Encompass Health Corp (EHC) 2002 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the fourth quarter earnings release teleconference. At this time, all participants are in a listen-only mode. Later we'll have a question and answer session and I'll give you instructions at that time. Should you require assistance from an operator during this call, simply press zero and then star and an operator will come on to your line to assist you. I'd now like to turn the conference over to the Chairman and the CEO, Mr. Richard Scrushy. Please go ahead.

Thank you and I want to welcome everyone to the HealthSouth call. In the room with us today, we have Bill Owens, our Chief Financial Officer, Larry Taylor, President of our Surgery Center Division, Pat Foster, who is President of our Inpatient Operations, and Dan Riviere, President of our Outpatient Operations, both ambulatory outpatient rehab and diagnostics. Also, Bill Horton, our General Counsel, as well as Malcolm McVay, who is our Treasurer.

I'd like to begin by stating that 2002 was a very difficult year for our company. The last six months, due to Transmittal 1753, the confusion from payers, physicians, therapists, we had to manage some very difficult situations. We had some negative press that added to those difficulties. We had a tough year. And we believe that we will get through this year, just like we got through the impact of the balanced budget act back in 1998. 1997 balanced budget act implemented in 98, had a similar impact on our earnings and our revenues. As the Transmittal 1753. We were able to work through those damages and through that situation, and bring our company back strong. We have a good team. We've got good facilities. We're an outstanding company clinically and we believe that we will overcome the difficulties of 2002 and we want to state that we're glad to put 2002 behind us. We think that we're going to be a much better company, and we're very focused on the issues at hand and the things we have to do and we hope to present to you today a plan that will give you comfort that this company is, in fact, focused on the issues that we need to be focused on and that we're doing the things we need to be doing.

Again, as expecting, fourth quarter was another challenging quarter, total revenues decreased 1%, excluding divestitures, versus fourth quarter of '01. Primarily, driven by outpatient rehab, down 25% due to the Transmittal 1753 and weak volume. Our outpatient revenues were down about 3% from the third quarter of '02. And it's important to note that that was with about 108 fewer sites. We believe that fourth quarter should represent a bottom from which we will see growth in 2003.

There were some positive trends in the quarter. Inpatient rehab revenues increased 12% over fourth quarter of our previous year. Surgery increased 5% over the fourth quarter of the same period previous year. Same store volume growth and inpatient surgery and medical centers, we had same-store volume growth in all three of those, 6% on inpatient rehab, ten consecutive quarters of same-store growth in surgery volumes, 12% same-store growth in our medical centers. In the fourth quarter of '02, DSOs declined 17 days. 15 days were due to a charge against AR, and two days reduction were due to us doing a better job in our collections.

Now, let's take a look at some of the financial highlights. Fourth quarter operating revenues were $1.89b. Compared to $1.15b same period previous year. So a decrease of about 2%, over fourth quarter '01, about a 1% decrease, excluding divestitures.

Fourth quarter operating EBITDA was $204m, about a 19% margin, compared to $315m previous year. Fourth quarter operating income, $19m, compared to $89m in '01. Fourth quarter operating EPS, 5 cents compared to 22 cents previous year, same period.

Now, let's look at our statistical highlights. Fourth quarter inpatient discharges were 30,602 compared to 29,297 fourth quarter, '01. We had a 4% increase from fourth quarter, '01. 6% same-store increase and we had three fewer sites. We had some units and hospitals we'd closed. Year over year quarterly inpatient operating revenues were $495m, compared to $443m. That's a 12% increase. Over fourth quarter, '01. Our pricing was 16,183 per case, as compared to 15,129. Fourth quarter surgery centers, surgery cases were 224,049, compared to last year, same period, 221,594. That's a 1% increase, compared to the fourth quarter of '01, 3% same store increase. We did close or sell ten facilities. So the difference was -- there's some good news in this, in that we have ten fewer facilities, but yet our numbers increased. So the existing same-store facilities did quite well.

Year over year quarterly surgery operating revenues, $259m compared to $247m. That's a 5% increase compared to the fourth quarter of '01. Pricing, another positive point here, $1,156 versus $1,116. So the pricing continues to inch up in the surgery center division.

Fourth quarter outpatient visits were 1,951,462. Compared to, '01 fourth quarter of 2,391,459, an 18% decrease from the fourth quarter of '01, 12% same-store decrease. We did reduce our facilities there at count reduction on those comparisons was 186 fewer sites that were closed or consolidated.

Year over year quarterly outpatient operating revenues were $177m versus $235m, same period previous year. That's a 25% decrease. Our pricing was $91 per visit, versus $98 previous year. And I might mention that that is a slight move up from previous quarter, and we continue to see that move up into the first quarter of '03.

