT to sustain a mid-20s operating margin.

The model has changed, Howard, somewhat. And the reengineering will develop the new model but, as Bill said, we have facilities that run higher than that. On the low end side as we close and consolidate, you'll see the margin, as Bill said, move back into where we wanted it to be.

And follow-up on CAP-X and cash flow, given continued consolidation on the outpatients side and taking into account new inpatient facilities slated to open over the next year, is $75 million a quarter a good run rate to look at next year or are we preliminary on that?

We are a little preliminary right now, Howard. We've said we're not going to release guidance for '03 until we finish the budgeting process. If you will allow us, please, to get through that and then we will release that for next year.

And last, the precash flow absent the bonds, the converts next April, is share repurchase the number one use of cash right now?

Always something we are looking at, Howard, with the prices we are at. Something we have to pay attention to.

I can't sit here today and say that's our number one priority beyond redeeming the converts but obviously something high on our radar screen and our number one priority is to use our capital to best benefit our shareholders. If that is the use to best benefit our shareholders, that's how we will deploy it.

Now to the line of Scott Estes with Deutsche Banc. Go ahead please.

Thanks, good morning everybody. Bill, when do you actually anticipate the budget process will be done and how do you disseminate the forecast according to that and I had another question just related on where you stand on the divestiture status of potential assets as well?

As we've said our target is mid-December. We hope and pushing hard and& working around the clock and I hope I can beat that. Absolutely no later than mid-December and we will put out a press release that includes statistical information, the information we released. The drivers of the business that you can use to update your model for next year.

And any comment on where you stand on the divestiture progress front and assets there?

We've had a lot of interest expressed in a variety of assets across all of our product lines. However, we don't have a gun to our head because we don't have maturities, we don't have a liquidity issue and feel it is in the best issue of all of our shareholders and bondholders to get in the high range of a market-based multiple on anything we sell.

There is a sense of those who expressed interest in our facilities that we are in a mode in which we might take less than a market-based multiple and that is not the case. We're keeping that option open but anybody that is interested and needs to -- or will have to pay a market-based price, this is not a fire sale and we feel like that's in the best interest of our shareholders and our bond holders as well.

Scott, what's important here is that we have an outstanding company. We have outstanding facilities in every area. What we do have is we have some markets that we believe are not long-term growth markets and looking to that. We don't want to jump to a conclusion and make that decision in a hurry.

We are working with the presidents of those facilities to determine what the opportunity is in the markets and make sure the facilities can achieve the margins we want to achieve here. Where we need to be applying the capital. Are they fixing something or selling that or someone else might have a better market or infrastructure than we have in the particular market. Those things are analyzed.

We have nothing for sale. People have to understand. We have nothing at the company for sale but we have had a lot of people approach us. What Bill is saying, as long as that option is always available to the company at any time. Are there certain prices that would make you want to sell individual things and the answer is, maybe.

We're in good shape here. We have outstanding management and our people focused now are recovering, we're in a recovery period of time, we are in a recovery phase.

We're going to pull through this, we're gonna pull through it and we believe rapidly. With good implementation of our management talent, good focus on working with physicians and payers and people who refer patients into our facilities. We got a good team of folks to do it.

So, we're not out there running around trying to push our facilities off on somebody else and we don't need to do that. Would we sell selected assets at certain times for the right price, the answer is we are always open to do that. We're a large company in 1800 locations and always studying that and our track record is when we find under performing assets, we do divest. We've done that throughout our history.

It's a good question. I want everybody to understand that our focus is to run the business, make it profitable and bring it back to the days where we think -- back to the levels it can achieve and work day to day with the doctors and referral sources here. And we've sittin' in this room with our Presidents of our divisions and they're all sitting here shaking their heads saying, that's right because that's where we're headed.

We have 50 thousand people out there we have to keep motivated and sitting here carrying on conversations about whether we are going to sell something or not is not a motivating thing so we don't need to discuss that any further but I appreciate the question.

Now to the line of Deborah Lawson with Salomon Smith Barney.

Hi, I was wondering, it's easy to see in the statistics that you published the impact on the rehab business and we can see the volume statistics and revenue per visit, the decline there. Correct me if I'm wrong, a lot of the impact, actually, has come in the inpatient division in this regard. So can you give us some sense as to how to interpret the statistics that you publish on the inpatient side? Vis-a-vis the revenue per discharge number?

