Encompass Health Corp (EHC) 2006 Q1 法說會逐字稿

Good afternoon everyone, and welcome to the HealthSouth first quarter 2006 conference call. At this time, I would like to inform all participants that your lines will be in a listen-only mode. After the speakers remarks there will be a question and answer session. [OPERATOR INSTRUCTIONS]

Today's conference call is being recorded. Your participation implies consent to our recording this call. If you have any objections, you may disconnect at this time. I would now like the turn the call over to your first speaker, Mr. Jay Grinney, HealthSouth's President and Chief Executive Officer. Please go ahead, sir.

Thank you, Angie. Good afternoon, everyone. Thank you for joining this HealthSouth conference call. The purpose of today's calls is to review the results of the Company's first quarter as found in our recently filed Form 10-Q. With me here today are members of our senior management team, including Mike Snow, our Chief Operating Officer, John Workman, our Chief Financial Officer, Greg Doody, our General Counsel, and our four Division Presidents, Mark Tarr form Inpatient, Joe Clark from Surgery, Diane Munson from Outpatient, and Greg Brophy from Diagnostic.

Before we begin the call, I would like to comment on the timing of this call, since I know it has caused some undue concern among some of you today. When we originally scheduled the call, we were uncertain of the exact timing of our filing. To be conservative we scheduled it in the afternoon. On a go-forward basis our plan will be to report and file on a normal schedule, which will include morning calls, and we should be able to achieve this no later than the third quarter of this year, sooner if at all possible.

With that I would like to ask Greg Doody to review some cautionary statements.

Thanks, Jay. There are a number of disclaimers and other cautionary statements set forth in the Form 10-Q that we filed with the Securities & Exchange Commission this morning, and in the Form 10-K we filed with the SEC on March 29, 2006. We will not review those disclaimers and other cautionary statements, however, we urge you to read each of them carefully. I would however, like to highlight the following.

The financial statement and is other information contained in the first quarter Form 10-Q are unaudited. HealthSouth's results for the period shown in the form 10-Q and discussed in today's presentation, are not necessarily indicative of operating results for other or future periods.

The information contained in our presentation may include certain estimates and other forward-looking information that reflect our current views with respect to future events and financial performance. Estimates are based on numerous assumptions and involve a number of risks and uncertainties, including those set forth in the first quarter Form 10-Q, and in other documents that we previously filed with the SEC. Many of which are beyond our control.

The estimates in the presentation are based on assumptions which HealthSouth believes are reasonable. However, there can be no assurance that any of these estimates will be realized. We undertake no duty to publicly update or revise the information contained in our presentation. You are cautioned not to place undue reliance on the estimates and other forward-looking information contained in the presentation. I also note the following with respect to certain financial information.

The financial information contained in the presentation includes non-GAAP financial measures, including consolidated adjusted EBITDA, which should not be considered as a measure of financial performance under Generally Accepted Accounting Principles. We use consolidated adjusted EBITDA to assess our operating performance, and believe it is an important measure of our operating performance, our leveraged capacity, our ability to service our debt, and our ability to make capital expenditures.

For a discussion of consolidated adjusted EBITDA, please refer to the first quarter Form 10-Q, and the 2005 Form 10-K. The classification of certain restructuring charges and expenses used to calculate consolidated adjusted EBITDA is not in accordance with GAAP, and our actual financial reports include, and will continue to include these costs.

With that, I will turn it back over to Jay.

Thank you, Greg. The filing of our Form 10-Q for the three months ended March 31, 2006, is a first 10-Q the Company has filed on a timely basis since the third quarter of 2002. As such, it is a very tangible sign of the recovery and turnaround of HealthSouth. Our accounting and financial teams have worked very hard to produce this filing, and I want to thank all of them for their outstanding efforts. This 10-Q also represents the first time the new management team has been in a position to provide prior year comparisons.

I want to note that the 2005 Q1 data will vary from the preliminary information we provided you last year at our June 29th update meeting. Let me begin by characterizing the quarter and the performance of our divisions, then I will ask John to provide additional financial information for the quarter. I will come back and provide some comments on the regulatory and reimbursement environment, and will share my thoughts on how we see the year shaping up and what we believe are the most appropriate benchmarks to use, to measure our long-term success. Finally we will open up for questions.

Overall the first quarter's results were in-line with management's expectations. Our two largest segments, Inpatient and Surgery which on a combined basis represent 82% of our revenues, and 95% of our operating earnings had satisfactory quarters, while our two smaller segments, Outpatient and Diagnostic experienced a variety of operational challenges. The Company's first quarter net patient revenues were approximately $792 million, down 56.6 million from a year ago. This revenue decline can be attributed primarily to less than anticipated volumes in all segments.