Fourth quarter diagnostic procedures, we had 266,432. Compared to the fourth quarter of '01, 275,191. And that's a 3% decrease and that's a 1% same-store decrease. And there are eight fewer sites there that we'd closed or sold. Year over year quarterly diagnostic operating revenues, $79m versus $84m. That's a 6% decrease from fourth quarter, '01. Pricing, $296 per modality, versus $307. Fourth quarter medical center patient days were 25,549. Previous year, fourth quarter, 22,766. That's a 12% increase year over year.

Year over year quarterly medical center operating revenues were $75m versus $69m in same fourth quarter, previous year. That's an 8% increase. And pricing was $2,924. So it was slightly down versus the $3,042 that we had previous year. So it's a slight decrease, but we had an increase in revenues, increased volume.

Inpatient rehab, I'm going to give you sequential quarter analysis at this time. Looking at discharges and inpatient rehab, third quarter, '02, we had 30,231. Fourth quarter, '02, it was 30,602 or 1.2% increase. Now, the comparison there, there was an additional -- one less site to compare there in one of the units we closed. Pricing, it was $16,342 in the third quarter, and $16,183, 1753 impact on the outpatient rehab there brought that number down.

Surgery centers, 220,120 cases in the third quarter of '02. And then the fourth quarter was 224,049. That's 1.8%. So we did have the comparison there is 1.8% increase and there were three fewer sites in that comparison as well. Pricing went from $1,146 to $1,156, basically up 1%.

Outpatient rehab, third quarter number of visits, third quarter of '02, 2,058,005. Fourth quarter, 1,951,462. We had a reduction of about 5.2% and in this comparison, about 102 fewer sites that were operational in third and fourth quarter.

Pricing went from $89 up to $91. So we had a slight increase in pricing, about 1.9%. Diagnostics, third quarter scans 275,791. Down to 266,432. We're convinced and believe that some of the -- where doctors had a choice and where others have choice, that we lost some business in the diagnostic area. We believe that we can bring that business back and we think a lot of it had to do with some of the confusion and some of the problems that we had last year. We're working very hard to bring that volume back up this first quarter and we feel good about our guidance this year, relative to diagnostics.

Pricing had a slight decrease; it went from $300 to $296, down 1.2%. Medical centers patient days, 25,129. That increased to 25,549 or 1.7%. Pricing of $2,851 went to $2,924 or a 2.6% increase.

I think it's important to look at the fact that as we, you know fourth quarter was just slightly off on the outpatient and the diagnostics from third quarter due primarily to fewer sites. We believe this confirms that we did hit a bottom and we'll talk about sort of the way we see the first quarter going in this year and our guidance in a moment.

We look at fourth quarter, '02, divisional revenue, our diagnostics were 7%, medical center was 7%, surgery, 24%. Outpatient rehabilitation was 16% and the inpatient rehab hospitals were 45% of our revenue and we had 1% that was other things.

Facility count breaks down like this. At the end of the year, we had 1,229 outpatient rehabilitation locations. We had 117 inpatient rehab locations, representing 7,526 beds. 203 outpatient surgery centers and four medical centers, representing 925 beds and 127 diagnostic centers. Total of 1,680 facilities. We closed, consolidated or sold 123 locations in the quarter. 108 outpatient centers, ten diagnostic centers, five ambulatory surgery centers, and three inpatient units that were closed. And we opened 11 new sites.

Our surgery center growth initiatives continued. We added 276 new physician partners in '02. We’ve added 869 new partners under this initiative, and we had 844 at the end of the year. We should exceed our 1,000 by the end of this year. The result is that we've had ten consecutive quarters of same-store growth.

Now, I'd like to go through in detail our fourth quarter charge. We had a restructuring charge of $255m. We closed 123 locations; only $60m of that charge was in cash. AR, we had a $176m charge due to our valuation of our AR and our change from cost reporting to PPS. FAS 144 charge, $56m, a write-down of tangible assets due to reduction in cash flow. The FAS 142 charge was $81m, a write-down of intangible assets due to the future cash flows and the impact of Transmittal 1753. We had a miscellaneous one time charge of $72m. Total one-time charges was $640m.

I'd like to also mention that our corporate governance initiatives continue. National search for additional independent directors. We have candidates to be in place hopefully by the annual meeting of stock holders. We believe that will happen. We've established a nominating corporate governance committee with outstanding advisers which we've announce who they were and feel very good about the committee and the work that they're doing. We've hired two outstanding search firms that are processing the candidates that the board will be reviewing, and we also are completing the new corporate governance guidelines that will be announced soon. We did complete the new charter and that announcement was made. We believe that from a governance standpoint, our committee is working very hard and is doing all the things that is expected out of us. And we have some very positive announcements coming forth in the near future, hopefully by the middle to the end of March, we will have the new directors announced, should have them lined up to come on board.

