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Operator
Ladies and gentlemen, thank you for standing by and welcome to the Pediatrix Medical Group Investor Conference Call.
At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session; instructions will be given at that time. (Operator Instructions). As a reminder, this conference is being recorded.
Ladies and gentlemen, certain statements and information during the conference call may be deemed to be forward-looking statements within the meaning of the federal Private Securities Litigation Reform Act of 1995. Forward-looking statements may include but are not limited to statements relating to objectives, plans and strategies and all statements other than statements of historical facts that address activities, events or developments that we intend, expect, project, believe or anticipate will or may occur in the future are forward-looking statements. These statements are often categorized by terminology such as believes, hope, may, anticipate, should, intend, plan, will, expect, estimate, project, position, strategy, and similar expressions are based on a subject and assessments made by Pediatrix management in light of their experience and their perception of historical trends, current conditions, expected future developments, and other factors they believe to be appropriate. Any forward-looking statements made during this call are made as of the date hereof, and Pediatrix undertakes no duty to update or revise any such statements whether as a result of new information, future events or otherwise. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties. Important factors that could cause actual results, developments and business decisions to differ materially from forward-looking statements are described in Pediatrix's most recent annual report on Form 10-K, including the section entitled "Risk Factors." Additional factors include but are not limited to uncertainties related to the possible discovery of additional facts beyond these reviewed by the audit committee in connection with its stock-option review, hostile litigation related to the matters investigated by the Pediatrix audit committee or the reinstatements to Pediatrix's financial statements and other historical disclosures and any regulatory actions of the SEC or the U.S. Attorney related to such matters.
I would now like to turn the conference over to Dr. Medel. Please go ahead.
Dr. Roger Medel - CEO
Thank you. Good morning. Thank you for taking the time today for our conference call, one that we've been eager to host for quite some time.
Today, we're glad to share with you Pediatrix's financial results and to talk about the great things happening for our company and our excitement about our future.
As we reported late last month, the audit committee's independent options review is complete. We're disappointed by the historical shortcomings of our processes and controls which were identified during the review. While we have worked hard over the past several years to put strong controls in place throughout the organization, we did not achieve an acceptable level of controls in this area. During the past year, we adapted our processes and controls for stock options, and we are committed to implementing the additional recommendations for our audit committee going forward.
We are pleased to be able to say that our SEC filings are now current. Our 10-K for 2006 has been filed, as have our 10-Qs for the 2006 second and third quarters and for the 2007 first quarter. Since we've released our second-quarter results this morning, we also expect to meet the filing deadline for our June 30 10-Q later this week.
Over this past year, I'm sure that you've been frustrated because we've been unable to provide you with information needed to understand the operating results of our business. I want to thank all of our shareholders for their patience, as well as for the support that we have received during this time.
We've been issuing quarterly revenue cash position and accounts receivable information so shareholders have had a sense that we continue to grow our business. Today's information should validate that we're not only growing but executing on our strategy of managing our business more efficiently.
With the issuance of our guidance for the remainder of 2007, we're confident that we will continue to grow earnings of our core sub-specialty at historical levels. In addition, following the Board of Directors' authorization, we expect to use up to $100 million of our cash to make open-market purchases of our common stock.
Karl Wagner, our Chief Financial Officer, will walk you through our financials in a few minutes. The focus of this call will be our full-year 2006 results, as well as the results of the first half of 2007.
In addition, I want to spend some time talking with you this morning about the highlights of the past year. Throughout 2006 and in the first half of 2007, we've grown our business in that we continue to make acquisitions within our core sub-specialty. During 2006, we added eight physician groups, including a very large neonatal and pediatric subspecialty practice in Atlanta. So far this year, we've added three physician groups. The pace of completed acquisitions has been slow this year, but we attribute that to deal-specific issues and timing. Our pipeline is full, and there are several transactions that we're moving toward closing in the near future. We're confident that there are still many opportunities for growth within neonatal, maternal [field] and pediatric cardiology physician subspecialties.
During the past year, same-unit growth has eclipsed acquisition growth, as we had a one-time benefit from the new neonatal intensive care code 99300 that better recognized some of our physician services. Going forward, we expect that growth of our core business will be balanced between acquisitions and same-unit growth.
We continue to manage a strong cash generating business, and most of our cash flows are available to reinvest in growing our business. For 2006, cash flow from operations of $177 million exceeded our guidance, even after we paid $25 million to settle the Medicaid investigation.
With the completion of or filings, we've now lifted a significant overhang that prevented you from understanding how our business has been performing. We had a great year in 2006, and that continues into 2007. These results are in the context of a company that has performed well over an extended period of time and remained focused during the last year. The ability to maintain our focus is a product of the depth of our management structure and the quality of people who are a part of this organization, both here at headquarters and throughout our regional network across the country.
For the past two years now, we have been talking about our new growth platform. During that time, we analyzed the anesthesiology opportunities, made some modest infrastructure investments, and have proceeded with due diligence with the expectation that we will close our first anesthesiology practice in the near future.