Let me give you a little more color on some of these major drivers. In Inpatient, we continued to see declines as more of our hospitals migrate to the 60% compliance threshold. Although the 75% rule continues to be a challenge for the industry, I am pleased to report that our compliance case volumes grew approximately 6% in the quarter. A strong indicator that HealthSouth's superior operating model continues to allow us to gain market share in the communities we serve. Additionally, our entire Inpatient portfolio's average is currently above 60%, and we remain confident in our ability to attract compliant cases.

Finally, as noted on the conference calls of some acute care companies, first quarter acute care admissions were weak in select markets. Since we are dependent on these up-stream volumes for our admissions, this factor also contributed to some of the decline in our inpatient revenue.

In Surgery, we reclassified two surgery centers in the first quarter, that became equity method investments rather than consolidated entities. We also closed nine centers in the second, third and fourth quarters of 2005, at the same time we eliminated certain low margin cases. These factors contributed to this division's reduced case load, and correspondingly lower net revenues.

Our two smallest segments continue to see volume erosion, due to competition from position-owned centers, and the impact of recently enacted Medicare changes. Although our Inpatient segments net revenues declined, we mitigated some of this shortfall, with continued discipline management of our expenses, which is reflected in this division's solid operating margins. As I mentioned previously, this is the first time we've been able to provide quarterized '05 data. It needs to be noted that our Inpatient division had a larger proportion of charges in the first quarter of 2005, than did our other divisions.

For example, in the area of fixed assets, the Inpatient division took charges in Q1 of '05, as part of the unwind of the Braintree Woburn facilities. This makes for better year-over-year comparisons in the first quarter, than what we anticipate in subsequent quarters. We also are seeing operational improvements in our second largest segment, the Surgery center's division. As we have previously record, the recent indication of our surgery centers has provided our physician partners with the opportunity to increase their percentage ownership of these centers. This shift is consistent with national trends.

Accordingly, our operating earnings margins after minority interest and equity and net income of non-consolidated affiliates declined in the quarter, compared to the first quarter of 2005. However, operating earning margins before MI, and net income from non-consolidated affiliates actually increased 140 basis points in the quarter, to 21.2% of net operating revenues, from 19.8% for the same period in 2005. This demonstrates that we are beginning to see some positive traction from the actions we have taken to improve the performance of this segment.

And we look forward to continued operational improvement in this division throughout 2006, and into subsequent years as we execute on standardizing our labor management and supply chain initiatives. Importantly, we also anticipate seeing year-over-year same-store growth in the Surgery center's division by the second half of 2006.

As I mentioned previously, our two smallest segments, which let me remind you again together contribute only 5% of our operating earnings, faced significant challenges in the first quarter. Our Outpatient volumes were down 15% compared to the first quarter of 2005, due to three factors, one, the closure of underperforming facilities, two, the impact of the Medicare therapy caps, which limits Medicare beneficiaries access to outpatient physical therapy care; and three, continued competition from physicians bringing this service into their practices.

The Diagnostic division, the Company's smallest division, experienced continued competition from physician-owned diagnostic equipment, as well as increased restrictions on utilization. As we have reported in the past, the division has suffered from poor billing and collection systems for several years, and continues to struggle with nine different legacy computer systems in the field that are not integrated.

While we are in the process of implementing a new enterprise-wide information system for the Diagnostic division, that implementation has not proceeded in an acceptable manner. This misstep is causing AR and cash collection issues for the division, which caused us to take additional expenses in the quarter.

Accordingly we have replaced the Division's senior management team, and our new team headed by Greg Brophy and Greg Eisenhower as it's CFO, is aggressively tackling these issues, and we're already seeing some positive results from their strong and capable leadership. Finally, we identified 16 underperforming facilities for either closure or divesture, which will improve the segment's performance, and allow to us redeploy some imaging equipment to our remaining facilities.

Because of these operational issues, which are now being properly addressed by the new management team, we have decided to delay the possible divesture of this division. We believe our shareholders will be better served, if we first address and fix these IT system implementation problems before we seek a potential buyer of these assets.

With that brief overview, I would like to ask John Workman to provide a summary of the highlights from our 10-Q.

Thank you, Jay. As Jay said, I am also pleased with the fact we have filed our first quarter 10-Q, and want to thank those in operations and the corporate office that allowed us to accomplish this. First, I want to make some comments on the income statement. There are several items of note that I want to mention. Relative to the first quarter of 2006, these are really all new events that occurred in the first quarter of 2006.

First, we incurred $361 million of expense in our recapitalization. To remind everyone, these were primarily tender costs as most of the debt we inherited was not prepayable, and also prior financing costs related to debts or consents while the interim management team was in place. I will talk a little bit more about the refinancing later.

Secondly, as part of the new debt issuance, we entered into a $2 billion swap on our term loan. We are not accounting for this as a hedge, and had a $3.8 million charge from the swap in the first quarter.