So summary of our fourth quarter results. I believe that this closes a very difficult chapter in HealthSouth's history. We believe that this fourth quarter results represent a bottom from which we can grow and produce positive results.

As we look at our guidance for '03, I'd like to walk you through a reconciliation of how you get from fourth quarter actual to the first quarter, '03, guidance. Because the guidance for first quarter of '03 is 13 cents. Of course, we had a 5 cent fourth quarter. If we look at the one-time fourth quarter '02 expenses, the surgery separation audit fees, legal and consulting fees, and miscellaneous expenses, that was about 3 cents. That would be added to the 5 cents. Sources for additional first quarter, '03, pickup would be layoff of employees, employees that we cut, elimination of expenses, overhead, closed underperforming facilities and our better than budgeted top line growth represent around a nickel. That totals you up to about 13 cents. I think it's important to mention that if you take fourth quarter, both the operating expenses and you take our GNA and you annualize those, from those numbers that you get, we have made reductions in field operations of around $267m through that -- if you do that analysis. And between $30-40m in corporate G&A, which would show that we've made a reduction of well over $300m in cuts that would reduce our expenses in '03. That bring you in line and bring us in line to achieve our guidance numbers that we have out there. So we feel very comfortable with the 13 cents guidance for the first quarter.

Let me mention a few things that also make us feel extremely positive about the first quarter. Inpatient rehab, our revenues were above budget, substantially in the 2003 first -- January. January discharges were increased 10% over January, '02, discharges. Surgery centers, revenues again were on target and slightly above budget. January cases were 3% over budget. Pricing was 1% over budget. So we're coming out of the chute we believe with some very good successes that show that we've bottomed out in December and in the fourth quarter. Outpatient rehab revenues, again were slightly over budget. January revenues. Referrals per day in January were up 2% over fourth quarter. January volumes exceeded budget by 2%. Diagnostic revenues also exceeded budget and January volumes exceeded budget by 5%. We do know our diagnostic volume is coming back and we believe that our revenues are going to come back in that area over where they were in that fourth quarter, which we think was our worst quarter. Same for outpatient rehab. So we want to reiterate that the EPS guidance of 55 cents for 2003 still looks like a very good number for us.

I'd like to take just a moment to talk about fourth quarter CAPEX and I like to give you the details. We have a lot of questions on the details of our CAPEX. So I'd like to walk you through that. There have been questions about whether or not we were going to sell some of our airplanes. Our airplanes are important and we do have a large number of facilities. We're based out of Birmingham, Alabama, and in order to fly our management team around the country, it takes several airplanes to do that. We keep people traveling, California to New York to, you know, Florida and throughout the Midwest and we have huge operation in Anchorage, Alaska and in Hawaii and throughout every state, all 50 states, every major city. And we have people on the road all the time. It's essential that we're able to cover the large number of facilities that we have. So it does require some aircraft to do that. We did buy four of our airplanes out of their leases so we spent $20m getting those planes out of their leases and we have put them up for sale. And in these difficult times we believe it's time that we need to keep our costs down and be focused on bottom line. That allows us some airplanes that we can make sure that we continue to try and do the best we can to serve, but we will be putting people on commercial in many cases, going forward.

Digital hospital cost us $36m. Our new hospital for the quarter. Our new inpatient development in Tetton Falls, New Jersey, Spring Hill, Florida, Anderson, South Carolina, Tuscon, California, and [inaudible], Arizona, along with two L tax in New Jersey and Louisiana cost us $17m.

We had to buy a new system to replace our med net system in our inpatient operations so our new connectivity costs were $7m. Our inpatient bed additions in Sunrise, Florida, cost us $2m. We had several relocations in our outpatient area. Grapevine, Texas, Dallas, Texas, Great Neck, New York, and Hagerstown, Maryland. We spent over a $.5m in relocation expenses there.

Our surgery development, [inaudible], Florida, Norwalk, Connecticut and Portland, Oregon, our now facilities and our relocations in San Antonio, Texas, Greensboro, North Carolina, St. Cloud, Minnesota and Dansbury, Connecticut cost us $7m, all combined. MRI and CT purchases this quarter were $6m. Maintenance purchases for maintenance, lease hold improvements, replacement equipment, surgical instruments ran $28.5m. The total is about $120 to $126m that we spent in the fourth quarter. And those are the details to support that by area. I think that's important, because as we look at our projections for the year, our CAPEX guidance that we've given you is $400m.

