Encompass Health Corp (EHC) 2006 Q2 法說會逐字稿

Good morning, everyone, and welcome to HealthSouth's second-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 period. (OPERATOR INSTRUCTIONS) This 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. Please stand by for your conference.

Thank you for standing by. I would now like to turn the call over to Jay Grinney, HealthSouth's President and Chief Executive Officer. Please go ahead, sir.

I think we will begin. Good morning and welcome to this HealthSouth second-quarter earnings conference call. I'm Jay Grinney, President and CEO of HealthSouth. With me here today are John Workman, our Chief Financial Officer, Mike Snow, our Chief Operating Officer, and John Whittington, interim General Counsel. Also here is Tyler Murphy in the back, Senior Vice President in our Treasury Department. This call is being conducted in person here in New York and is being webcast simultaneously for investors unable to join us.

Before we begin this morning's meeting, I would like John Whittington to review some cautionary statements.

Thank you, Jay. Good morning. There are a number of disclaimers, risk factors, and other cautionary statements set forth in the 10-Q that we filed with the Securities and 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, risk factors, and other cautionary statements; however we urge you to read them carefully.

I would however like to highlight the following. The financial statement and other information contained in the first-quarter Form 10-Q was 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 second-quarter Form 10-Q and 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 information contained in our presentation. You are cautioned not to place under 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 leverage capacity, our ability to service debt, and our ability to make capital expenditures. For a discussion of consolidated adjusted EBITDA, please refer to the second-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 would like to turn it back over to Jay. Thank you.

Thank you, John. We obviously have quite a bit to cover this morning and not only do we want to review with you our second-quarter results, but we are also announcing today a major strategic repositioning of the Company, the decision to apply for relisting on New York Stock Exchange, our intention to seek shareholder approval for a one for five reverse split to occur at the same time as our relisting and finally, that we will be keeping the HealthSouth name.

We believe these actions will significantly increase shareholder value over the long-term as HealthSouth focuses on a simplified pure play business model in the postacute arena; reduces a substantial portion of our long-term debt, thereby creating a strong balance sheet capable of aggressively pursuing growth opportunities in the highly fragmented postacute space; reduces the number of outstanding shares, thereby making our stock more attractive to institutional shareholders while providing greater visibility to changes in our earnings per share; capitalizes on the HealthSouth name and the positive attributes associated with it; and takes the final step in the rehabilitation of the Company by going back to the New York Stock Exchange, which should provide additional liquidity in the stock and help increase analyst coverage.

Before John Workman reviews the second quarter in greater detail, I would like to go over some of the highlights from the quarter. Our pre-tax loss from continuing operations was $28.9 million, which represents a significant improvement over the loss a year ago. While it is a non-GAAP measure, I'm very pleased to report that consolidated adjusted EBITDA came in at $135.9 million which represented an increase over the second quarter of 2005. This occurred despite a decline in net revenues primarily attributable to the impact of the 75% Rule, reduced Medicare reimbursement, and the divestiture of nonperforming assets.

As John Workman will show you shortly, we saw solid operational performance in inpatient, surgery, and outpatient, and a stabilization in our diagnostic divisions. While we still face our share of operational challenges, overall these results were in line with our expectations and within the guidance range for the year.

Looking at the segments, we remain very pleased with our inpatient division’s ability to attract 75% Rule compliant cases. In the quarter, compliant cases were up 4.8% compared to the same period in the prior year. This is at the top end of the 3 to 5% guidance we provided in May and reflects the success of our targeted marketing efforts and preference for the high-quality rehabilitative care offered at our hospitals.

As everyone knows, CMS recently issued its final rule on the IRF PPS update scheduled to take effect October 1. While we were disappointed that the industry did not receive a greater increase to reflect the rising costs of providing high-quality rehabilitative care to sicker patients, we appreciated CMS's willingness to enter into a dialogue with the industry about the appropriateness of the data sources that were used along with the underlying assumptions and analytical methodology.

Although we were unable to persuade CMS to reduce the upcoding adjustments to more accurately reflect what is occurring in our hospitals, we look forward to working with them in the future to insure subsequent regulatory decisions are based on contemporary data. Moreover we were encouraged by Dr. McClellan's comments that CMS was willing to carefully evaluate the role comorbidities play in determining whether a patient qualifies for inpatient rehabilitative care. Our position and that of the industry and our referring physicians is that comorbidities must be a consideration when determining the level of care a patient requires. From a patient care perspective, it makes no sense to allow comorbidities to be considered today but not after the rule reaches the 75% threshold.

We will be presenting to CMS and the law makers the findings of clinical research that supports this position, and we trust CMS will be willing to conduct an objective analysis of this issue.

With respect to our surgery division, we remain very pleased with the results of our resyndications. In the first six months of 2006, we have seen a case growth increase of 2% for those ASCs that were resyndicated by year end. We remain optimistic that in aggregate the division will yield positive same-store growth by year end. Our pricing remains solid as our new managed care team executes on its strategy of obtaining market competitive reimbursement from commercial payers. We believe it will take another couple of years to achieve market parity, but this creates nice upside for future periods. We also continue to see improvement in our operating metrics and we reiterate our belief that this segment should reach market comparable margins by the end of 2008.