Thirdly, we also incurred approximately $4.3 million of non-cash expense related to the application of FASB Statement 123-R share-based accounting, and this is reflected in the line salaries and benefits in the P&L. None of these impacted adjusted consolidated EBITDA. Relative to the first quarter of 2005, remember this is the first time we have provided quarterly information for '05. In essence causing us to do both quarters and both years at the same time. It was subject to a review of all items during the year, including year end adjustments and amounts were reflected in the appropriate quarter. As a consequence, amounts may be different than our previous business updates which we told you they would be.

Having said that, some items of note are a $215 million non-cash charge related to the proposed settlement of securities claims. As a reminder, this amount is reflected as a liability in our balance sheet but will be accounted for differently, for example, as equity once the shares and warrants are issued.

Secondly, relative to the first quarter of 2005, we had a credit or income of $30.5 million from the elimination of a reserve, when the leases related to the Braintree and Woburn facilities were terminated by the landlord. This reserve was established in 2001 for the excess lease payments on the Braintree Woburn facilities. The lease arose from a transaction entered into by the prior management team, associated with exiting a group of nursing homes that were losing money. This credit is in the line Other operating expenses in '05. Offsetting this reserve elimination is the income that would have otherwise been recorded on the facilities, but this is excluded both in 2005 and '06 in the Inpatient division.

Thirdly, again, staying with the first quarter of '05, there is the recovery of equity of losses of approximately $6.9 million, that were previously charged against income and related to some of our non-consolidated subsidiaries. The most significant impact of this was in the Surgery and Inpatient divisions. These last two items that I mentioned, the 30.5 million and the 6.9 million benefited adjusted consolidated EBITDA by $37.4 million in the first quarter of 2005. Overall adjusted consolidated EBITDA still reflected a decline, even if you considered the 37.4 million of items I just mentioned.

However, I would point out that the first quarter of 2006 was in-line with our expectations as Jay said, and the first quarter of 2005 was a strong quarter, representing approximately one-third of the full year adjusted consolidated EBITDA. A few concluding comments on the income statement before moving on, first, volumes. While each segment reported declines, the rate of decline was less in the first quarter than in the full year of 2005 versus 2004 in three of our four segments. Relative to margin rates, two of our segments reported rate improvements, one a slight decline, and one a significant decline.

Lastly, relative to professional fees, I am reminding everybody that professional fees are expenses incurred, and are not necessarily expense in the year they are related to. They do show a slight decline in '06 versus '05 but again to acclimate everybody the cost in the first quarter of '06, primarily relate to the 2005 10-K whereas those in the first quarter of 2005 relate to the comprehensive 10-K filed for the years 2000 to 2003.

We also had costs in the second quarter of 2005 related to the comprehensive 10-K that was not filed until late June of '05. Further in 2005, there was immediately followed by this comprehensive K, the 2004 10-K filed in December of '05. So as we progress through the year, we should see a year-over-year improvement relative to the '05 compared to the '06 numbers.

Turn next turning to the balance sheet, which in the 10-Q is compared to the prior year, just to comment on a few of the changes in some of the captions. Cash and marketable securities are down due to the payments made out of Company funds as part of recapitalization, and the first quarter payment to the Department of Justice.

Secondly, accounts receivable, a slight increase but it is seasonal and comparable to our experience in prior years. Other long-term assets declined, primarily because of the write-off of deferred financing costs, that were related to the prior financings and were expensed as part of the recapitalization. Accounts payable declined as we paid the year end amounts due to consultants plus capital in the first quarter of '06.

Accrued expenses had a significant decline primarily related to the timing of payroll payments, and the accrued interest on the debt that was paid early. Normally our interest had a significant portion in the second and fourth quarter, but with the refinancing, this was all accelerated as part of the refinancing. Government and long-term obligations just were reduced by the payment of the first quarter amount.

Turning to cash flow from operations, besides shortfall in earnings, which was slight, there was an increase in receivables of about $13 million, a reduction in payables of $13 million, and a reduction of accrued expenses of about $46 million. All of these negatively impacted cash flow from operations. As I mentioned earlier, included the interest on debt paid early. If you total these three items, they total approximately $72 million, and are the primary drivers creating the negative cash flow from operating activities as profiled in the 10-Q. However, the negative change for operations was more than offset by favorable activity in investing and financing activities, and when all is combined, we had a $45 million less use of cash in this quarter compared to the prior year.

Next I would like to just talk about briefly liquidity and net debt. If you look at our total debt minus available cash and marketable securities, it is relatively flat in the first quarter of '06, versus the first quarter of '05. We did have a revolver that had $350 million that was unused at the first quarter of '06, compared to a $250 million unused amount at the first quarter of '05. We had $50 million of revolver drawings at the end of the first quarter of 2006. Since that time we have paid the revolver down by $25 million, leaving a $25 million amount outstanding as of now.