Let me give you how that breaks out. It shows in the fourth quarter that we're able to bring that down. If we took the airplane where we bought those airplanes out of the lease, so that we could sell them and they have been placed on the market and we have already sold one and believe we have another one fixing to move. Put that back, you can see we're right on target with a $400m number. We committed $70m, we've already committed $70m in inpatient hospitals and surgery centers that are under construction today. The $70m in that number. New development for this year, we anticipated would be about $55m. Our maintenance CAPEX is going to run around $120, $125m, and what has made that a little higher is that we're -- we're having to spend $10m on a HIPA software program to be in compliance with HIPA. And $20m is being spent in our ADA compliance. So to get in line with all of the issues relative to ADA and making sure our facilities are in line 100%, there's some additional work that has to be done there.

So if you took those out, you could see that that would bring our maintenance CAPEX down under $100m and we think we can get that done, hopefully, we can continue to bring down that area. So the new hospital, we have about $150m scheduled to spend this year, which brings us to a total of $400m. We're committed to that number and feel good about it.

Actual January and estimated February numbers, actually, were only about $50m. So that run rate brings us well under the $400m for the year. We feel very good that our guidance is in line and we should not exceed the $400m for the CAPEX in '03. I think it's important that, you know, to discuss pricing and contracting for a moment.

Our company is very focused in the pricing and contracting area. We have trained all of our people now, they've been into our headquarters, additional training took place in the fourth quarter and we believe that our people are ready. We believe that our pricing will tick up this year because of that, and our people understand we have placed some new floors in certain areas. We have eliminated and will eliminate contracts that are non-profitable. And we will be on top of our renewals and make sure that we're at least getting our cost of living increases in there, which are extremely important.

We also believe that our sales and operating team are in position and trained as well to increase through-put to overcome the effects of the Transmittal 1753. January and February are an indication that that training is in fact, paying off. We believe that -- and that's an indication of some very promising things to come. We believe that. We think that, again, you should focus on the reductions that we have made, as I mentioned, well over $300m in expense reductions that we've put into place that will be effective this year, that as you look back at fourth quarter, all of those -- the effect of those cuts was not in the numbers in fourth quarter. And as well as the cuts in G&A.

2003, we believe, will be a comeback year for the company. We're rebuilding our relationships, we are closing underperforming facilities. We've added incentives to our marketing team, our sales team, our pricing and contracting team. We've cut our expenses substantially. We've added programs aimed directly at the consumers. We're very focused on programs that are highly profitable, like our stroke program and we're focused on maintaining our leadership role in all of our business lines. And we also are extremely focused on the return on capital and return and we're very focused on building shareholder value, as well as making sure that we do all the things that we need to be doing in the area of corporate governance.

Now, with that, I'd like to ask -- we're going to jump to our attorney, I'm going to ask him to read our forward-looking statements. Let me just say, that, you know this company is a great company with very high quality assets. This management team is very strong and extremely experienced and is in place and is running very hard to overcome what was a very difficult fourth quarter and a very difficult last six months. The company has ample liquidity to perform and do the things it has to do in order to build this business and bring it back from where we were this last six months. We do have a very strong and sound balance sheet. And we certainly are a very focused on increasing, as I said the return on capital and bringing these volumes back and getting our pricing where it needs to be. With that, I'd like to ask Bill Horton to read or forward-looking statement before we go to questions.

Thank you Richard. Some of the matters discussed in this conference call or in the accompanying press release may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21A of the Securities Exchange Act of 1934. Some of these forward looking statements may be identified by the use of forward-looking terminology such as believes, expects, may, will, should, seeks, approximately intends, plans, estimates or anticipates or other comparable terminology or the negative of those terms or by discussions of strategy plans or intentions. These forward looking statements are necessarily estimates based upon current information and involve a number of risks and uncertainties. There can be no assurance that other factors will not affect the accuracy of such forward-looking statements. While it's impossible to identify all such factors, some factors which could cause actual results to differ materially from those currently estimated by us include but are not limited to competitive pressures in the healthcare industry and our response thereto. Changes in reimbursement policy by government and third party payers. Unanticipated 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 our other public announcements to which you should refer for further information.

Thank you, Bill, we'll be glad, operator, to go to questions at this time.

Ladies and gentlemen if you wish to ask a question, please press one on your touch tone phone. You'll hear a tone indicating you've been placed in queue. You can remove yourself from queue at any time by pressing the pound key. If you're on a speaker phone, please pick up your hand set before asking your question. Our first question is coming from the line of Frank Morgan from Jefferies and Company. Please go ahead.

Good morning. Two questions. Can you tell us cash flow from operations in the fourth quarter? You've done a good job explaining how the effect of the cost cuts wasn't really reflected fully in the fourth quarter number. Could you give us general guidance in terms of the kind of margin or either just dollar EBITDA that we may see in the first quarter to get to this 13 cents? And then kind of conceptually, across the course of the year, should it just be generally a slow, sequential ramp-up in margins or what will that look like? Thanks.