Last week CMS issued a proposed rule for a revised ASC payment structure beginning in 2008. The proposed rule would set ASC rates at 62% of hospital outpatient department or HOPD rates. The proposed rule also would increase the type of cases that could be performed in ASCs. While we were anticipating the proposed rate would be in the 70% to 75% range, at this time we believe the additional volume coming from these new procedures will offset the lower than anticipated reimbursement in a manner that will be neutral to positive for the Company. We are concluding our analysis of the proposed rule and will be submitting our comments to CMS during the comment period.

Our outpatient division reported very solid growth in year-over-year second-quarter operating earnings of 32%. This was achieved through continued focus on managing our expenses, strong unit pricing, and continued diversification of our referral sources away from physician groups that have brought these services into their offices. While our diagnostic division's results continue to reflect challenges associated with the implementation of that division's new billing and collection system, we remain very encouraged by the efforts of our talented new management team headed by Greg Brophy.

We are finally seeing the light at the end of the tunnel with respect to this revenue system rollout and believe the division is capable of realizing adjusted consolidated EBITDA inclusive of both division and corporate overhead in the low to mid $20 million range. Achieving this will be predicated on bringing our bad debt to industry and historic levels, which is approximately 4% of net revenues and completing the installation of the IDX System across the portfolio thereby eliminating approximately $10,000,000 in one-time implementation costs.

Greg and his team will have closed or sold 17 underperforming units by the end of the third quarter, further strengthening this division's go-forward run rate. We remain on track to market this division in the fourth quarter and continue to believe there will be interest in this portfolio.

Finally before I turn the podium over to John Workman, I would like to comment on some of our recent development activities. In the quarter, we announced several development transactions signaling our move from playing defense to playing offense. These transactions were in addition to the opening of a new 40-bed rehab hospital in Petersburg, Virginia and the groundbreaking for a new 40-bed rehab hospital in Fredericksburg, Virginia, both of which occurred in the second quarter. As we have previously stated, there are tremendous opportunities to increase our inpatient rehabilitation market share through construction of de novo sites as well as market consolidations where we joint venture with or acquire competitors.

Our recently announced letter of intent for a partnership with Tucson Medical Center is an example of one such consolidation. This transaction is a win-win for both parties. Tucson Medical Center is able to offer high-quality rehabilitative care through the new joint venture, while freeing up valuable hospital space and beds to further their acute care mission. HealthSouth meanwhile is able to consolidate the market, thereby eliminating duplicated IRF services while partnering with an outstanding local health care system.

On our first-quarter call, we stated our objective was to begin seeing tangible development activity beginning in 2007. It is clear we are well ahead of our earlier time frame. Indeed, in the second quarter we brought on board an experienced and highly qualified Senior Vice President for development, Cynthia Dotson. I had the pleasure of working with Cynthia when she was a senior executive in HCA's development department, and she brings a wealth of experience and discipline to our development activities. Over the several months, Cynthia will be ramping up her team so we can aggressively but rationally pursue the many expansion opportunities we have identified.

We currently have over 40 development projects in the pipeline. Approximately 85% are IRF related and 15% are LTCH related. These development initiatives are essentially balanced among consolidations, acquisitions, and de novo projects. Before year-end, we expect to close on three market consolidations, file two more CONs and this would be in addition to the LTCH CON filed last week with our partner, the University of Virginia, and will close on approximately 60 beds through acquisitions.

We also announced in the quarter the acquisition of seven outpatient centers in Indianapolis and signed an agreement with a major airline whereby HealthSouth will be the exclusive provider of workers' compensation care for this company. Along with a similar contract last year with the Hyundai plant in Alabama, this underscores the Company's continued efforts to diversify our outpatient physical therapy base.

With that, I'm going to ask John Workman to review the second quarter with you.

Good morning. We have made available a press release as we know our business is complex and in the press release we have attempted to identify the highlights including by segment and have provided some supplemental information that many of you have requested in the past. We believe these should be helpful to you in trying to analyze our results. I don't plan on reading the press release. It is available on our website and for those of you in the room here in New York, I think we had copies to pass out. Finally as there is a lot more information that's going to be shared today, as Jay talks about the pursuit of strategic alternatives, I'm going to keep my comments generally brief.

Looking at our consolidated results and starting with revenue, overall in the quarter revenue was down 3.8% from a year ago. All divisions experienced some revenue decline, but most of it was related to attributable facility realignments with the exception of the inpatient division, which continued to suffer because of the implementation of the 75% Rule. However, the second quarter decline is a sequential improvement from the first quarter of 2006 in which we experienced a 6.7% decline. I'm going to talk a little bit more about each segment as we go forward.

Looking at operating earnings, and while operating earnings overall reflected a decline in the quarter, if you exclude the diagnostic division as a non-core asset and look at our core operating earnings of the remaining divisions, we actually experienced an improvement of $7.8 million and 120 basis point improvement as a percent of revenue relative to operating earnings margin rates.

As Jay had mentioned and though it is a non-GAAP measure, adjusted consolidated EBITDA of $135.9 million for the quarter reflects a $2 million improvement and a 90 basis point improvement in rate compared to the second quarter of 2005. When you combine the second-quarter adjusted consolidated EBITDA results with our first-quarter 2006 EBITDA results, that brings us to a total of $272.2 million for the first six months, which reflect a run rate in line with the previous guidance that we've given you of $525 million to $550 million for the full year 2006.

Lastly in talking about consolidated results, I want to spend a moment on cash from operations. Net cash from operating activities was a source of cash of $20.7 million in the quarter, compared to a use of cash in the same quarter a year ago of $36.9 million, a dramatic improvement. Now some of that is attributable to the refinancing and the timing of interest payments, but overall a significant improvement from the same quarter year ago.