Last, we would like to talk about the recapitalization transaction. As mentioned and described in our 10-K and 10-Q, we refinanced virtually all of our debt in March 2006. This significant transaction allowed us to first take advantage of a strong lending market, second, align our covenants and restrictions more in-line with our business strategy, third, allow for a very significant portion of our debt to be prepayable. As Jay mentioned, one of our objectives is to reduce our debt by $1 billion by 2011 from a combination of operating cash flow and non-operating sources of cash. For example, our tax refund and potential derivative claims proceeds.

We expect our cash flow from operations to improve after 2007, once our settlement payments and professional fees are behind us. Fourth, the significance of the refinancing is to reduce the uncertainty of having to refinance significant maturities in the future.

As you can see from the graph provided in the 10-Q on page 57, we faced minimal required maturities until 2012. One piece of this financing was an interim loan facility for $1 billion. While there are rollover provisions, we intend to take this facility out via a high yield bond offering in the second quarter of 2006. We believe the recapitalization kind of sets the right stage for the Company going forward, and gives us a great deal more of flexibility.

With that, I will turn it back over to Jay for some concluding comments before questions.

Thank you, John. Before we open it up for questions, I would like to comment on the following: our view of the recent proposed payment rule for IRF's, and the final payment rule for LTACs, an update on the research we're co-sponsoring as part of our long-term efforts to provide solid clinical data, from which modifications to the 75% rule can be made, the status of a brand assessment study, that will help us determine if a name change is warranted, the appointment of a new medical director, and finally guidance.

With respect to the Medicare payment rules, the proposed IRF rate increase was essentially in -line with what we expected, with the exception of the 2.9% upcoding cut. While we agree with CMS that the program should not have to pay for coding changes that don't reflect real changes in patient acuity, our experience suggests that we are in fact seeing more acutely ill patients in our facilities. We will be engaging The Lewin Group to assist us in analyzing national data, to determine the appropriateness of this reduction, and will incorporate our findings with our comments to CMS. HealthSouth currently owns and operates 10 long-term acute care hospitals.

As a result, the final LTAC payment rule does not impact the Company in a material way. Based on our current analysis of the impact of this rule, we anticipate our revenues will decline by approximately $1.2 million per quarter for the twelve months beginning July 1, 2006. This estimate may change as we complete our analysis, and it also reflects the net revenue impact only. We have not factored in the results of actions we will take to mitigate the earnings hit of this pricing change.

Having said this, one consequence of the final LTAC rule is that we have placed a moratorium on all LTAC development projects, pending a rework of the pro formas using these new pricing assumptions. The Company had ten LTAC development projects in the pipeline, that are currently on hold. As we have previously reported, HealthSouth is following Congresses admonition. to further study the efficacy of inpatient rehabilitative care. and are currently co-sponsoring along with other industry leaders several important research initiatives.

In these research studies, we are evaluating the efficacies and outcomes of rehabilitative care provided in IRF versus skilled nursing facilities, for post surgical knee and hip replacement patients, patients experiencing cardiac and/or pulmonary conditions, and cardiac and/or pulmonary patients where the cardiac or pulmonary conditions are secondary to overall deconditioning.

We also are attempting to evaluate the comprehensive costs to the Medicare program of knee and hip replacement patients who get treated in IRFs versus SNIFFs, taking into consideration the total cost of providing care for these patients, including for example, the cost of post discharge home health services and readmission rates to acute care hospitals along with their associated costs.

These various research initiatives should be completed and preliminary reports ready by early 2007. We will seek support from the entire post acute industry in using the outcome of these studies to advocate for appropriate modifications to the 75% rule. Our objective will be to ensure that Medicare beneficiaries receive appropriate rehabilitative care in the appropriate setting.

I also want to share with you that we are evaluating whether or not a name change is warranted, given the extent to which our name has been tarnished by the misdeeds of the previous management team. To help us with this assessment we've engaged a national research firm to evaluate the following. Is there inherent value in having a national healthcare brand. If there is value in having a national brand, what attributes or qualities are associated with the HealthSouth name. If HealthSouth has negative attributes, can it be repaired and if not, is a name change warranted.

Obviously this evaluation will include a cost benefit analysis, since any potential name change, would require significant resources which may or may not be justified. We will keep you posted on the results of this effort. I am also pleased to announce the payment of Dr. Dexanne Clohan, a Board-certified physical medicine and rehabilitation physician, as the Company's Chief Medical Officer. In this role, Dr. Clohan will be responsible for the development and implementation of clinical initiatives for the Company, including measurement and tracking of patient outcomes.