At the same time that we have been working on this new initiative, we have continued to grow our core business. As I have said in numerous venues, I remain confidence that there are opportunities for us to continue to attract physician groups within our course subspecialties. I also believe that we will continue to see modest growth from commercial reimbursement and patient volumes. I think our numbers reflect our ability to manage our business.
Let me call attention to something that might be obvious. Our operating efficiencies are the result of a core competency of managing the administrative functions of hospital-based physician practices. It is that core competency that we believe is transferable to anesthesiology. Throughout this process, we have been talking with you about anesthesiology as a new opportunity, and I've taken responsibility for setting an expectation for our entry into this specialty. I know that many of you are anxious for us to pull the trigger on that first transaction.
I want you to know that we have been building some of the infrastructure that's required for us to manage these anesthesiology practices. It's been modest and focused on operations, coding and collections. We have made these infrastructure investments without changing the positive direction of our general and administrative expense management. These are people who are working with our business-development team to understand the practices we're looking at and they're working with various departments within Pediatrix to understand the right way to integrate these future practices.
We remained committed to our decision to build a parallel infrastructure for anesthesiology and there are two important reasons for that. First, for all of the similarities among hospital-based physician groups, there are many differences, and we've learned to respect those differences in other sub-specialties and second because we don't want to do anything that might jeopardize what is working so well within our core operations. We remain excited about as anesthesiology as a new growth platform for our company. by now, investors should know that we will be thorough in our approach to this opportunity.
We continue to move through the due diligence process, a process that is more time consuming than for our neonatal practice, principally because this is a specialty we're still learning, these are larger practices with more partners and more employees and more contractual issues to be completed before closing. We're also optimistic that we can add value to these practices, and that's what will create a new long-term growth driver for us. The opportunity for us in anesthesiology is to try to replicate the kinds of efficiencies that we have been seeing in our existing sub-specialties.
Of course, I think the real story behind our numbers is the income statement levered, our ability to add practices, and the revenue relates to those practices at a rate significantly faster than the infrastructure required to support those practices. The story is best told in looking at the details of our income statement. So, let me turn the call over to Karl for the financial statement review.
Karl Wagner - CFO
Thanks, Roger. Good morning, everyone. It's a pleasure to be here talking to you today about our complete financial results.
As Roger said, this call is intended to bring you current on our financials, and so we will focus on our results of operations for the 12 months ended December 31, 2006 and our 2007 second-quarter and first-half results and the financial guidance for the remainder of the year.
Our annual report on Form 10-K, which was filed this morning, is a detailed explanation for the restatement of our financial results. A discussion of the restatement also includes detailed quarterly balance sheet and income-statement information for the quarterly periods of 2005 and the first quarter of 2006.
Before walking through the results we reported today, numbers that demonstrate that we remain focused on growing our business, I want to discuss some of the items that make it difficult to use GAAP financial statements as a sole barometer for the business trends. To that end, I will discuss comparative information on a non-GAAP adjusted basis that excludes several items. Those items are identified in today's press release with appropriate reconciliations, which are available on the Investor Relations page on our corporate Web site at www.Pediatrix.com.
In comparing the full year of 2006 to 2005, we've adjusted for the following items. Equity-based compensation expense was $11.9 million in 2005 and $20.1 million in 2006 and were allocated to both practice expense and general and administrative expense. These expenses were the combination of the restricted stock grant awards and adoption of FAS 123R, expensing stock option grants, at the beginning of 2006.
Our 2005 results reflect the $20.9 million increase in reserves associated with the national Medicaid investigation that was resolved in September of 2006. In the 2006 second quarter, we reported a pre-tax gain of $1.6 million on the sale of our corporate aircraft, and that's included in the GAAP G&A expenses, costs associated with the stock-option review of $4.8 million that were incurred in the second half of 2006. As I said before, all of these adjustments are itemized by applicable periods in the GAAP reconciliation tables in our press release.
For purposes of this discussion today, income statement items discussed will be presented on a non-GAAP basis adjusted according to the items identified and in our press release, unless specifically noted. I'm going to use these adjusted numbers in my comments to make it easier or for you to understand how our core business is performing.
When adjusted, the numbers show that the nature of growth during 2006 primarily reimbursement-related increases, flowed through our income statement in a way that resulted in operating income leverage and of course operating-margin expansion. That trend of operating leverage continues through the first half of this year.
You are familiar with our revenue numbers, which we have been reporting throughout the past year. As a reminder, revenue increased by 18% during 2006 as compared to 2005. Now, it's comprised of same-unit growth of 11.9% and acquisition-related growth of about 6%. Same-unit growth in 2006 included the impact of the new neonatal code that Roger mentioned earlier on the call. The impact from this code was not fully realized in the first part of 2006 because some payors did not recognize the code as of the first of the year.
As for our payor mix, government payors were 54% of our overall patient volume in '06, which is the same rate as in 2005. While the payor mix for patient volume remained consistent with the prior year, we did realize a slight improvement in our net payor mix as a result of positive reimbursement trends in our contracted business.