Said another way, if you look at our adjusted consolidated EBITDA at 135.9 and you look at our net cash interest expense for the quarter, which was $78.7 million, deducting that and then deducting the $22.4 million that we spent on CapEx, we had available cash flow of approximately $35 million which was channeled clearly into the settlement payments and professional fees.

Looking at the operating segments, I'm going to talk about inpatient first. Revenues were down primarily as a result of the 75% Rule. As all you know, we're moving from the 50% to the 60% threshold in 2006 and that is affecting our inpatient division. However as Jay mentioned, we had strong compliant case growth in the quarter at 4.8%, which is in the high end of the range that we had indicated before because we expect this to be in the 3% to 5% range going forward. This resulted in a more acute patient being treated in our hospital, which combined with some minor retro adjustments in revenue helped us to increase the net patient revenue per discharge in this division for the second quarter of 2006. Unfortunately because PPS pricing has moved down some of those, that increase in acuity as to a net patient revenue price increase does not necessarily translate into a margin increase also. I'm going to talk about that in a little bit, in a moment because the pricing does not keep in step, if you will, with the higher acuity patients, if you will, because of changes made in PPS last year.

Operating earnings in the inpatient division declined $14 million, but $7.8 million of that is a decline related to a $4 million loss on asset disposals in the current quarter compared to a $3.7 million gain on asset disposals in the same quarter a year ago. The remainder of decline is attributable to the more acute patients and the fact that we are spending more salary and benefits cost and more supply costs in treating those patients, as well as incurring inflationary costs to hire and retain qualified clinical personnel without the pricing increase from CMS that we would have liked to have had.

We had mentioned to you before that we expect some margin compression in this division as a result of these factors and clearly we're starting to see some of that in the second quarter. We would expect margin compression at least compared to 2005 in the inpatient division as the year progresses, however as we will have an extra year at the 60% level in 2007, we believe 2006 will be the low point and we should see that with the continued growth in compliant cases we would expect operating margins to start to improve along with revenue growth in the inpatient division in 2007.

Jay hit upon the development activity. Subsequent to the end of the second quarter, we did announce the LOI, if you will, on the facility in Tucson. We also announced that we had disposed of our last non-U.S. hospital and are selling the Australian hospital, which will result in some cash proceeds and some gain to the Company in the third quarter.

Turning to the surgery division, the surgery division's drop in revenue in the quarter is really all the result of facility realignments. In the second quarter, we had three facilities that moved from consolidated to nonconsolidated and we also had seven facilities that previously -- that have been closed that did not qualify as discontinued operations and have been closed since the second quarter of 2005. Those two activities relative to the facilities fully explain the revenue decline in the quarter.

As we've previously indicated, we do expect same-store sales growth in this division by the end of 2006 and we saw nice sequential improvement in the second quarter compared to last year, so we are starting to see that that has leveled out. We would describe the second quarter of 2006 as basically flat, and we believe that we can build from there and that is consistent with what we've told you in the past.

As to operating earnings in the surgery division, they declined slightly in the quarter, but $1.6 million of that is attributable to an impairment charge that we took as we worked through some facilities that are underperforming. If you adjust for the impairment charge, we actually had a margin rate expansion of 30 basis points over the same quarter a year ago. That is after minority interest as you look at surgery sometimes some businesses look at operating profit before minority interest. We always look at it after minority interest.

We have previously indicated that the surgery division continues to focus on productivity and productivity in terms of scheduling and saving money on salaries and wages and supplies and we have indicated before that we would expect that to result in margin expansion as the year progresses. The fact that we've started now seeing some margin growth in the second quarter we believe confirms that direction and believe we're headed in the right track.

Looking at the outpatient division, first looking at revenue, revenue continued to experience significant declines in the quarter, but consistent with the same level of declines that we saw in the first quarter of 2006. The decline is attributable to continued pressure from the physician owned physical therapy services, challenges in recruiting therapists, closure of underperforming facilities, and the annual Medicare limitation that was put in place for outpatient physical therapy.

If you look at operating earnings in the outpatient division, this division has continued to aggressively pursue expense reductions including closure of facilities that are underperforming and as a result of that the division had some significant growth in operating earnings in the second quarter of 2006 compared to a year ago and an explosive growth in the margin rate in this division in the second quarter. We would see that continuing those efforts aggressively focused on expense reductions and closure of underperforming facilities.

It also had some development activity in the outpatient division. The division is focused on those situations where they can come in and take a significant market share and have a presence in the market and were able to close on such an opportunity subsequent to the end of the second quarter in Indianapolis, Indiana. That acquisition should be immediately accretive to the Company from an EBITDA standpoint and is one of many that that division is also looking at pursuing going forward.

Turning to the diagnostic division, the diagnostic division also experienced a decline in revenues. They were slightly greater than the first quarter in terms of the rate of decline. But having said that, we continue to see pressure there also from physician owned facilities where they are putting in the imaging facilities themselves and also, as Jay mentioned, we're looking at underperforming facilities in the diagnostics division and closing those. That is something that really had not been done as aggressively in the diagnostics division and is one of the things the new team is focused on.