Working with divisional physician leadership, Dr. Clohan will coordinate the Company's clinical research efforts, evaluate new technology and investigate potential new clinical services. She will have management responsibility for quality reporting, credentialing, research, and will chair the Patient Safety and Quality Standards Committee. Prior to accepting this position, Dr. Clohan served as a Medical Director for several well known organizations, including AETNA, Meridian Healthcare Management, and Memorial Independent Practice Association.

In addition, she practiced medicine with Rehabilitation Associates Medical Group, and served served as Director of Congressional Affairs for the American Medical Association. Dr. Clohan's appointment is critically important, as we move forward with our strategic plan, focusing on quality and the implementation of best practices across our operating platform. She brings a wealth of experience to this role, and will be a valuable asset to the Company as we move forward.

Finally, as we stated on March 31st, we are resuming guidance with this call. Accordingly, I would like to layout for you both long-term and short-term perspectives. As we have shared with you in the past, our long-term strategic plan can be summarized with the following five points: one, we intend to increase our IRF market share through organic and compliant case growth, market consolidations, and development of new IRFs. Two, we will expand into select complimentary post acute services, such as home health. Three, we will increase our market share in Surgery and Outpatient by organic growth and developing or acquiring new surgery centers, and new Outpatient clinics in target markets. Four, we will focus on enhancing our operating margins, and grow same store volumes in our three ambulatory segments, and finally, five, we will reduce our long-term debt.

With our strategic plan as a backdrop, our specific long-term objectives are as follows: first, we will focus on achieving same store volume growth by 2007 that meets or exceeds industry trends. These trends currently are 2 to 3% in Surgery, 1 to 2% in Outpatient, and 1 to 2% in Diagnostic. Second, in our Inpatient division we intend to out perform the market ,by realizing compliant case growth of 3 to 5% per year during the phase-in of the 75% rule. Once the rule has been fully implemented, we will target to grow Inpatient admissions by 2% per year.

Third, an important objective will be to achieve peer group operating earnings margins in Surgery, Outpatient, and Diagnostic no later than 2008. Obviously we are installing systems and implementing cost control measures today, that should begin to yield results in the near term, some of which we are starting to see in our Surgery division today. Fourth, from a development standpoint, we are targeting to build or consolidate five to eight IRFs per year, and fifth, add 8 to 10 new ASCs per year by 2009.

Sixth, as John previously mentioned, we believe we can significantly reduce our interest expense and increase our earnings per share by reducing our long-term debt by $1 billion over the next five years, through asset divestitures, receipt of our tax refund which is currently on our balance sheet at approximately $240 million, from operating cash flows which starting in 2008, will no longer be used for payment of litigation settlements or restructuring costs, the combination of which is expected to be approximately $210 million in 2006, and $150 million in 2007. It is also important to note that our operating income will be shielded from federal income tax for many years because of our significant NOLs. Then finally we will be able to use the proceeds from derivative actions to pay down our debt.

At some point in the next five years, the Company believes it will be the beneficiary of the various derivative action taken against our former auditor, our former investment bank, and our former CEO. These proceeds could be significant. With these long-term growth objectives in mind, we believe 2006 will be a year where we will continue to see revenue and earnings erosion, as our Inpatient hospitals migrate to the 60% compliance threshold.

Although we expect to see continued improvement in our Surgery division, the previously mentioned challenges in our Outpatient and Diagnostic divisions, will place downward pressure on net revenue and earnings. Accordingly, we anticipate 2006 net revenues before potential closures or additional portfolio rationalization, to fall somewhere between 3.1 and $3.3 billion.

Although we will aggressively pursue expense reductions, anticipate modest same store growth and Surgery cases by the second half of '06, and are looking for 4 to 6% compliant growth in our Inpatient division this year, the overall decline in Inpatient volumes will be difficult to overcome by cost cutting alone, especially considering our continued commitment to building a reliable infrastructure and control environment. As a result, we anticipate our 2006 adjusted consolidated EBITDA will be between 525 and $550 million.

In conclusion, I would like to say that I am very pleased with what we have been able to accomplish in a relatively short period of time. The dedication and support of HealthSouth's 37,000 employees has been terrific. We look forward to continuing to build upon the solid foundation that has been established during these past two years.

Last Wednesday marked my second anniversary as HealthSouth CEO. In many respects, it seems like just yesterday that I arrived here for my first day on the job. Of course there have been other times when it seemed a lot longer than two years.

We have assembled an outstanding team, recruited a brand new Board, developed and implemented a new strategic plan, are on track to apply to be listed on a National Exchange in the third quarter, and have created a new corporate culture based on integrity, trust, honesty, transparency, and maintaining our commitment to high quality patient care.

While we still have our challenges to be sure, what business doesn't, but we are a much stronger company today, than we were two years ago, and will be an even stronger company two years hence.