Moving down the income statement, our profit after practice expense grew in line with revenue growth. Clearly, with our model, our direct costs are growing roughly in line with our revenue. There are a few reasons for that. First, more and more of our physicians are participating in our bonus plans, which allow them to earn 50% of income growth above certain levels. Second, our office-based practices have a different cost structure than hospital-based practices, particularly higher rent and supply expenses. As we have grown in our office-based practices, particularly pediatric cardiology over the past few years, we have higher practice supply expense as a percent of revenue.
For 2006, our profit after-practice expense was $321.8 million, up 17% from $275.1 for 2005.
A significant part of our financial success continues to be our management of General and Administrative expenses. That's been the consistent driver of operating margin expansion over the past few years. G&A expense grew at a rate of 4.8% for all of 2006. This spread between our revenue growth and G&A expense growth in 2006 is a byproduct of the nature of our revenue growth for this year.
About 60% of our same-unit revenue growth during 2006 was related to reimbursement, either better contracting rates or the impact of new neonatal code. It cost us the same to collect for services billed under this new code, for example, as it did for the codes that it replaced, but obviously our revenue for each billed code is higher.
Obviously, G&A expense as a percent of revenue has been declining, leading to expanded operating margin. During 2006, G&A expense was 11.1% of revenue, which was down 140 basis points from 12.5% for all of 2005. As we've said all throughout this call, G&A expense management is a catalyst for our expanded operating margins.
Operating income for 2006 was $221.8 million, up 24% from $178.8 million for 2005, resulting in operating margin for 2006 of 27.1%, up 132 basis points from 25.8% in 2005.
Moving on, net income grew by 25% to $139.8 million for 2006 from $111.5 million in 2005. After considering those items that affected comparability, EPS for 2006 was $2.83, up 22% from $2.32 adjusted in 2005.
At this point, I'd like to shift to our 2007 second quarter, which was announced in a separate press release this morning. There are several items that make comparison 2006 and 2007 difficult, so I want to exclude those for purposes of this discussion. As I said earlier, these items are detailed in our press release available on our Web site, but they include the gain of $1.6 million on the sale of our aircraft in 2006, costs of $6.4 million during the 2007 first quarter that related to employee benefit expense associated with taxes under the Section [409-A] of the Internal Revenue Code, costs associated with a stock option review during the 2007 first half. For the first quarter, these costs were $1.5 million and $1.8 million for the second quarter of this year. As you might imagine, there will be additional related expenses beyond these periods. Our last piece is the tax revision for the 2007 first quarter was reduced by $1.2 million as a result of the expiration of a statute of limitations on certain tax positions we take.
For our discussions of 2007, we will no longer adjust for equity-based compensation expense, as these costs are accounted for in the same manner for both the current period and prior year. Our revenue of $226.8 million for the three months ended June 30, '07 was up 11% from $203.8 million for the same period in '06, driven by solid, same-unit growth of 8.7%. Same-unit growth for the 2007 second quarter for patient volume was 5.3%. That includes neonatal intensive care unit patient days growth of 4.2% on a same-unit basis and continued contributions from our maternal/fetal medicine and pediatric cardiology physician practices. Reimbursement-related same-unit growth came principally from improved contract and reimbursement from commercial payors, the impact of our annual fee increase, and some slight improvement in the new neonatal code.
For the second quarter, profit after practice expense grew by 12.1%, or slightly faster than revenue growth for the period, to $90.5 million, and profit margin after practice expense increased by 28 basis points to 39.9% for the 2007 second quarter compared with the 2006 period.
The trend of strong G&A expense management continued in the second quarter of '07, leading to operating income growth that exceeded revenue growth. G&A expense increased by 6% for the 2007 second quarter from the prior-year period and was 12.4% of revenue for this most recent period. This compared to 13% for the second quarter of '06, a 62 basis-point decline.
Operating income of $60 million for the second quarter was up 16% from $51.9 million for the comparable 2006 period. Operating margin was 26.5%, up 99 basis points from the 2006 second quarter.
Our effective tax rate for the quarter was 39.25%, which increased as a result of the adoption of FIN 48, which I will discuss in a moment, as well as changes in the state tax laws in Texas.
Net income for the 2007 second quarter was $37.4 million, up 15% from $32.6 million from the year earlier. Second-quarter earnings per share of $0.75 was up 13% when compared to $0.66 for the 2006 second quarter, and our weighted average shares outstanding were $50.1 million for the second quarter as compared to $49.5 million for the 2006 period.
In looking at our balance sheet, this discussion would be little easier to follow without all of the non-GAAP/GAAP comparisons. At June 30, 2007, our balance sheet continued to be strong. We had $136.6 million in cash, $132.8 million in accounts receivable with a DSO under 60, and virtually no debt. Our biggest liabilities were accounts payable and accrued expenses, which were $170.3 million at June 30 and include accruals for incentive composition and 401(k) matching payments, which are primarily paid during the first quarter of each year.
For all of 2006, cash flow from operations was strong at $177.3 million. It's important to note that this number is after we paid $25.1 million to settle the Medicaid investigation.