If you look at operating earnings, as Jay has mentioned and as I commented earlier and as we look at this as more of a noncore business, we did see operating earnings decline significantly in the second quarter of 2006. $4 million of those charges related to asset impairments and loss on disposal as we move through some of the underperforming assets. The remainder of the decline is really attributable to two things or both tied to the same factor. One is expenses related to the installation of a new billing and collection system which is called IDX. It is owned by GE Healthcare. And secondly, is we experienced higher bad debts in the quarter related to trying to install the new system, but really related more to the problems with the old system that existed that needed to be replaced. We believe that that situation will be improved as the new system moves forward, and it should help correct that.

As Jay said, we have a new leadership team in the diagnostic division that came on board in the first quarter of 2006. They are focused on many of the things to improve the results in this division. First in rationalizing underperforming facilities, and Jay commented on that. Secondly is effectively implementing the new billing and collection system and accelerating its installation in a shorter time frame than might have otherwise been done. We would expect that to be done by late '06/early '07. We have said it before, but it is worth reminding everybody again, this division had eight disparate billing and collection systems. So we are moving to one system which is a bit improvement. Obviously it is costing us expenses in the quarter to put in that system, but it should have good long-term events or long-term benefits.

The division is also and the new team is focused on increasing scan volumes by expanding referral sources. These efforts should set the proper stage as we look forward to 2007. If you exclude the non-recurring items such as the asset losses, the system installation expenses, and look at a normalized bad debt after the new system is in place that we would expect, we do expect the EBITDA in this division to get back to 2005 levels or above. As Jay mentioned, that would put us in the mid $20 million range even after divisional and corporate overhead. So we think the division would be well positioned for an outside group to invest in that division.

Looking at corporate and other, which is our last segment, it had an improvement of $22.1 million in the second quarter of 2006 compared to the first quarter of 2005. The second quarter of 2006 reflected a $6.9 million gain from the collection of an investment in Source Medical that had previously been written off. We did not expect to get any of this money in the Company which provides some system services, got some venture capital funds and as part of that needed to reimburse us, so we were fortunate to collect that cash and recognize that gain.

There was also a settlement charge of about $16.7 million in the corporate division. $3 million of that relates to the nonprosecution agreement which is our last issue with the DoJ and as we settle the DoJ, any criminal issues, we made a $3 million payment to the Alabama Postal Inspectors fund. Don't ask me for that link. There was a $3 million exposure for some qui tam litigation that we posted a reserve for and lastly we posted $10.7 million for ongoing settlement discussions with our subsidiary partnerships. This amount is expected to generally be non-cash and as a result of adjustment at the facility level, in terms of our partnerships as we move through the progress or process of communicating with our partners and looking at all of the things that have gone on including the tax impacts to some of the partners, so as part of that we have made some entries in terms of settlement costs. Those were $10.7 million in the quarter. We would expect some additional charges like that again principally non-cash in the third quarter and some of fourth quarter, but all of that should be behind us by the end of the year 2006. Some of those amounts are reimbursing for tax consequences, but we will receive a future tax deduction if you will on behalf of HealthSouth.

The second quarter of 2005 comparing it to last year included a $13 million charge, impairment charge related to the digital hospital. So if you look at it quarter-over-quarter $22.1 million improvement, we had the $6.9 million Source Medical but we had a negative in that in terms of the settlement, $16.7 million compared to a $13 million charge a year ago on impairment.

The last thing I'd like to talk about is the financing related costs. Interest expense net of interest income was less in the second quarter of 2006 as debt was lower because of the issuance of the preferred stock that we put in place as part of the refinancing. We also reflected a mark-to-market favorable adjustment of $18.6 million as a result of our interest rate swap on $2 billion of our term loan, which basically locked in or LIBOR at 5.22%. So we would expect that to be a favorable position to be in.

As a reminder, the refinancing was done to eliminate the uncertainties of future financings, to provide relief on many out of market covenants that existed with the Company's old debt structure, and to give the Company more operating flexibility as well as limit the amount of near-term maturities the Company was going to be facing in the new financing structure. While not done in anticipation of the topic that Jay is going to discuss, we do believe it allows us to effectively deleverage the Company with any proceeds including amounts are already expected from a tax refund and potential derivative proceed. So now we have prepayable debt as before we did not, and so we do believe we are in a good position now with our capital structure.

At the end of June, 2006, we had $50 million borrowed on our revolver, which is the same amount that was borrowed at the time of the refinancing. Since the end of the second quarter, we have paid down $25 million of that revolver.

With that, I'm going to turn it back over to Jay.

Thank you, John. I now would like to spend some time discussing the strategic repositioning of the Company, our plans to apply for relisting on the New York Stock Exchange, our belief that a reverse split makes sense for our shareholders, and our decision to retain the HealthSouth name for our ongoing Company.

Our decision to reposition the Company as a pure play postacute healthcare provider was driven by four factors. First, the postacute space is a highly segmented sector with solid growth prospects given the aging of our nation's population. One out of every three patients who are admitted to an acute care hospital ultimately get discharged to a postacute provider for some kind of follow-up care. With the aging baby boomers, acute care utilization is expected to increase over the next several decades.

Currently the postacute sector is an approximately $125 billion industry that is not served by any single provider. In fact, with the exception of long-term acute care hospitals, the top five providers in each postacute segment represent less than 20% of that segment's total market share. Clearly there is a lot of headroom in the space. Many of these providers are small, locally owned operators who will either be looking for an exit strategy in the next several years or will not be able to compete effectively as CMS moves towards an integrated postacute payment system.