Debbie, we did a much better job in our inpatient business in dealing with Transmittal 1753.

The estimate we put out there expected certain things to happen in inpatient rehab and all of those have not happened. Fortunately for us, those assumptions we made helped deal with the fact that we lost more volume in outpatient rehab than we anticipated and kept our overall estimate pretty much in line. But the estimate or the impact on outpatient services and the inpatient division was approximately $10 million during the quarter which was driven mostly on pricing and some reduction in volume.

Okay. And lastly, can you just give us some sense of the $75 million in CAP-X, what that went toward?

Yeah, Tadd has that information.

Yeah, Debbie, primarily the $75 million, we opened seven new outpatient sites as Bill said earlier, and two new surgery centers. We have four inpatient hospitals that are presently under construction along with two LCACs.

We continue to move forward with construction of our digital hospital and continue to make MRI and CT upgrades along with other diagnostic upgrades in our diagnostic facilities. Relocations, ADA compliance expense and some small IT spending. Maintenance for the quarter represented about 24 million of the 75.

Okay. Great. Thanks a lot.

A question from the line of Matt Ripiger with JP Morgan.

In terms of the sequential drop with rehab volumes, I was wondering if you could characterize how much was Medicare-related and how much was commercial.

What's important here is, we can break that out for you, as we look at the actual drop in utilization and chase that down, we're looking at a falloff averaging across the board two patients per facility per day. Two visits. We are running, Bill, about 10% in Medicare.

That's correct. The volume declines, Matt reflect our overall mix.

Really has not varied greatly from what our overall mix is with our new volume. We are still 9-10% Medicare on the volume side. So it has been across the board decline in overall volumes. 11000 decline in referrals. The average referral is about 10 visits so 100 thousand decline in visits just off the referrals. So we really haven't seen a change in the mix as a result of change in volume.

And a follow-up. In terms of $51 million in incremental costs for the quarter I related to change in rehab reimbursement, were any of those one time in nature or do you expect those training costs to continue in '03?

We will be bringing our-costs down and some of these costs are unique to what we are expensing right now. We are still experiencing the costs as we speak.

If you followed what's happened with Transmittal 1753, CMS has promised they would have FAQs out and they still do not.

The APTA just in the past couple weeks has put guidance on their website to therapists on how they think Transmittal 1753 should be dealt with. So there is a lack of concrete guidance right now and we are continuing to deal with that with our therapists.

There will be costs ongoing related to continuing to train, to rework our scheduling process, to make sure that documentation reflects the new regulations.

On the corporate level, the $12 million increase we saw in corporate expenses, is definitely unique to what we are going through right now and those will not continue into '03. I can't tell you we don't expect them to continue into the fourth quarter of this year but those costs will be going down as we clear some of the hurdles that we are clearing right now.

On top of that, we have an overall objective to make meaningful and significant reductions in cost structure across the board. Into '03, you will see the cost structure coming down.

Thanks, very much.

We will go next to the line of Eli Radinsky with Jefferies and Company. Go ahead please.

Two questions from me, first of all can you discuss whether you are planning in buying back bonds over the next couple of quarters? Also when you are discussing your contracts with the managed care players has there been any discussion by any of the managed care players for money due to 1753 on a retroactive basis they want back from you and more structure on how the negotiations with managed care companies are going along. I imagine you have renewals coming up January 1st. Thank you.

First of all, Transmittal 1753 went into effect on July 1. That's important to understand that. Look at the front page of the document, effective July 1. Bill, you want to comment?

Let me say something, I'll let Tadd answer the question on the bond buy back. Let me deal with the other payers.

With me in the room is Dan Rivera who is President of our Outpatient Provision. Dan and I spent a lot of time in the last six-eight weeks on the road visiting payers discussing transmittal 1753 and group therapy but other issues with the payers. At the current time, we have had no payers indicate that (a) they have any interest in indicate to us they plan to adopt it or (b) to go back and try to seek any refund or reimbursement that they might perceive might be available to them. Right now we're in good shape when it comes to other payers.