During 2006, we invested $91.8 million in group practice acquisitions, including four neonatal physician groups and four pediatric cardiology practices. During the 2007 second quarter, we generated cash flow from operations of $67.1 million. Maintenance capital expenditures remain minimal at about $1.9 million for the quarter.
Looking at the highlights of our results for the 2007 first half, which I will mention on a GAAP basis only, our revenue is $441.3 million, which is up 13% from the first half of '06. Operating income was $96.8 million, which includes expenses of $9.7 million associated with the stock option review and accruals for payments related to Section 409-A.
Net income was $61.9 million. Earnings per share was $1.24 based on a weighted average of 15 million shares outstanding. These compare with revenue of $391.5 million, operating income of $91.1 million, and net income of $56.9 million, and earnings per share of $1.16 based on a weighted average 49.2 million shares for the first half of '06.
Through six months of 2007, we generated cash flow from operations of $36.3 million, which includes negative cash flow during the first quarter as a result of bonus payments, principally to physicians, as well as tax payments related to 2006 that were pushed into the first quarter of this year.
Year-to-date acquisition spending is approximately $16 million, which includes neonatal practices in San Francisco, California, in Munster, Indiana acquired during the first quarter, and a San Antonio, Texas pediatric cardiology practice we acquired early in the third quarter.
This has been a fairly extensive review of our financials, and I want to thank you for your patience on this.
Before talking about guidance that we issued this morning, I want to discuss the impact of FIN 48 on our 2007 results and go forward. FIN 48 is an accounting interpretation that requires us to evaluate the positions we've taken on tax returns and adjust reserves as of the beginning of 2007. The evaluation is based upon specific criteria as outlined in the interpretation and resulted in an increase in our reserves for certain tax positions that we've taken on our tax returns.
We now expect our effective tax rate to be 39.25% or 1.5 points higher than for all of last year. This change is not limited to our adoption of FIN 48, but also includes changes in state tax laws in Texas. We also expect there may be considerable variability in our tax rate because certain statutes of limitations may expire on previously filed tax returns.
At this time, I would like to discuss the financial guidance we issued, along with our results for 2007. As we stated in our press release, we expect to earn $1.58 to $1.62 per share during the second half of '07. When added to our actual results for the first half of the year, we expect to earn $2.82 to $2.86 per share on a GAAP basis, or $2.91 to $2.95 per share when adjusting to exclude the cost associated with a benefit from a lower tax provision in the first quarter of this year, employee benefit expense related to Section 409-A, and stock option review expenses that's incurred in the first half of the year. This compares to 2006 GAAP EPS of $2.52.
I know it's been a while since we've been able to discuss guidance and to provide any meaningful update on our numbers. Assumptions behind our guidance include continued neonatal intensive care patient unit volume growth of 3% to 5% on a same-unit basis and favorable third-party reimbursement of between 2% and 4% for 2007. Our first-half same-unit growth exceeds those guidance metrics but those resulted in some benefit from the new code, which we have lapped at this point.
We're also expecting some modest contributions to investments of between $50 million and $55 million of our capital in core physician group practice acquisitions for the full year. Our guidance does not include any estimates for anesthesiology group practice acquisitions.
Our revenue assumptions will be impacted by changes effective and proposed on the reimbursement front. We are expecting that our Medicaid reimbursement in Texas will increase effective September 1 as a result of the state agreeing to raise reimbursement for physicians participating in the Medicaid program. But we don't know the full impact, as rate-specific services have not been finalized.
On the other hand, we do need to caution that a proposed CMS rule could impact our pediatric cardiology practices. Specifically, CMS is proposing to bundle a specific CPT code relating to imaging studies into one of several existing codes for services provided in conjunction with this study. This study is performed fairly frequently by our pediatric cardiologists. Unfortunately, CMS' proposal to include these images services under existing codes does not come with corresponding increases in reimbursement for those codes. We are working with physicians within our group and outside of Pediatrix to try to reverse this proposed rule but there is no way we could predict the outcome of our advocacy efforts. We do think it's important to mention this to you at this time. While we are still working through the estimated impact of this proposal, it could equate to the significant proportion of the improvements we expect from Texas Medicaid going into 2008.
We know that there will be additional expenses related to the stock option review, beyond what was incurred as of June 30, and our guidance does not include any of those costs. We do expect that general and administrative expenses, as a percent of revenue, will continue to be a leverage point on our income statement but just not at the level we experienced in 2006.
I want to remind you that our 2007 guidance incorporates the higher effective tax rate for 2007. That change alone accounts for a reduction of approximately $0.07 of estimated earnings per share for the year when compared to the effective tax rate for 2006.
Finally, our Board of Directors has authorized a repurchase of up to $100 million of our shares through open-market purchases. These purchases should be expected to occur from time to time and are subject to market and economic conditions. We do not include any impact of the share repurchase in our guidance (inaudible) a company that has continued to grow and to be managed more efficiently. Our guidance for the remainder of the year suggests that we expect to continue along the trajectory of the recent past.
At this time, I want to turn the call back to Roger for a few additional comments before we open this up to your calls.
Dr. Roger Medel - CEO
Thanks, Karl.