CMS recently announced the creation of two technical advisory panels to review a single postacute assessment instrument and indicated they would be seeking providers to participate in a postacute demonstration project. HealthSouth will be volunteering for this effort. Under such a system, the winners will be those providers who can offer the highest quality care at the lowest cost. We believe large, integrated companies such as HealthSouth with our scale and our inherent efficiencies will be able to compete very effectively in this kind of environment. Additionally as I mentioned earlier, there are significant consolidation, acquisition, and de novo growth opportunities in the IRF and long-term acute segments in which we were able to expand.

Second, the Company's highly leveraged balance sheet limits our ability to fund these growth opportunities for the foreseeable future. Given our current debt load, we anticipate we would be able to fund only about $140 million per year in CapEx over the next six years with roughly half of this going towards maintenance or current assets. This does not provide enough growth CapEx to fund the development projects in postacute and ambulatory surgery segments. We would need significantly more CapEx over the same time period to fund all of these growth opportunities, with a disproportionate amount needed to fund the more capital intensive IRF and LTCH projects.

Third, by unlocking the value of all of our ambulatory divisions, we believe we will be able to devote more of our cash flow to growing our core inpatient rehabilitative businesses. In the second quarter, our inpatient segment represented 57% of the Company's total revenue and 86% of our operating earnings. Cash flow from this segment is significant. We believe there is significant value in the ambulatory segments, the growth prospects are bright, driven by more surgical procedures moving to the lower-cost ASC environment, and as I mentioned earlier, CMS is creating place of service parity between ASCs and higher cost hospital outpatient departments.

Coupled with a very robust private equity market and the lending market's willingness to leverage these assets, think of some of the recently announced transactions, deleveraging the Company through appropriate divestitures, we believe, is in our shareholders best interests. In the event we spin these assets, our current division management teams would take these segments out. Because of the size and complexity of the surgery centers division and Mike Snow's experience with these partnerships and the resynidication process, Mike would join Joe Clark and the surgery division team in leading this business.

Fourth, we have concluded there are very few if any strategic or operational synergies associated with keeping the Company together. As we analyze our Company to discern a common denominator among these businesses, the only meaningful connection we could identify was with the role orthopedic surgeons historically played. They referred knee and hip replacement patients to our inpatient rehabilitation hospitals. They referred their patients to our outpatient physical therapy clinics. They did surgery in our surgery centers. They ordered CAT scans and MRIs from our imaging centers.

Today our ability to treat their knee and hip replacement patients has been severely limited by the 75% Rule and these same orthopedic surgeons are now competing with us as they bring outpatient physical therapy and imaging services into their offices. While they still are partners in our surgery centers, the interdependency with other divisions has all but evaporated.

Furthermore, as we explore strategic alternatives with acute care hospitals, we often find our divisions at cross purposes with one another. On the one hand, we are attempting to partner with acute care hospitals to consolidate the IRF space and to provide high-quality postacute care. On the other hand, our surgery centers often compete with those very same hospitals, thereby creating confusion in the marketplace and unnecessary tension within the Company.

So against this backdrop we've decided to explore strategic alternatives for our surgery and outpatient divisions and have engaged Goldman Sachs to assist us with this process. The planned divestiture of our diagnostic division will occur simultaneously and will continue to be handled by Deutsche Bank. As we stated in our press release, we expect this process to take about a year. We do not expect to be commenting on the progress of these efforts unless and until we have finalized an alternative that has been approved by our Board of Directors. We think this is the best way to ensure confidentiality amongst prospective buyers while helping ensure we obtain a fair price for these assets to the benefit of our shareholders.

As we have also mentioned in the past, HealthSouth has significant NOLs. The anticipated transactions may provide an opportunity to unlock some of the value of these NOLs as we move through the divestiture process. And finally, until we know precisely which strategic alternative is in the best interest of our shareholders, we will not provide pro forma income statement or balance sheet information related to the remaining Company. In the event we choose to sell one or both of these divisions instead of spinning them, this information could be used to back into expected sales price. Obviously that could create an artificial ceiling which might preclude our getting the best price for our shareholders.

We also announced today that we have been cleared to submit an application with the New York Stock Exchange seeking to be relisted on that exchange under the symbol HLS, thereby meeting our goal of applying to be listed on a national exchange by the end of the third quarter. We anticipate we will begin trading on the NYSE by the end of October.

Coincident with our relisting, we will be seeking shareholder approval for a 1 for 5 reverse split. Later this month we will file with the SEC a preliminary proxy statement with respect to the stockholders meetings to approve this reverse split and if our plans go according to our expectations, we anticipate completing the reverse split and our New York Stock Exchange listing by late October.

We are mindful that reverse splits if not done for the right reasons can be problematic. Fortunately we believe we are proposing a reverse split for good, solid, logical reasons. First we want to bring the share price of our stock along with the number of outstanding shares to a comparable level with other similar sized healthcare companies. Second, as most of you are aware, many institutional investors and their investment committees shun single-digit stocks. By completing the reverse split, we will broaden the pool of investors interested in and able to invest in HealthSouth and our future growth.

Third, a lower share count will provide greater transparency into our operations by enabling investors to see more clearly the impact of our strategic and operational initiatives on our reported earnings per share. Finally, fourth, many of our stockholders pay commissions based on the number of shares either bought or sold. By reducing the number of shares outstanding, we will significantly be lowering these transaction costs.

In the final analysis, it simply does not make sense for a Company the size of HealthSouth to have 400 million shares outstanding. By affecting this reverse split, we also will be cleaning up this legacy from the past.