Frank, this is Bill. On cash flow from operations, we're not ready to release that number today. As would be expected with all the unusual things that are in this press release, our auditors have been very focused on some of these items, and there are a couple of little things not finished yet that we're not comfortable with all of the information related that has to come to get cash flow from operations. So that is a number we'll have in the next week or so, but we don't have it available today. From a projection standpoint, Malcolm, why don't you take that in light of our press release that we made in December on current year guidance, and answer Frank's questions there.

Sure. Frank, we're projecting for the first quarter of '03, EBITDA should come in the range of $253m. We would then expect a sequential ramp-up to end the year in compliance with our guidance, which would be EBITDA between $1.55b and $1.60b for the year.

Okay, any other information you can share with us in regard to balance sheet information?

We can tell you, it's still a little preliminary. It looks like debt declined about $5m. That being the result of our line of credit ticking up $5m sequentially. But we bought back $10m of converts as a discount. Debt declined $5m. It would appears that cash, on a sequential basis, it increased and I cannot give you the range of the increase, but it did increase.

Thank you.

And like I said, Frank, we'll have that information in just a few days. It's just a few ticking and tying that the auditors want to do before we release that.

Thank you.

Thank you. Next question?

Our next question comes from the line of Howard Capek from UBS Warburg, please go ahead.

Good morning. I was wondering if we could focus on the AR charges in the cash portion and the like. A few pieces. One, can you go over inpatient versus outpatient? On the inpatient side, if it's kind of cost report related, is there an explanation why, if it's over 365 days, it wasn't already 100% reserve for? On the outpatient side if you could kind of walk through the timing and the period fourth quarter taking a charge against revenue and just explain it a little bit better?

Glad to, Howard. Once again this is Bill. There's two components of the of the AR charge. On the retros, which was $65.8m, that all relates to inpatient rehab. And that's simply a change in estimates. We have a model internally that estimates our cost report settlement or our cost report settlements for internal projections. And those cost reports don't get filed for nine to ten months later. Each year, during cost Reimbursements those, you know, we've estimated and adjusted down to actual filings. And our model was such that, you know, those worked themselves out every year between the, you know, the true up of the prior years and the estimate of the current year. However, this year, with going off of cost based reimbursement, and filing all of the final cost reports, you know, there is no true up in the current year of the model. So it just, everything that's out there has just fallen out. It is -- I mean, it's not a valuation of AR. It is our open cost reports and what we expect now based on all the information we have after having filed all those final cost reports. The reimbursement that we'll receive on those. So, you know, it's not a matter of valuing individual accounts that were over 365 days old. It is settlements on cost reports that date for several open periods, not only terminating cost reports, but other open cost reports that are still out there being settled. And, you know, that information being booked in the fourth quarter, we did not get all of our cost reports filed until very late in the year and the information in this year was a year in which the forms and the reports were not available until late. We filed them all by the deadlines, and that information, pulling all those together, was not available to us in the fourth quarter. So it's properly booked as a change in an estimate in the quarter in which the information was available to us.

On the AR charge of $110m we go through a detailed analysis at the end of every year as a part of our audit. It's a standard process, we've been through year after year after year. This year, when we went through that process at the end of the year, it showed that based on the information available to us, that our reserves appeared to be under to the tune of, you know, around $100m. As we researched that and went back and we applied the procedures that we always apply at the end of every quarter, which are analytical procedures that did not drive us to do more detailed work and we went back and did the detailed work, it revealed that this is truly a fourth quarter issue, and, you know, that our reserves had dropped significantly in the fourth quarter, driven primarily by increased collections and so it was, you know, we're very comfortable and Ernst and Young has that done the work to be very comfortable, this is a change in estimate. The reality is we have, based on the information we now have available to us, we realize that the valuation of some of our older accounts was not conservative enough, and we are upping that valuation, and it's properly booked in the fourth quarter, because that is the quarter in which the, you know, the changes in the reserves occurred, and the information, the updated information based on enhanced collections, better systems have made available to us. Hopefully, that clears that up for you.

Okay. And if I could follow it, do these charges have any impact or are they going to trigger any covenant issues with any of your debt?

Malcolm, why don't you cover that?

Absolutely, there are no issues with any of our public debt on the bank side. Clearly, we've had -- we've had warning that this situation was coming with the charges. We've been in conversation with our banks. We're in the process right now, just from an abundance of caution, of working through the amendment process, which I believe will close in the very near future. I do want to reiterate, we are not currently in default on any issue with the banks.

Thanks.

William Owens Thank you, Howard. Next question?

The next question comes from the line of Gary Taylor at Banc of America. Please go ahead.