Finally, I want to add some perspective to the numbers that Karl has discussed this morning. We have a long track record of growth at Pediatrix, growth that comes with significant operating efficiency. While we report our results and talk with you on a quarterly basis, we really do manage our business for the long-term. We have seen consistent, solid revenue growth for an extended period of time. Consistent with our discussion of recent results, our long-term success comes largely (inaudible) the product of managing our business (inaudible). These results over this extended time period are not an accident. They point to an organization that has a deliberate strategy, a durable business model and the ability to execute. Sure, for any number of issues, there has been and will continue to be quarter-to-quarter variability but we have assembled a track record of solid, long-term performance.
With that, I would like to open up the call for questions. Operator?
Operator
(OPERATOR INSTRUCTIONS). Art Henderson, Jefferies & Co.
Art Henderson - Analyst
Good morning. Thanks for all of the information and congratulations on getting all of this behind you. I know that that's a relief.
A couple of questions -- you talked about, Karl, the Texas Medicaid situation sort of improving from a reimbursement perspective. I understand you don't know where the rates are but do you have any sort of idea as to what we're talking about in terms of magnitude? Any sort of range that you could talk to?
Karl Wagner - CFO
You know, I hesitate to do that just because the ranges have been all over the place, and we've got -- seen proposals over the last couple of months from 5% increases to 30% increases. So, I'm a little hesitant on where it's going to come out. We do think it's going to be probably the middle of that or better, but until they are done, we're just never really comfortable on saying where it's going to be. As the political process works, things tend to change and shift. We're watching it very closely and we are in there doing advocacy to try and make sure that the rates are representative of our services, but it's hard to say where it will come out.
Art Henderson - Analyst
Okay, that's fair. That would start up in September?
Karl Wagner - CFO
It's supposed to be effective September 1, but administratively, if they don't get the rate set pretty soon, I don't think they'll be able to have that occur, so that's going to be part of the issue as well.
Art Henderson - Analyst
Okay. I take there's nothing in your guidance that assumes higher reimbursement.
Karl Wagner - CFO
We've not build that into our guidance for this new Texas Medicaid change in that, you know, there's some uncertainty as to it.
Art Henderson - Analyst
Okay, that's fair. On another issue, is there any commentary you could make about what's being talked about in the House SCHIP Bill or what's being talked about in the Senate that might have some bearing on your business as it relates to the things that they're talking about? Could you just kind of go over where we stand on those bills?
Karl Wagner - CFO
Yes, just real quickly, one, I mean, SCHIP is a very small part of our business. I mean, when you look at our government payor mix, most of it is all Medicaid. Now, we're watching these bills very closely because there's some potential for expansion. What we've been seeing, one, are arguments that something needs to be done about pushing people out of commercial insurance. SCHIP seems to be being heard at least at some point and we're getting advocacy as well from the insurance companies out there to try and make sure that doesn't happen. So that's a positive in going through it.
But the two bills that are out there at this point are significantly different and it's going to be a difficult process to reconcile those. So, we're watching it. We have advocacy involved. We do have a lobbyist up in Washington to help us watch this and making our points made to the right people as well as people from here being involved with that. So we're watching it very closely. It's kind of hard to say where it will come out at this point.
Art Henderson - Analyst
Okay, one last question and I will jump back in the queue. Obviously great work on the SG&A over the past few quarters. Are these levels that we are seeing here today sustainable? Is there potentially some more improvement that we could see, or is this kind of a comfortable level where we could operate for awhile?
Karl Wagner - CFO
Well, we're comfortable where we are at from a G&A standpoint, and we always strive to keep the growth rate in our to G&A expenses lower than our revenue growth rate, so we will continue to try and improve our operating margin from that standpoint. But we're very comfortable with where we are at this point and wouldn't see that going the other way for [certain] over time.
Art Henderson - Analyst
Okay, great. Thanks, very nice quarter.
Operator
Kevin Ellich, RBC Capital Markets.
Kevin Ellich - Analyst
Good morning, guys. First off, I was wondering if we could get a status or an update of the SEC and the U.S. Attorney investigations on the stock option review.
Karl Wagner - CFO
At this point, you know, they are undergoing investigations and we're really not going to go in and any comments specifically on what's going on. You know, there is some disclosure in our financial statements about that. We are cooperating with them through this process but there's really not more we can say about that.
Kevin Ellich - Analyst
Okay. Then does Pediatrix have any plans on taking any legal action against Larry Mullen for the stock option issues?
Karl Wagner - CFO
You know, at this point, we're not commenting on the stock option review. I think all of the information that is out there in the press release and in the filing is about what we're going to talk about the process that went on.
Kevin Ellich - Analyst
Okay. Moving onto anesthesiology, I was wondering if Roger could give us an update as to the status. You know, I heard the prepared marks but I'm wondering if we are very close. Then also, I believe there were some proposed changes in the physician fee schedule that would actually improve the reimbursement. I was wondering if that would impact the acquisition valuations for anesthesia.
Dr. Roger Medel - CEO
Yes, good morning. I would say we are close. We've been, as I said in my prepared statement, we've been going through a due diligence process that has been very thorough and we're very comfortable with what we are seeing. I would definitely expect to see a transaction before the end of the year.