With that, Angie, I'd like to open up the lines for questions. I would like to ask each of you to please limit yourself to one question, so we can accommodate as many questions as possible.

[OPERATOR INSTRUCTIONS] Our first question comes from Frank Morgan with Jefferies & Co.

good afternoon

Hey, Frank.

Question on the Inpatient side of the business. It looks like if all your facilities are now at the 60% threshold, and you're growing I think in the quarter you mentioned 6% growth in compliant volume, I am curious why you still expect to see a decline in year-over-year volumes, and maybe you can talk about what happens over the course of the year on a sequential basis, and then the follow-up to that would be implied within that 525 to 550 of EBITDA, what are your assumptions with regard to both minority interest and equity income? Thanks.

Frank, this is Mike Snow. On your question getting to the growth in compliant cases, remember that's part of the story. The 60% threshold is obviously a step-up for us this year, and that 6% growth in that component, still means that we have to drop out non-compliant cases on the other side to get to our compliant threshold, so we are still going to see year-over-year volume shortfalls, because of the step up to the 60% threshold. We would be having to grow a lot faster than the 6%, to be able to overcome the threshold jump-up from year to year.

And right now we have, our average is over 60%, but we do have some facilities, Frank, that have not yet had to meet that new threshold, and we'll be seeing that roll in

Frank, with respect to, This is John, on the minority interest and equity and net income of non-consolidated affiliates, on the equity and net income, I would kind of look at the first quarter number, and take that as a proxy for what we would expect in each quarter going forward.

Clearly as we said in the 10-Q, '05, there was some recovery of losses for amounts previously written off and reserved. So that's not indicative. For lack of a better issue right now, I would use the minority interest, and look at annualizing it as a similar quarterly pace, than what you see in the first quarter. We have seen some growth in minority interest year-over-year as reflected in the first quarter.

On that first question, would you expect to see from your levels here in the first quarter, would you expect to see sequential growth at all in the rehab volume?

Between, probably not in the second quarter. First quarter is typically a very strong quarter for us, so I don't anticipate that we're going to be seeing that.

Okay. Thank you.

Thank you, Frank

Our next question is from Rob Hawkins with Stifel Nicolaus. Your line is open

Good afternoon, Rob

Hi. Just a couple of questions.

Just one question, Rob

What's that?

Only one question.

Only one.

If we go through everybody then we can circle back

How about this. You guys did a great job over the last couple years giving us EBITDA by business line, and now you're stepping away from that in the 10-Q. It is a great way for investors to try to figure out how each of the businesses is doing from a margin perspective, and the latest numbers don't really help us there. Can you give us EBITDA by division right now?

Rob, this is John. I think we went to, in the 10-K operating earnings by [segment] also

You could pull it out in the segment data and put to it. it look a little bit of doing, but you could get to a more or less accurate number.

Right. As we go forward and start to move more towards a normal company, we're more focused on the operating earnings by segment, not the EBITDA.

So it is something you're not going to start giving out and do for investors?

It is not something we intend to do until the year end again, when we would have the full segment data. I think that's what you were using to bridge EBITDA by segment.

All right. For the ASCs, you mentioned you close nine facilities. I am still trying to understand that impact. Do you have to, you said you couldn't include those as discontinued ops. Are those losses from the nine closures still impacting the ASC earnings for the first quarter, and will they still be doing that for the rest of the year?

These would be in the '05 first quarter year. They're still in there. I think we pro filed $2.6 million in revenue impact, Rob, in the first quarter of '05 versus first quarter '06,

But they're not impacting '06 going toward, they've been closed?

The losses until they're closed, would affect operations unless they qualify as discontinued operations, and then we pull them out of both years.

Okay. Thank you.

If they didn't qualify, they're still in the prior year, but they are closed

Our next question is from Derrick Dagnan with Avondale Partners. your line is open, sir

Thanks. John, I was wondering about the interest rate swap, and do you plan to make that a hedging instrument, and if so, could you give a little, or if not, could you give a little more color between the breakout of the loss between the 3.4 million the 0.4 million, that makes out the total 3.8 million loss there?

Number one, as we looked at it, we decided that it really was not going to qualify for hedge accounting, and so we will be accounting for that as expense, you know, or income, depending on what happens year-over-year. We thought it was as we went through that issue again, it was very complex, and as you know, a lot of companies have gotten the accounting for that incorrect over the years, and we did not want to be one of those. The LIBOR rate that's locked in is about 5.22%, so you know what that rate is, that we swapped, and it does phase down over time.

So that's definitely something ongoing for the foreseeable future?

Until LIBOR increases above that, yes.

All right. Another thing on the therapy cats for the outpatient business, did you see any favorable impact from the exception process?