Good morning. Couple questions. Can you give us the net AR on the balance sheet? Is that available yet?

Malcolm?

Yes, AR balance is $1b.

That's gross, Malcolm. You need net.

$828m. $828.4, in that range.

Okay. Second question is, and I assume that this is built into your first quarter guidance, but you will anniversary the PPS change on the inpatient side and year-to-date over the old cost system you've been running up about 6% or 7% per discharge. Any thought on what your Medicare rates will look like year over year for the first quarter?

Malcolm, we did release pricing in our release of our estimates for 2003, didn't we?

Yes, we did. It's in that press release.

Gary, we are comfortable with those numbers. I apologize. I don't have those in front of me. But the -- we have included our projections for next year where we believe pricing will go, which, you know, I think is pretty -- is stabilized for inpatient, a slight increase. You have to remember, we have had impacts of Transmittal 1753 in our outpatient business of our rehab hospitals, which has kept us from being able to grow that pricing any more.

And that's in the release that's out today? Is that right?

No, that was in our release that we put out in December when we did our guidance for '03. It's got pricing by product line in it.

Okay. I'll revisit that. The other question I had was, can you just help on this kind of bridge between the fourth quarter and the first quarter? Richard mentioned three cents associated with the ASCs, which I saw there were two ASC charges that were excluded from the five cents. So I was a little confused how that comes back to you.

If you look at things that hit our operating expenses during the quarter, we had a substantial expense for attorneys, consultants, related to the litigation and the -- and the SEC investigation. That totaled, you know, in the neighborhood of $6m. We had $2.6m, which is the ASC issue that was discussed. Audit and tax fees associated with the spin of the surgery centers that we called off, but we'd done all that work and we had to pay all those. And then just various other miscellaneous --

Which was several million dollars.

So you take all of those, and so the three cents is taking all of those things that hit the fourth quarter, which are part of our operating costs, but are not things that will repeat in the first quarter. And so if you normalize those fourth quarter earnings into a repeatable basis, you go from five cents to eight cents. Then what our challenge as a company is growing from that 8 cents to the 13 cents that is projected in the first quarter, which is what Richard was talking through the elimination of physicians, substantial reduction in costs across-the-board that we're projecting this year. $300m for the year off our fourth quarter run rate, which, you know, is about $75m a quarter. Reduction in costs if you just take the $300 and divide it by four. And then, you know, we do -- if January's able to repeat itself for the other two months of the quarter, we did beat our volume budgets across all of our product lines for the month of January. So that's how we get to, you know, it's primarily through realizing those cost reductions that we began implementing in the fourth quarter, and, you know, realizing those throughout the year.

Let me give a little more color on that too. Very good question. We went through extensive training on how to deal with the 1753 situation, and, of course, we had some very conservative things happening in the field. Dan Riviere is in here with our outpatient business. One of the problems we had immediately was that all our coding shifted to the more conservative approach of group therapy and coding and treating one patient at a time. And we've been through extensive training. We brought in a medical director of a major payer and let him speak to our people about how that major payer wanted to -- wanted us to code his patients as well as, you know, in the charting and how to practice on those patients. And as we have met with all the major payers and we found that literally nobody is going to follow the Transmittal 1753 rule. However we had a lot of our people coding as if all of these patients were in the Medicare category. We went through extensive training in the last quarter to convert that back to where it needed to be and that was to make sure all of the Medicare coding is done appropriately and right in line with 1753, which it is. And we're in 100% compliance with 1753. But there was no reason to code other patients that shouldn't have fallen into that category the way that many of our therapists were coding. That has been converted and we're seeing that come back now in January and February that's making a major impact. You'll see the increased volume as well as the pricing going up because of that and you’ll see the increased revenue. Add that back in and that puts us back in line where we need to be in order to achieve the numbers we have for guidance. We're already seeing that in January. We were in a training mode in the last quarter, you know. This hit us in summer of August, late August. We worked very hard in September October, November and December to get us back on track. We knew it would take several months. That's not an excuse. That's a reality. And so we feel that we put it on track now and we're seeing the results. So that's sort of how you get there. I know that's a lot of conversation, but it's worth talking about.

Great. I just want to confirm. When you said CAPEX for '03, $400m total CAPEX for '03 did I get that right?

That's right.

Last question, on the inpatient rehab side, you had about $495m in revenues in the quarter. Could you approximately break out how much is inpatient revenue versus outpatient? Is it 80/20? Any way to roughly give us that number?

Gary we don't have that number in front of us, and the problem with doing that is that our contractual, we can break it out on the gross revenue side, but we do not break out contractual adjustments between inpatient and outpatient, so it is not a number we've made public in the past. It's not something I have in front of me. We need to look at it. To do the net revenue side, it would require some estimation. Gross revenue is doable. We just don't have it in front of us. If we can get that and discuss that offline, I'd appreciate it.