As far as the reimbursement, yes, we have seen the same things that you have seen but again, like Karl had said earlier, it's hard to predict because there was one point where we were worried not too long ago about a cut in the reimbursement. So yes, we've seen that there is potentially going to be an increase in reimbursement for anesthesiology and that clearly helps.
Kevin Ellich - Analyst
Well, I guess, to that point, Roger, does it impact the valuations? I mean, do the multiples go up on the transaction then?
Dr. Roger Medel - CEO
Not because of that point. I mean, it's all up in the air. I would say, clearly, if it does happen and two years from now, some groups are seeing better reimbursement, it wouldn't necessarily drive the multiple up. It would drive up the amount that we're paying for them but it wouldn't necessarily drive the multiple.
Kevin Ellich - Analyst
Okay, that makes sense. One last question then -- you know, you mentioned that there were some deal-specific issues that were holding up the neonatal acquisitions. I was wondering if we could get any color or commentary regarding those deal-specific issues.
Dr. Roger Medel - CEO
Sure. You know, this is something that we see occasionally, you know. Every few years, we will have a year where things just seem to go south. My major point was that this isn't a problem with our pipeline; it is a problem that you'll go into -- you agree to price, and you'll agree to a number of issues and then you will get in, you know, to get the due diligence time and all of a sudden, there will be a problem with a physician, or there will be a problem with maybe the way they code for services, or there will be a problem with the hospital. So you know, when I talk about deal-specific issues, that's what I mean. I mean that this is nothing that we see that's infecting the neonatology acquisition process; it's just that we've had some issues come up with specific deals. Each issue has been different and has been specific to those groups and that has kept us from going ahead and completing the acquisition.
Kevin Ellich - Analyst
Okay, congratulations on ending the -- well, getting the filings done. I will hop back in queue. Thanks.
Operator
Bill Bonello, Wachovia Securities.
Bill Bonello - Analyst
Good morning. Just a couple of follow-up questions -- I'm trying to understand why the CMS proposal on the bundled CPT code would impact your reimbursement. Is it the assumption that, if CMS makes that change for Medicare, then states and commercial payors will make a similar change, or how does that flow through?
Karl Wagner - CFO
Yes. The expectation is, when CMS comes through and bundles this code so that can't be used any more, that we will see the same thing with Medicaid and with commercial payors, where they will not be utilizing -- we won't be able to utilize that code any more. Unfortunately, the methods it's gone through in this process, it hasn't followed the typical process of validating RVUs before making the change, which may make a reimbursement change in the code it's getting bundled with. So right now, the proposal would have no increased reimbursement for that code that it's getting bundled with that the physicians are currently providing once it includes these services. So that's where the concern is.
Bill Bonello - Analyst
What ability do you have, particularly with the commercial payors, to negotiate on that front?
Karl Wagner - CFO
Well, you know, it can be very difficult. Clearly, we would have to negotiate that, but typically they will follow CMS rules as far as some of those specific issues go and will have that in their contracts. So we would have to negotiate away from that rather than having the ability to keep where we're at. So we will be negotiating a loss back to a positive versus having the positive continue and then negotiate to try and prevent the loss.
Bill Bonello - Analyst
Okay, so typically, the contract is to follow CMS on the code?
Karl Wagner - CFO
In a lot of cases, that's the way it would work.
Bill Bonello - Analyst
Okay. Then just in light of that, do we need to be concerned at all about the proposed cut in the Medicare conversion factor? If, for some reason, that didn't get fixed is Medicaid or commercial reimbursement tied to that in any way?
Karl Wagner - CFO
Medicaid on a state-by-state basis can be impacted by that. Not every state updates their information on an annual basis, so there is some potential. Most of our contracts are not updated based on current-year Medicaid changes. We do have some Medicare (inaudible) but they don't adjust to current-year Medicare, so it wouldn't necessarily affect us in that. So there is some impact but it's not significant like this would be.
Bill Bonello - Analyst
Okay, that's very helpful. Then just turning to the -- well, actually, just one last thing. You said that Texas is not in the guidance. I assume this potential offset is also not in the guidance.
Karl Wagner - CFO
That's correct. This offset we wouldn't expect would occur until January 1, if that were to occur. As I said, we are out there doing what we can to try and get Pediatrix physicians and non-Pediatrix physicians. Clearly, they've been interested. It's come through an unusual process, so you know, not only just pediatric cardiologists but adult cardiologists are also involved in this process. So we're pushing pretty hard (multiple speakers).
Bill Bonello - Analyst
Thank you. Then on the taxes, I'm just trying to understand. It sounds like, at least part of the change in the effective tax rate, we may not see a corresponding increase in cash tax payments. Would that be right? Would part of it just simply be an accounting change or how do we think about that?