As a matter of fact, Bill, as we were discussing this with most of the payers we were asking both questions whether they were watching this or going to adopt it, or go backwards and they indicated to us that they were watching it but absolutely had no plans of adopting it and absolutely not going back on any of the charges or reimbursement they have given in the past.

Important to note that concurrent therapy is an accepted practice within the Medicare guidelines in certain types of facilities.

All therapists are trained and taught to dove tail in every university and training facility in America and it is an accepted practice throughout all the country and there is not a single physical facility in America that does not practice concurrent practice. It would be a significant cost increase to every single payer out there. It would eliminate concurrent therapy.

It would drive the cost through the roof and you're talking literally hundreds of hundreds of billions of dollars of cost increases to payers if you tried to do that, tried to move to a non-concurrent therapy environment or one on one and a significant waste of resources. Our experience with the lawyers is they understand that and want to keep their rates low.

When you look at outcomes, you'll see that for example HealthSouth as well as other providers, their outcomes are improving continuing to get better and better as technology has changed, clinical practice has changed. I think we have excellent results. People are getting off the healthcare dollar quicker.

You can look at the number of visits made to a physical therapy facility which is almost half what it was five years ago. We are seeing better outcomes. Less money spent. We don't see the payers turn around and say let's go the other way. Spend more one on one and waste the resources. We believe that there will be an access problem. It would be difficult to access the facilities.

Already a crunch with the elderly now with the 1753 rule which creates a problem going forward for the Medicare program. On the current basis it would be horrible to the payers to try and push everybody through that model. It doesn't just make sense.

That's what Dan and Bill are saying to you.

And in terms of the bond buy back as we said earlier in the third quarter, we repurchased about 444 million face value of our bonds. Going forward, the answer is pretty much the same as the one Bill gave on the stock buy back. We will evaluate the best use or best uses for our free cash flow and liquidity going forward. We will work closely with our various constituents, bondholders, and banks to make the right decision.

Thank you very much.

We have a question from the line of Angela San Philippo with Piper Jaffray.

When we think of free cash flow going forward, the $70 or so million, is that a good run rate or at least a base going forward?

It is Angela, right?

Right.

As we've said, we want to get through our budgeting process. We don't anticipate that the results that we have posted for the third quarter will be reflective of anything. This is a challenging quarter.

A lot of unusual things going on during the quarter and we do not anticipate that being a normalized quarter. Therefore, we would prefer to get be able to get through the budgeting process, -- evaluate the impacts we'll have over the next one, two and three quarters and then put out a number that we feel comfortable. This was a very unusual quarter and we would not feel comfortable anybody basing projections long-term off the results of this quarter.

Thank you.

We have a question in queue from Alex Guyer with UBS Warburg.

Just wondering if you can give us a little sense of what you might expect in the way of volume rebound on the outpatient side for the fourth quarter? How much of what you saw in the third quarter might have been strictly related to the 1753 transmittal and whether there is the opportunity here in the short-term for recovery sequentially?

Alex, we are working hard. The one thing I can tell you is we are working hard to get that volume back.

Statistics through what we have seen to this point indicate there that there is no additional losses from what we have seen, but our statistics do not indicate a significant recovery from that level, either. So, you know, we -- all I can tell you is we are working hard to get it back. Our people out there are working hard and we do believe we'll get that volume back. Whether or not it will be this quarter or not difficult to say.

My other question is what extent if any have you seen improvement in the DSO since the end of September quarter and what your expectations for that metric for the next quarter, too.

Until the balance sheets for October, I will not have an indication where DSO's are for the quarter or for the month. It is only the fifth of the month so have not closed our balance sheet. I will tell you that cash collection trends continue to be strong and very optimistic and excited about where our collection trends are and have been. But other than that, I have no indicators of where it might end up for the end of the quarter.

Thanks.

We have a question from the line of Bill Binelo with Wachovia Securities.

A couple of follow-up questions. Just wanted to follow-up on the commercial contracting.

The $10 million impact on the outpatient revenue and inpatient facilities is less than half of what you'd initially projected. Is that totally attributable to the fact that the commercial payers did not change their reimbursement practices?

It's attributable to several things.

One, just the pure population of patients you're dealing with in an outpatient population in a rehab hospital is a more manageable population. Being able to schedule the patients accordingly with a higher Medicare mix. The Medicare patient is the unusual patient in our free-standing rehab facilities.