Okay. Thanks.

Okay. Thank you. Next question?

Once again a reminder, press 1 if you do have a question. Next, we go to the line of Angie Samfilippo at Piper Jaffray, please go ahead.

We're going to take Angie and then we have time, I think, for one more. Go ahead, Angie.

Good morning, guys. Could you just tell us whether or not you expect any more charges going into 2003 or do you feel that your books have been scrubbed at this point?

We believe the deck's been cleaned and scrubbed and we do not anticipate any additional charge this year.

Okay. Your minority interests as a percent of revenue continues to increase. One of the obvious explanations could be that maybe you're having to pay your surgery center doctors a little bit more. Is that fair?

Actually, Angie, our minority interests comes from our surgery center division and our inpatient division. We don't have a lot of minority interest in inpatient, but as you look at our business, our declines in our business have come from physical therapy and from diagnostics, which has little, if any, minority interests. So it's really if you're comparing it as a percent of revenue, it's because of declines in parts of the business and the revenue that do not have minority interest associated with it. So it's not an indication that we're having to pay our partners more. I mean, those are -- those are just based on the cash flow and their relative ownership.

And the partnerships we have on the rehab hospitals are, you know, we have a joint venture with major -- with several major tertiary care hospitals we've joint ventured with them on those hospitals.

Perfect. My last question, Richard, you had just said you're not experiencing pushback from some managed care clients regarding the Medicare transmittal. I was just wondering if you could reiterate that, maybe expand on what you're seeing in terms of managed care pricing and how it relates to the Medicare transmittal?

Absolutely. Bill has been very involved as well as Dan and some of the others in the room here in meeting with the payers and making sure that, in fact, we were doing everything that they wanted us to do. I think we've met with the majority of the large payers and have had outstanding conversations. Bill, you want to give a little --

We have gone out and met with all of our major payers, explained to them what it is we do, taken several of them to our sites and let them, you know, witness firsthand what we're talking about in our concurrent therapy model. All our payers have said they concur that our prices that have been set with them have been based on that model, and that they do not expect us to follow the guidelines that Medicare set down through Transmittal 1753. We have contracts with all of our payers. It describes what we can and cannot do. We're in compliance with all of those contracts. So from a pricing standpoint, we are, you know, negotiating with payers for pricing. And, you know, that's just the normal process that we go through. Has really nothing to do with the coding of therapy.

A couple of things. I'd like to comment on, first of all, on our contracts, the biggest challenge we have, again is making sure that our people are there when those contracts come up for renewal and that they're sitting at the table having conversations with the payers. And the problem is that with over 4,000 contracts, it's a challenge to make sure that they don't auto renew and that, in fact, we get the appropriate cost of living increases and other things that one has to have in order to keep your, you know, keep from bringing your profits down. So it's training our people, it's systems that notify them 120 days before a contract comes available or is, you know, the renewal opportunity is there for us to sit and discuss with them. What we might be able to do to work with the payer. In a way that encourages them to continue to do business with us. But as they've had to have increases from their customers in order to survive, we have to have increases as well in order to cover our cost of living and those have to be negotiated in and we have to make sure that that happens.

The other issue is some of those contracts that we got stuck with came from some of the other acquisitions that we made. They burned us pretty good, because they had negotiated rates that were lower than our costs in some cases and too low in other cases and just not competitive with the market. We've been working out of those contracts, all of our people, again, have been trained and are skilled to go out and make sure that every contract we have that is too low, because either we got it from, you know, from an acquisition or someone signed that contract back several years ago and we've been unable to get it increased, that those people are put on notice that we can no longer operate with contracts that are not making money. One of the things that Bill said I think, is very important, is that the payers understand that our costs, in the negotiations that we had with them in the contracts were based on what our current costs were at the time and that's the way we're negotiating contracts today. In the Medicare situation, our costs were brought down -- our costs were where they were and the pricing that we had based on Medicare pricing prior to the Transmittal 1753 was based on where our costs were. When we shifted to 1753, our costs continued to be, you know, where they were, based -- and the pricing that they eliminated when they went to 1753. So there was a very unfair situation there. And that's our biggest complaint with the way that was handled. And our goal is, over time, to see things improve. And we're doing everything we can in terms of the way we're treating patients, we’re rescheduling patients to, in fact, overcome that. I think we’re making major progress. It certainly does create an incentive to try and move your mix to more of the commercial and more of the managed care patients.

Thank you very much.

Thank you.

Final question comes from the line of -- just one moment. Comes from the line of Anker Gandhi (ph) from Goldman Sachs, please go ahead.

A couple questions. First of all, coming back to the AR issue, can you clarify for us in terms of the change in AR reserve, what proportion of that relates to outpatient therapy?