Karl Wagner - CFO
That clearly is a potential. This is a tax issue we've had or a tax position we've taken for several years -- under this new rule, basically the evidence that we can use in evaluating the tax position change, so now we have to reserve for that. You're not changing the tax position on our returns. We also look at it go-forward. At this point, we haven't been paying it on the old years, so we would expect not to pay it but it could go the other way and the state tax issue could come in and evaluate that and come up with a different determination. So that's why we reserved for it under this new guidance.
Bill Bonello - Analyst
Okay. Then is there any ability to sort of give us a sense of how much of the increase, the 150 basis point boost is that accounting change or reserve change versus how much is just actual increased rates in Texas?
Karl Wagner - CFO
I would say about 1 percentage point is the FIN 48 and 0.5 point is Texas, roughly, and those numbers are not perfect but --.
Bill Bonello - Analyst
Okay. I assume, at this point, we would expect that. I know you're not giving guidance for '08 but is there any reason not to expect that to continue into '08?
Karl Wagner - CFO
I would expect that rate would continue.
Unknown
Bill Bonello - Analyst
Okay. Then, just the last question -- can you give us an operating cash flow and CapEx outlook for the
Karl Wagner - CFO
From an operating cash flow standpoint, we didn't give that this morning. We're struggling with that and looking at some of the specific costs because it's getting impacted by a lot of the costs that we've talked about. We do have some or costs to come through, that's why we haven't given it, although we would like to say we are -- excluding the information, we will be in the range of last year's number. A big piece of that, as we paid a big tax payment in the beginning of this year that relates to '06, so that's pulling us down this year and '06 get the benefit of that. So we haven't given real specific guidance as we're trying (inaudible) those numbers are.
From a CapEx standpoint, we don't expect to see anything unusual than the roughly $10 million or less that we see on CapEx in any year.
Bill Bonello - Analyst
Okay, thank you very much.
Operator
Rob Mains, Morgan Keegan.
Rob Mains - Analyst
Good morning. One clarification on the anesthesiologist, you know, pipeline -- last quarter, you had described yourselves as being close to two practices. Is that still the case?
Karl Wagner - CFO
Well, we're going to -- we've always said, Rob, that we're going to do one first and analyze it and digest it and all of that. We have been and continue to deal with two practices or more. We're going to close one first and get that under our belt. As we learn from it, we will move forward with the second one. But I would not expect to see back-to-back anesthesiology acquisitions.
Rob Mains - Analyst
Given the infrastructure investments that you're making now, though, might that kind of give you a leg-up on the learning curve?
Dr. Roger Medel - CEO
Oh, definitely. I mean, you know, we are at a point where we expect that our second anesthesiology acquisition, while it wouldn't be immediately following, might be within six months or something like that.
Rob Mains - Analyst
Karl, you have a good explanation on what was going on with margins from '05 to '06, why they were a little bit down, at least kind of the sort of practice gross margin. They moved up again, though, in '07. Anything particular you would point to there?
Karl Wagner - CFO
No, it's not specific when you go through that. It fluctuates a little bit here or there. It wasn't a big change. It was, I think, a 20 to 30 basis point change and that fluctuates a little bit based upon the particular time of year, where the growth is coming from and the like.
Rob Mains - Analyst
Okay. Is the first-half level -- I know that there's some seasonality in there. Is that something, though, that could be sustained?
Dr. Roger Medel - CEO
I'm not sure that I would say that we're going to sustain the growth in our margin after practice expenses. I think we're just going to maintain to be flat. We've had it fluctuate a little bit, you know, 20 basis points here or there. But it's not a place where we're looking to create our operating leverage from.
Rob Mains - Analyst
Okay, fair enough. Then, on the same store growth, specifically on the volumes, your overall volume growth was greater than their neonatology, the (inaudible) practice or same-store growth, which kind of implies that your office-based specialties are growing faster than the neonatology. Is that a secular trend? Is there something particularly that's going on, do you think, with your practices that is enabling you to have such strong growth (inaudible)?
Dr. Roger Medel - CEO
Well, I think, one, having moved into pediatric cardiology a lot stronger in the last few years, like maternal/fetal medicine, those are areas where if you -- where you can have the physicians in place, there is quite a bit of demand for those. They are small specialties which are continuing to grow. As we can put more physicians in market, it allows us to expand that business easier. So there is demand for the business that we're trying to meet in a lot of the market. So I think we're going to continue to see growth based upon the specialty demand. They are small specialties at this point but they are continuing to grow.
Rob Mains - Analyst
Okay, that's helpful. Thanks a lot.
Operator
Dawn Brock, JPMorgan.
Dawn Brock - Analyst
Good morning. This was a very nice surprise this morning! There's one area kind of going off of the last question that I wanted to get some color on. Coding changes in general, this is more in the pricing side versus the volume side -- coding changes in general, while we're not looking for anything in the realm of the 99-300 code that was introduced in '06, are there any other positive changes or tweaks that are expected as we move through the end of '07 or into '08?
Dr. Roger Medel - CEO
You know, there's been looking at some stuff in '08 that may be tweaked for codes. Until everything is finalized and absolutely done, we don't know what it's going to be, but nothing like the magnitude of what we've seen with the 99-300 code that we saw last year, the code changes we saw several years ago.