The Medicare patient is over half of our patients and outpatients in our hospitals, so being able to manage that population from a scheduling standpoint, having the resources there, pulling therapists from the inpatient side, you have a pool of therapists to deal with inpatient, a pool to deal with outpatient and so you able to cross-utilize and pull from resources to help manage that process.

To some extent it is impacted by the fact we haven't seen a move from the third party payers to indicate that any changes are going to happen there.

And the other thing, of course, we are abiding by Transmittal 1753 but we still, the people that process claims for Part A facilities or rehab hospitals have still not received notice of Transmittal 1753. It has only gone to part B carriers. There are even billing related to this and the part A intermediaries have not been notified. We are in compliance. We have tested that.

We are complying with Transmittal 1753 across the board and we anticipate that because we have been able to manage that patient population that we will be able to continue to control the impact of Transmittal 1753 on our rehab hospitals and our challenge now is to get the volume back into the outpatient rehab centers and we can see that happen. We'll see a substantial piece of this downward trend turn around.

Can I follow up on something you just said about the intermediaries not having received the transmittal yet.3 I just want to make sure that I understand the implication or the potential implication of that. Is that a potential implication on how you bill going forward as opposed to some kind of implication on how you've been paid in the recent quarter?

No, we are billing according to Transmittal 1753 and have been for the entire quarter.

The only implication there is are there other providers who are filing claims under part A who are not abiding with transmittal 1753 because it is a coding issue. It is nothing they had to change in their systems. It's with whether you choose the group code or choose to limit your individual codes to four units per hour. It is up to the clinician and the people who bill at the facility level to make sure they abide by that transmittal. We are doing so.

What I'm telling you, the part A intermediaries have not received that transmittal if other providers are submitting claims not applying transmittal 1753, the part A intermediaries would probably still be processing those claims.

And switching gears, can you give us a sense of the volume attrition and cost buildup rolled out over the course of the quarter. In other word, did you lose customers or lose referrals as the quarter progressed and sort of implement costs so we should expect the full impact to be a little bit greater than it was in Q4 than it was in Q3?

If we were not taking actions otherwise to control costs in other areas, then that might be the result but you will not see an increase in costs as a result of this in Q4 because we are working hard every day to get our costs under control.

The month of September was the worst part of the third quarter and a lot of that was press-driven and everything that we experienced as a company and our people experienced across the country and the spotlight we were under in the month of September. But we do not anticipate that the month of September will repeat itself three times during the fourth quarter, either. A lot of confusion about how to bill, what to bill, physicians and people thinking that all the innuendoes, all the hammering that this company took, all the press trying to connect dots that didn't exist and here we were trying to get patients in the door, our therapists standing around reading about their company in the newspaper, we lost a lot of productivity, our marketing people that would have been out there on a normal business making calls, going into doctor's office and the doctor only talking about what is in the newspaper.

They didn't want to talk about patients that day. We lost the mode of bringing the business in. Our business was severely interfered with. We are now with the Fulbright report out there that helped us some.

There's other things that are helping us and our people are out there tackling every day now trying to turn that around. Physicians that were regularly sending us patients dropped off. And right on top of it, Dan, you may want to comment on it. I know you guys are doing everything you can to rebuild that confidence out there and get the patients back in.

We spent a lot of time in September just having conference calls to get the information to combat, all the rumors and innuendoes in the field. We spent a lot of time regrouping internally.

Now we have the people refocused and attack plans on big time physicians in the past who are not referring or referring not at the same levels and we are visiting each of those and talking about the in outcomes and experience they've had with us in the past, they'll have that going forward. We think the volume will come back during the fourth quarter.

And what's important is that, we never dreamed when we had our press conference in August that we would have to deal with the innuendoes with the press and the interference with our business. There's no way we could deal with the impact of the worst case.

Fortunately inpatient, it was not as bad as we thought it would be and we may be able to totally eliminate it in the latter part of next year and offset it by engineering and scheduling and other things, but there is no way this company could have understood the absolute difficulty and the hammering we would go through immediately after we made the announcement and began to make adjustments fore 175. It complicated our lives, the senior management here, we spent unbelievable amount of days involved with lawyers and PR people and dealing with the investigation and so on and so on which took our focus away from being where we needed to be, meeting with doctors and meeting with payers and dealing with it.