Malcolm, do you have that? I don't have that information in front of me, Malcolm do you have it in front of you?

I don't. I can get that back to you shortly.

Okay.

I might mention we're in two separate rooms here. That's two separate cities with this call. So we're not -- because of different commitments we had to make. So that's -- we're not looking at each other here. Sorry for that.

That's all right. Maybe if you have it handy, what percentage of that was Medicare receivables if you have that handy, or I could get both of those after the call from you.

The 65 on retros is all Medicare. The other, because of the way we go through the analysis, will take some work to -- it's not a number that we have available to us. It's not that I don't have it in front of me. The overall evaluation in breaking that down into its buckets has not -- is not complete. We've got it at a global but we don't have it broken down by payer. So that one, will take a little time. We will have that, but we don't have it today. The -- by product line, we'll be able to get to you offline.

Great. Also, when we were visiting you about two weeks ago, Bill and Richard, you mentioned that you'd be meeting with the SEC soon. Have you had that meeting yet? Number one. Number two, regards to them launching a formal investigation how does that tie in to, if at all, the results of the investigation, the independent investigation that you guys conducted which showed you know, that everything internally was fine and in compliance?

Well, I think it's a good question. Bill, do you want to comment on that?

Sure. Anker, we have continued, as we've said, in our public statements to cooperate with the SEC in terms of information they have requested. That's an ongoing process. These things, you know, do not tend to move on any particular predictable schedule. We continue to feel good that because we went through this extensive process this fall with our own internal investigation, which was a very thorough, very intense process, you know, that we have a good command of the facts. We know, you know, we have documents that the SEC has requested that, you know, we have already gathered and assembled, which has enabled us to be responsive. And we continue, as I said, to be prepared to cooperate and provide whatever information, whether it's, you know, whether it's documents or interviews or testimony that we have to provide or whatever they ask us for. And as I said, we feel like we're, you know, in a position, having done a good bit of work this fall on our own internal investigation, which we initiated, you know, before we heard anything from the SEC that we have a pretty good command of what's out there to give them and what documents are there to produce.

Let me make a quick comment, Bill, if I could add to that Anker. Our Board of Directors, I think, was very astute in requiring an outside, independent law firm, who we'd never used, to come in and ask all the management to move out of their offices as they gathered all their files, all their computers, imaged everything that they had, went through all of their e-mails and then gathered all that up. All of that has been made available to the SEC and will be turned over as requested. And there will be full cooperation from our company to the SEC in any and everything that they ask us to do. Meetings have all been scheduled with the senior management. Those meetings start taking place over the next couple weeks and we're looking forward to putting this behind us. We'll cooperate fully, again giving them everything. I think it was astute on the Board’s behalf to do the study, do the investigation and gather all the data and information so they knew exactly what would be found. We did invite the SEC in. We're there to do whatever we need to do. We do not believe the company has done anything. For that reason, our Board now knows and has gathered every document and looked in everything that was there, in every file, in every memo, every communication that took place. All senior officers and others that were involved in this case have been investigated and have been interviewed and that information was gathered, has been presented to our board by an outside investigating firm. So we feel extremely comfortable that we know exactly what is there, and again, we'll fully cooperate in every way with the authorities.

And to date, none of the senior management has met with the SEC?

No, I think we start meeting in a couple of weeks.

Okay. And then last question, if I may. You also took a $19m reserve for contractual, unfunded contractual retirement benefits. What are they for? Are they for a particular group of people? Give us come clarity on that.

The majority of that is, in fact, there were five founders -- several founders of the company that fell into a -- had a retirement contract that -- and we do have a founder that has retired and is out there, has been retired for several years. And because of those contracts, nothing had been accrued. We had not even thought about accruing for those. As I guess the auditors reviewed that, Bill, they said you need to accrue for these.

Right.

And there's only one retired founder out there, and he had, you know, M.S. and had to retire. Dr. Tony Tanner and he's receiving retirement pay for that. That's what that is. He receives that until he's, I think, 65 or something. He's in his mid to late 50s now.

So is any of that cash, or --

Yeah, it's cash.

The whole thing is cash?

Yeah. It's paying him a percentage of his salary. But only to the founders. There was a handful of people that fell in that category. It's very limited. But anyways --

Oh, I see, okay.

It cleaned up something that needed to be done.

Okay. Great. Thank you.

Thank you. Okay. I want to thank everyone for being on the call, and we appreciate your support, and we hope we've answered the questions that you might have and we feel, again, very good about where the company's going and we feel good about the strength of the company and, you know, our 50-plus thousand employees are focused on what we need to be doing and we look forward to next quarter, first quarter results and reports on the first quarter. Thank you.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.