Finally today we announced that the Company will retain the HealthSouth name. The market research we conducted overwhelmingly indicated that the name HealthSouth is synonymous with high-quality rehabilitative care. This was especially true where it matters the most, with the patients we serve in the local communities. As we reposition the Company as a pure play postacute provider, this valuable brand equity is part of our heritage that we are holding onto, thereby avoiding a very costly rebranding effort to a new name.

In conclusion, the actions I have just outlined represent the remaining steps in the transformation of the new HealthSouth. Over the past 27 months, we have accomplished a great deal. We negotiated consents with bondholders that cured outstanding defaults. We successfully negotiated settlements with the CMS, the Department of Justice, and the SEC, and scheduled these payments out over time. We recruited a strong, new, independent Board of Directors. We replaced virtually every member of our senior management team.

We reconstructed and restated four years of historical financial statements, investing over one million man hours in the process. We identified and addressed multiple material weaknesses in the Company's internal control environment. We filed three Form 10-Ks, including a comprehensive 10-K for the years 2000 through 2003 along with 10-Ks for 2004 and 2005. We refinanced our entire balance sheet to provide maximum prepayment flexibility going forward.

With today's announcements of our strategic repositioning and relisting on the New York Stock Exchange, we will begin a new chapter in the history of HealthSouth, a chapter focused growth and strong operational performance that we believe will yield shareholder value for years to come.

That concludes our formal comments. With that, I would like to now open things up for some Q&A. I think there are microphones too, so everybody can hear, including those on the phone

A lot going on here but certainly I guess just first in terms of your preference in terms of a spinoff or sale, can you just talk a little bit about what you're thinking about and the thought process? And also I was intrigued by your comment that Mike is going to be joining the surgery center team. I just wanted to just get more comments there in terms of just the thought process and once again in terms of a preference here.

Then just my second question is on the surgery center volumes, I was just wondering if you could break out a number. You talked about some of the I guess extraordinary items there, if you could just give us a sense of what a true same-store case growth number could be in the surgery center segment, that would be very helpful too. Thank you.

First in terms of our preference sale or spin, at this point we are agnostic. We want to do what we believe is ultimately going to be in the shareholders best interests. In terms of Mike taking that out if we should spin it or for that matter if a financial sponsor came in and wanted to have a very strong management team, I think we would be able to provide that. In fact that is one of the real assets I believe as we look at the potential divestiture of these segments. We have assembled outstanding management teams in each of our divisions and each of them are capable of bringing out or running those divisions on a stand-alone pure play basis.

Obviously surgery is the largest, the second-largest division and would be the largest division going out. It is a complex division. There's a lot of growth opportunities that are clearly there. If you think about what has happened with CMS, that has really been the overhang that has worried a lot of people, what is the impact of that going to be on the surgery center space on a go forward basis? We now know that the pricing is going to be favorable to neutral and then you think about all the new volumes that is coming in that will be able to come into the surgery centers, it creates a tremendous amount of upside.

Then in our case we have not yet achieved market comparable margins and there's still more work that needs to be done there, but that too presents very nice upside for a potential buyer coming in looking at this and seeing that there is still value to be achieved in that segment. So with that, we felt that positioning Mike to go out with that made the most sense and clearly the remaining [Company] -- we are only a pure play Company that is going to be much smaller. It will be about half the size in terms of revenue and so on. And so we felt that that made the most sense from a repositioning of the executive talent perspective.

In terms of same-store volume growth on our portfolio, we think that the 2% to 4% range is very achievable. As I mentioned, if you look at the resyndicated surgery centers, those that were resyndicated by the end of '05, and you look at the kind of growth that they realize, that portfolio realized in first six months, we were up 2%. As we mentioned to you when we resyndicated these, many of our initial resyndications were defensive in nature. So we think that a 2% to 4% same-store volume growth on a go forward basis is very achievable.

I just had two things. Are there any approvals needed from your debtholders to do any of this spins or sale? Or is that --?

We would have to obtain consents on this. But I think since we did do the refinancing and we have so much of our debt that is now prepayable, I think that our lenders will see this as a very positive sign.

Let me add. If we -- on the spin it requires more permission. On the sales it requires less permission. That is going to the bank group as to use of proceeds basically and since we have disclosed that we would use those for deleveraging, we don't think that would be a big issue.

Just secondly, could you remind me where stand now on NOLs? You had sort of mentioned I'm assuming you had --

Yes, we have on our balance sheet at the end of '05, we have roughly an $875 million asset that is fully reserved that if you grossed that up and look at the NOLs, that's well over $2 billion worth of NOLs that have not been recognized in the financial statements. Again as part of the potential structuring of a transaction, that gives us a favorable position because we can utilize those NOLs to a prospective buyer whether it is in one form or another to give them advantaged tax position and obviously we have the NOLs to absorb that. Obviously we would expect to get value for that.

Right. Could you just address how the additional volume would play out, just give us a sense of the additional procedures that would be opened to your outpatient surgery centers?

Mike, do you want to address that?

Initially the 14 procedures that are coming in are orthopedic spinal type procedures. We have not fully analyzed what we (technical difficulty)

(OPERATOR INSTRUCTIONS)

-- is a real positive, though. We are starting to see the parity in terms of where the procedures can be provided, which is long overdue. If you think about the original list was created at a time when there was not a lot of certainty about could these procedures be done safely in an ASC environment? Clearly the evidence overwhelmingly says yes, they can. So we are very encouraged by this. We think that this is the beginning of a trend. We think that that will continue to occur over time.