As time goes on and some of the hammering stops, we'll spend our time dealing with clinical issues, why doctors need to be putting patients in our facilities instead of in conversation with what was in the newspaper. It's been very difficult and a factor, a learning curve for us.

We never dreamed it would happen and hopefully we'll overcome this. I think that is what Dan is saying. Well over 400 people out there in the marketing situation trying now to get everybody back to business again and looking doctors in the eye saying we're a great company.

No one questioned our clinical capabilities. We are the best in the business and everyone knows that. Now we just need to get the volume back. We got a lot of hard work. It's a recovery time. It will take the next twelve months and every day it gets a little bit better.

Thanks a lot.

Okay. I think we've been on for an hour. You guys want to take one more, one more question.

That will come from the line of A.J. Rice with Merrill Lynch.

Hi, everybody. Just a couple of questions. First of all relating to the margin trend, I know there's a lot going on in the outpatient division, in the surgery center and imaging divisions, can you give us some flavor, is the year-to-year trend still flat to positive there?

Yeah, A.J., basically, the free operating margin for both surgery and diagnostics did dip in the quarter. Not significantly.

Certainly no where near as far as outpatient, and as far as surgery is concerned, we attribute the fault of that to the seasonal comparison. If you look at a year over year situation for surgery, the operating margin actually increased. So I feel like that is indicative of that business being in very good shape. In terms of diagnostics, there was a slight deterioration in that margin related to the statistics that we went over earlier in terms of pricing and volume.

Obviously, that's impacted also by referrals as well as surgery which we had some impact there. Just real quick, we have the President of the Surgery Division Larry Taylor. He is jumping at the bit to make a comment.

Thanks Richard. The changes we made through the third quarter for initiatives breaking surgery out as its own division has put the appropriate light in focus on that division. Our surgeons and our operations with that, the team is very focused, specialized and assuring that those relationships move forward. With that I feel confident with regards to the future of the surgery division as well.

Great. On the inpatient division, the year-to-year volume gains are strong. Is that just the inpatient volume or some element of outpatient, the Medicare part B as well there or is that strictly the number of inpatient?

That's strictly the number of inpatients. The way the outpatient gets factored into our statistics is just on pricing. You see that our pricing per discharge is up over $16,000 per discharge and that reflects the outpatient volume in there. But, there is no equivalent calculation. That is pure inpatient discharges.

And then, just my final thing to ask you was on the CAP-X, you're at $75 million for the current quarter. If I've got my numbers right, that's down quite a bit from the sort of 135-ish that you were at in the second quarter. Some projects taken off the table or what accounts for the moderation?

I think we have had some inpatient hospitals previously that were under construction that have come to fruition over the past year. We have not - the spend on the digital hospital was not significant in the third quarter. Basically development was just slower than it had been in the previous quarter.

And spending, A.J., with the pressure we've had, we pulled back on everything. So you've got a significant pullback there. People are very focused now on every issue. As revenue goes down you start thinking about cash. So, I think ee did an outstanding job managing cash. The debt paydown and stock buy back. When you're getting hammered like we were getting hammered there, you just don't spend anything. You pull back.

Thanks a lot.

Before we leave, I would like our general counsel now to read our forward-looking statements and thank you for being on the call.

Some of the matters discussed in this conference call and the associated press release may constitute forward-looking statements within the meaning of Section 27A of the Security Act of 1933 And Section 21A of the Securities and Exchange Act of 1934. Some of these statements may be identified by the use of forward-looking terminology such as believes, expects, may, will, should, estimates, approximately, anticipates, estimates or similar words and by discussion of strategy plans or intentions. These forward-looking statements are necessarily estimates which we believe are reasonable based on current information and involve a number of risks and uncertainties and there can be no assurance other factors will not effect the accuracy of such forward-looking statements. Some of the factors which could cause actual factors to differ materially include but are not limited to competitive pressures in the healthcare industry and our response, changes in reimbursement policy by governmental and third party payers, and anticipated delays in the implementation of our strategic plans, 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 public announcements to which you should refer for further information.

Thank you very much for being on the call. Have a good day.

Ladies and gentlemen, that concludes the conference call for today. Thank you for using AT&T's teleconference service. You may now disconnect.