Derrick, this is Mike Snow. We really didn't. We were hopeful that once CMS came out with their plan, which we actually were fairly pleased with, that we thought that might would help us. Frankly, if anything it might have thrown a little confusion in the marketplace. We've been actively going out there with an education plan and marketing plan for our referral sources, to educate them about the exception process, but we've not seen that it is really helped a whole lot yet.

Okay.

I think what that does is creates an opportunity for us, in working with the referring physicians and with the patients themselves, to make sure that care that is needed gets administered, and that we don't allow fear or undue concerns, to get in the way of these patients getting the kind of healthcare services that they need.

Okay.

All right?

Thank you, [OPERATOR INSTRUCTIONS] Our next question comes from the Balaji Ghandi with Oppenheimer.

I will ask two, and you can save the other for the end if nobody asks it. One is on the IRF proposed rule. The guidance that you issued, does that include your kind of anticipation for what the fourth quarter will look like with that proposed rule?

Yes.

What is that impact, do you think, on revenue?

We're going on the assumption that it will be in-line with what the proposed rule has stated. We do feel pretty strongly that the upcoding adjustment, that 2.9% takeaway is not warranted.

We think that again as I said in my comments, based on our real world experience and the patients that we're treating, they truly are sicker. It is not just a function of coding changes. It is a function of the fact that they truly are more acutely ill.

We do think there is going to be an opportunity, and we appreciate the opportunity afforded us by CMS, to provide comments, and to try to justify an additional reduction of that 2.9%, and obviously, you know, whatever we can get will be additive to our revenues for the quarter, the last quarter of this year

Got it. Okay. On the therapy caps, could you quantify or just what the contribution to the drop in that Outpatient segment was from the therapy cap issue?

We had about 400 visits per day short fall year-over-year, Balaji, in the quarter, which is about 2.5 million or so of revenue. That was the impact we had in the quarter

Most of that was in January, I guess?

No. Actually it was fairly well spread through the quarter.

Volumes started a little bit slow every where in the quarter, so January was not a typical January quite frankly. I think you saw that even in some of the acute care hospitals who reported that their volumes were weak, and there was just a weakness in the market overall. I think it was spread pretty much across the quarter.

Okay. Thank you very much.

Our next question comes from Kemp Dolliver with Cowen & Company. Your line is open.

Thanks, and good afternoon, and congratulate you again for a timely and accurate SEC filing.

Thank you. We take these very seriously, and I know everybody would like to have had it out sooner, and as do we, but we feel pretty good that we got it out, we got it out on time, and our goal is to continue to do so.

Right. Which is more than your predecessors could say. Just one question, and that relates to the segment data in the 10-Q that shows corporate and other. For the quarter there is roughly a $90 million operating loss shown for corporate and other, and we're interested in just how, I guess what part of that is essentially representative of a good run rated for corporate overhead this year? Normalized?

That corporate overhead number, you know, you would not want to take that expense and annualize it, as there are fair amount of things that get expensed in corporate and other, not the least of which is primarily most of the professional fees.

As I said earlier, those will start to decline as we go throughout the remainder of the year, and so I would expect that number to start dropping off in the second quarter, in the third quarter, and in the fourth quarter, from prior year levels, so less than half of that would be an appropriate run rate.

That's great. Thank you.

Our next question comes from Darren Lehrich. Your line is open.

Thanks. Good afternoon want to get your comments with regard to managed care pricing outlook and where you think that organization is, relative to your expectations so far this year, and just maybe a longer term outlook on pricing by segment, please. Thanks

Darren, this is Mike Snow. We've actually experienced some fairly good results. As you know, we brought in a new Senior Vice President over Managed Care at the end of last year, and she has been busy building the organization, making contacts, prioritizing contracts, et cetera, throughout the division, and have been seeing fairly good results there. We have had increases in the zone of around 4% or so in Inpatient, and around 5% or so in the Surgery division.

We've not had increases that are material in Outpatient and Diagnostic, and in fact every time we talk to a contractor in Diagnostic, they want to cut our rate, so we kind of learned our lesson not to talk to them as often, but that's kind of what we're seeing out there right now.

Okay. How sustainable is the question is, how sustainable do you think these kinds of increases, and where are you really in this process relative to your expectations?

It is not like nothing was done before the new team arrived. I am not sure how sustainable those level of increases are, but I do think they approximate the market out there right now.

One of the things that we are seeing is that we have a lot of inconsistency in our templates, in the contract language, and [Terry] and her team are also tackling, standardizing some of those, and obviously we don't always get in to contracts what we want, but we are developing a playbook if you will, so that we're approaching these on a consistent basis, and there may be some opportunities to realize some additional rate, just by adjusting some of the language, and some of the wording in those contracts.