Then the other thing that you have to think about it is a lot of cases that we would -- that would qualify I should say for an ASC are being done in HOPDs primarily because of the convenience for the surgeon. They will have a case that has to be done there because it is not permitted in an ASC and then will have to follow cases, some of which can come over. So not only will we get the new procedures resulting from the addition of those 14 categories, but we also think we're going to get some additional pull through as surgeons are now able to provide that care to their patients in a lower-cost, higher quality, more patient-friendly kind of ASC environment.

Two questions regarding the spin-off. (technical difficulty)

Yes.

(technical difficulty)

Sure, it depends on how much debt we were able to put on it and that is on each of the segments. That is one of the things that we want to look at and evaluate and determine what the capacity is, what the tolerance is in the credit market. But the answer to your first question, yes, it would require (inaudible) consent.

-- think about strategic development and opportunities going forward? Can you expand on that a little bit?

Sure. The question is what is Cynthia Dotson, our Chief Development Officer going to be doing? First what she has done is she has brought an enormous amount of discipline and process to our development activities. We have now shared that and sort of given our senior vice presidents in the inpatient division the knowledge that they need to be able to go out as really development people because they are the ones out in the markets, they are the ones that have the relationships with our competitors to begin that process. Basically we're going to be looking at three things.

First is as we've said all along consolidations within the IRS space. If you recall on the first quarter I said there were about 20 projects we had in the pipeline. We now have 40 projects in the pipeline. We are very encouraged by the level of activity in the IRF space. So what we want to do is we want to go out, look at our competitors in existing markets where they are struggling with the 75% Rule and complying with the thresholds and to then enter into discussions with them whereby we would acquire that business or we would joint venture that business with them and bring that business, bring that volume into our facilities.

Second would be the acquisitions in either existing markets or new markets and we are actually looking at some one-off acquisitions in non HealthSouth markets. Then the third thing would be going in and looking at de novo sites. We mentioned the two Virginia facilities. We've identified several other markets that are underserved by inpatient rehabilitation where we think we would be able to go in and build a brand-new IRF.

We are also looking at the same kind of development activities in the LTCH space. In that instance we're being a little more cautious because of the restrictions there and that we think are coming with the admission criteria that will be established a little bit later, but we do think that there is a very nice growth opportunity for long-term acute care facilities in the appropriate setting where we can get the acutely levels that are really appropriate for LTCHs.

She will be devoting most of her attention on that. We're going to continue to pursue growth opportunities in the other segments and one of the things that we are now going to the turning our focus to is establishing that pipeline in our surgery division. What we wanted to do first in surgery was make sure that we had our operations in place and that we were addressing the needs from a resyndication standpoint. We have achieved those and so now we're moving into looking at the growth opportunities that are there in that segment.

So do we have a question from the phone?

Derrick Dagnan, Avondale Partners.

While we are waiting for the technical hook-up to get us a question from the phone, we'll take a question from the back.

Just following up to your comments now, can you talk about other areas of postacute that you've talked about the past, including SNF? And although it is on the outpatient side you've also talked about home health at some point in the past.

Right now for the immediate term our focus is going to be in inpatient rehabilitation and in long-term acute care. However, we do believe that there are very nice growth opportunities in home health and home hospice. If you look at both of those segments, they're both going in that 8% to 10% plus range year-over-year. I think CMS likes those services because they are a lower-cost alternative to some of the other postacute settings and in both instances they are highly, highly fragmented. So as we go down this road of an integrated postacute payment methodology, we think that is going to lend itself very nicely to an integrated approach where a large-scale efficient provider like HealthSouth can come in and provide high-quality care at a to low cost.

I think we now have the phone systems working. So if we could take a question from the phone lines.

Derrick Dagnan, Avondale Partners.

Thanks for taking my question. I was wondering if you could comment on the CMS rule for imaging centers that was recently released? Maybe in comparison to your expectations and then possibly on the impact for the prospects of selling that division.

Mike, do you want to handle that?

I'm assuming you're talking about the DRA in the multiscan limitations. There is no question it is going to be detrimental on the division. We'll have to see how that plays out with -- we know that Congress is looking at ways to try to fix the physician fee schedule. And whether or not this gets wrapped up in that and there is some abatement of the rule remains to be seen. So I think we're just going to have to let that play out, but we have taken that into consideration as we have forecast this division going forward.

So we still believe that on a net basis, net of division overhead and net of corporate overhead that segment is going to be a $20 million to $25 million EBITDA business inclusive of the impact of the Medicare regulations.

(technical difficulty) Deutsche Bank Securities.

Just a question with the pipeline build that you are anticipating I think in the inpatient business. I kind of have a recollection of 125 to say 150 of CapEx spend as being your need. Is that changing significantly? Could you just talk more about your CapEx needs with this extra growth opportunity?

Clearly the CapEx needs are much greater than the ability to fund those needs at the 140 level. That is pretty much what can afford with today's debt load over the next five to six years. We can essentially maintain a $140 million CapEx spend and still meet all of our other obligations. That is really the problem that is created here or the opportunity actually -- we should really look at it from that perspective. We see so much growth not only in the inpatient and LTCH space but also in surgery that as we looked out over the next five in six years and determined how much CapEx we would need, we realized that it was significantly greater than that 140 per year.

Now after we divest of surgery, outpatient, and diagnostic, there will still be a lot of cash flow coming from the inpatient division and we anticipate that the CapEx spend will be a little bit less but not appreciably less than 140 and we would be able to fund that very easily.