I would characterize our position as being sort of early stage. Terry has been with us now for I think three months, four months, and has I think done a remarkable job in a very short period of time. I think the real benefit of her efforts will be seen in 2007, 2008, and beyond. There aren't a lot of contracts that are able to be negotiated or renegotiated when someone comes in in January or February, but certainly as we look to contracts that we renew at the end of the year, and opportunities to renegotiate at that time, I think we're going to start seeing some additional improvement.

Okay. Thanks a lot.

You bet.

Any other questions, operator?

Our next question is from Troy [Hottenstein with RG Capital]

Hi guys, thanks for taking my question. I just wanted to know what the status was on getting listed off the Pink Sheets, either on to the new stock exchange or NASDAQ?

We're still on-track to be apply to be listed in the third quarter of this year. We felt very good about our ability to get the Q out the door on time. As we mentioned back in I guess March, we want to have two 10-Q filings under our belt where we know with certainty we can meet that very important requirement.

I think the last thing we would want to do, is to seek to be listed today, and then for some reason, and as it is hard to appreciate this I think from the outside, but trust me, there is a lot of work that has to be done especially for a company that isn't used to doing this, isn't used to doing it with accurate numbers, and so on, and we still have a lot of work that we're doing with our internal control environment, and solidifying that and enhancing that. We really want to make sure we can do this, and do it successfully.

We're very confident we'll be able to get the second quarter Q out on time, and then as soon as we're confident of that, we'll go to both New York and NASDAQ and well, actually we'll do that before that, but we'll formally apply once we have that knowledge under our belt, and Greg and I will probably be going up, and probably with John sometime in June or July to be really start those discussions in earnest, and we have the information. We know what the requirements are. Wwe've done our homework. it is just going through the evaluation process.

it should happen pretty quickly after you file your next 10-Q, given you're going to do a lot of the flag work it sounds like now?

Yes, the application, and it takes anywhere from six to eight weeks to process that application, and we will obviously want to get listed as fast as we can. But we want to make sure that we can do so, and meet all of the requirements.

Excellent. Thanks, guys

I think one other comment on that. If I am not mistaken, one of the requirements for listed on NASDAQ is the share price has to be above $5 a share for a period of time, so all of you who are out there who want to get us listed, do what you can to get us above $5 a share. I think we have time for one more question

This is John. It is in response. I don't want to leave Rob hanging out there, or others who are thinking about EBITDA by segment. And so while we haven't broken it out, one reasonable methodology might be to look at our 10-K depreciation by segment, and applying that to the quarterly numbers if you're trying to get some approximation by segment as some suggestion. With that, we'll turn it back over to questions

Maybe one last question if there is one.

Our last question is with Frank Morgan with Jefferies & Co.

Start out and close with Mr. Morgan

One is housekeeping. Could you explain to me on the warrants that are being issued in the settlement, the timing and what is the dilutive impact of that, in terms of share count, and to end on a high note, any thoughts on what we should think about EBITDA growth for '07 versus '06?

Do you want to take that?

Frank, it is Greg. We don't know the timing. As you know, we have the preliminary settlement announcement and working on the papers now to get that done. As you know, settling this type of litigation takes a long time. We don't really have the terms. That's what we're working on, the terms of the warranty. We don't know exactly what the other terms are going to be, other than the number of warrants that there are, which are north of 40 million

And 28 strike price, Frank.

In terms of '07 growth, we're not in a position to comment on that today, but I do think it is very fair to say, that we will be expecting growth in 2007 from an earnings standpoint. We'll have that additional year with all of our inpatient hospitals still at 60%. There absolutely is going to be the expectation that in our largest segment, there will be volume growth and there will be earnings growth occurring, particularly if we get additional relief on the pricing side.

We've already talked about Surgery, our second largest segment, and the fact that we are anticipating same-store increases in cases by the second half. We expect that is going to roll into 2007. The pricing upside we just talked about a minute ago. We also think we'll see some margin expansion through our labor practice and supply chain initiatives, so we also are looking for growth in Surgery centers in 2007.

I think Outpatient and Diagnostic a little harder to maybe peg right now, but I know that in Outpatient we're going through and very aggressively looking at any underperforming facilities, any that are on the cusp. We're also looking at acquisitions in Outpatient in target markets, where we already have a nice presence, and we're working on two or three outpatient acquisitions.

Diagnostic, we still have work to do. I am very confident that Greg Brophy and Greg Eisenhower and their colleagues, will be able to tackle the problems in our Information and billing systems, that will improve our cash flows in that segment, and then with the rationalization of our division, by getting rid of those 16 facilities, I think we'll have a pretty solid base to go forward with.

I can't give you the specific numbers, Frank, but I think it is very fair to say that you go through, and you look at what we've accomplished thus far, what we've got in place, what we're start to go already see, coupled with the additional year at 60%. 2007 absolutely should be a growth year for us.

Okay. Thank you.

All right. Thank you, everyone for participating, and thank you for your support of HealthSouth.