One other thing I would add about some of the growth opportunities in the inpatient division, as we have said before, some of those are joint ventures which require no cash or if they are acquisitions that we pay for over time, that really those are kind of cash neutral because the incremental EBITDA coming in from those if we can pay for it over time almost are self-funding, reminding everybody that if it is a capacity issue in those circumstances and what we're doing is bringing over the volume on incremental margin rates, which look very attractive to us. So that can help diminish some of the CapEx, but as Jay said, it will be at least the same level but more obviously deployed in the inpatient division.

Okay, so the time being and before the sale and the spin, you are going to maintain that 140 spend level?

Yes.

Okay. The last one just on the compliant cases. I don't know if I heard it and you may have put it out there, I just haven't gotten through everything. Currently where are you with the compliant cases in the inpatient side?

Our compliance case growth was 4.8% over the second quarter last year and if you look at our overall portfolio in compliance we are in the 62%, 63% range. So we are within striking distance of the 65% threshold that many of our facilities will have to start achieving and meeting in the first part of '07.

So at this point, you don't really see that a barrier or an issue for you, the 65% level?

No, and in fact we think that there are going to be continued growth opportunities. We are able to weather this fairly well because of our focus on our marketing efforts and the fact that our hospitals have historically been known for neurological care and taking care of stroke patients and so on, which obviously are exactly what the 75% Rule is intended to attract. So we think that the 65% threshold is going to be easy to obtain.

Thanks very much.

-- ballpark (technical difficulty)

The sale would not if it meets certain criteria. It has to meet certain criteria, as you know, fair market value and use of proceeds. There's criteria that allows that to happen.

Mike, on the orthopedics?

Ortho, the exact percentage escapes me but it's in the 20% zone. I don't remember exactly what it is.

I was hoping you could clarify again the time line on this. I think you said about one year. Could you be a little more specific there? Is there any concern that if this were to in fact go out for a year it would potentially have impact, say, on the surgery center business and volumes?

Then secondly it looks like you are almost to 65%. What about 75%? Just curious on as you are going through this transition process, how do you assess that last leg going all the way up to 75%?

Finally on the investments you've been making in IT and clinical systems to better manage the business, is any of this impacted as a result of the spin? Does this change your outlook for CapEx in those areas?

All right, in terms of the timing, we are saying up to a year to give ourselves as much flexibility as we need. Clearly we want to move this process along as fast as we possibly can. One of the primary gating items is going to be getting carveout financials, and that is something that we have started talking with our internal auditors about. We are getting a sense that that is going to take may be three months to accomplish to get that for the segments, maybe a little bit longer. At the same time we will be exploring the spin alternatives and starting to model that. We need to put the marketing material out. We've had a lot of interest in the surgery division. So we are going to have to start whittling that down and seeing, making sure that we have potential buyers there that would be able to close a deal.

So there is a lot of work and I am trying to set the expectations for everybody. As I said before, if we can do it faster than that, we certainly would want to do that. Do I think it is going to have a negative impact on the surgery center business? Actually no. I think it will have a very positive effect because the surgeons know that they are a bit of an outlier in the company. The company really does not have a cohesive theme more strategy. It is four very different businesses that happen to be under one umbrella. And by recognizing that and acknowledging that there aren't any financial synergies, there aren't any operational synergies, and by then saying we're going to divest the ambulatory segments and focus on the postacute care segment, I think is going to be seen as a positive by the surgeons and I think that it is going to be seen as a positive by the employees and the surgery centers.

In terms of IT spend, most of the big costs that we are incurring from an IT perspective are really in two areas. One is upgrading our financial system and implementing the new PeopleSoft upgrade. That will obviously continue, but to the extent that it has implications in the ambulatory divisions, those costs obviously would go away. The other is we have not begun this process yet but we are looking at a clinical information system for our inpatient division, and those would be two big spans on a go forward bases. Clearly that second piece would not be affected.

Just if I could add to that, currently we are implementing in the inpatient division a new revenue and billing collection system, PatCom, that should be done by late '06 and we talked about in the diagnostics division the IDX implementation. So those two are underway. It does kind of get the Company to have a common platform by division at least at that point in time.

A question for John. John, on the NOLs, $2 billion seems about greater than what we had modeled. So I want to get (multiple speakers).

I think -- I should have described -- that is either existing NOLs or if you look at our deferred tax footnote, you'll see there's several items that are reserves that as those are paid become tax deductions. So I am thinking through the $2 billion which is the existing NOLs plus as we pay the DoJ settlement, that becomes tax-deductible. Those types of things become future tax deductions.

And then something about a decade out for my tax factors class. What is the applicability of the NOLs to the divisions, i.e., does the tax law in surgery get associated with the (multiple speakers)?

It is hard to move the NOLs with the divisions. What we were characterizing is something a little bit different. If you think about the surgery division being sold for maybe twice its tax basis, what we can do is to offer a buyer a step up in that tax basis so they get the benefit of future deductions, which would result in taxable income to HealthSouth. Obviously with our large NOLs we can absorb that and it is a way of monetizing part of that NOL too. Because you look at $2 billion worth of NOL the Company staying as is, it is going to take quite some time to monetize those. So this is a way on a potential buyer to put something into the pot if you will that is a sweetener but we would expect to paid something of that obviously.

Other questions? All right, well, thank you all for coming. I appreciate your being here this morning with us.