There is a new code they are looking at for -- or that they're going to put in place for admits in the NICU, but the admits are one of an average length of stay that's 18 days, so it's not as big an impact as the other codes. So I think that will happen. I don't know what the reimbursement of that is going to be but it will be slightly improved. But as I said, it's not nearly as big as we have seen in the past. That's about the only tweak that we're looking at, at this point, so we will be looking at that in '08.
Dawn Brock - Analyst
Okay, so we're still looking at the 2% to 4% on pricing being possibly at the higher end as we move into '08 but definitely within the range?
Karl Wagner - CFO
Yes, we expect it's going to be that 2% to 4% and it could be at the higher end because of that code change.
Dawn Brock - Analyst
Okay. Then, on the acquisition side, obviously we're at the low end halfway through the year. The $50 million to $55 million -- that is an annual number for '07, correct?
Karl Wagner - CFO
That is correct.
Dawn Brock - Analyst
Okay, so we should be expecting a lot of activity over the next, you know, five months?
Dr. Roger Medel - CEO
That's the plan!
Dawn Brock - Analyst
Okay, okay. Thank you very much. Great quarter.
Operator
(OPERATOR INSTRUCTIONS). Kerry Nelson, SkyStone Capital.
Kerry Nelson - Analyst
Nice quarter. I have a couple of questions just clarifying some of the things you said earlier. I guess one is, on the issue with Texas and the reimbursement there and then combine with that the issue that you mentioned in terms of the CMS code. If both were to occur, and I know you think that there's a good chance the CMS code change won't occur, but if both were to occur and the Texas were to fall in the middle of that range that you suggested of 5% to 30%, what would the net effect be?
Karl Wagner - CFO
Well, that's an awful lot of caveats in there! (LAUGHTER).
Kerry Nelson - Analyst
Well, I think what I'm trying to get at is some boundaries or some sort of bookends on your impact or expected impact on the CMS side.
Karl Wagner - CFO
Yes, I think that CMS proposal is on the best handicapping that we've done. As I said, that CMS proposal would take a significant component of what we would get from Texas. So, that's --.
Kerry Nelson - Analyst
Meaning the net combined would still be positive but minimal?
Karl Wagner - CFO
I would expect that's about right.
Kerry Nelson - Analyst
Okay, that's great. Then secondly, can you just clarifying something you said earlier? Guidance '07 GAAP, $2.82 to $2.86, and then after that, you mentioned adjusting -- some numbers after adjusting for the lower tax and the options review. Can you just say what those numbers were again?
Karl Wagner - CFO
It was 2.91 to 2.95 for the year after taking out the tax benefit we got in the first quarter for the statute of limitations and then the options expenses.
Kerry Nelson - Analyst
I got it. That's great.
Karl Wagner - CFO
The other piece in the tax was the tax rate change reduced our expected EPS for this year by $0.07.
Kerry Nelson - Analyst
I got it. Okay, perfect. Thanks very much. Congratulations.
Operator
Bill Bonello, Wachovia Securities.
Bill Bonello - Analyst
Just two follow-ups -- Karl, can you give us any sense of the magnitude of operating and capital investment that might still need to be done over the next year or so in order to be ready to support the anesthesiology expansion?
Karl Wagner - CFO
Well, capital expenditures related to the anesthesia wouldn't be huge from the infrastructure development for that. I mean, we will have some IT expense that we have to incur in doing that and some office space as we grow for the people as we do that. So from a G&A infrastructure, I don't expect that there would be a significant amount there.
As far as the people infrastructure, you know, that will grow. We've built several positions at a management level that are helping us in our exploration of this, as Roger had mentioned, in the collections area and the operations area and the like. We will have to build that some more, but I don't think it's going to be anything. I am hesitant to give exact numbers but I don't think it is anything we are going to see that would impact our G&A leverage that we've seen over the past.
Bill Bonello - Analyst
Okay, so in general, should we think of sort of worst-case scenario is the ramp-up in anesthesiology is neutral at first and then gets better over time? It sounds like you wouldn't expect, from either a cash-flow or an earnings standpoint, to really see much dilution.
Karl Wagner - CFO
Yes. I mean, from a cash-flow [earnings] standpoint, I wouldn't expect to see much dilution. I mean, we would expect the deal would be accretive actually, so in looking at that -- and when we get a transaction done, dependent upon size and the like, you know, it will impact those numbers to some extent. But I don't think it's going to impact our G&A leverage on expense from the -- as a percent of revenue in a dramatic way.
Bill Bonello - Analyst
Okay, that's helpful. Then just one last question, just as we think about sources and uses of cash going forward. As you've paid out physician bonuses in early '07 for '06 results, was that impacted at all by the fact that you hadn't reported numbers and should we be thinking that there might be any kind of a true-up in terms of bonus payments that needs to be made, or were you able to do accurate assessments sort of at the practice level so that the cash payments have been what they were supposed to be?
Karl Wagner - CFO
Yes, the predominant, the largest portion of our bonus payments being the physicians, we were able to calculate clearly what their numbers were going to be through this process, so that wasn't a problem. There's a little bit that got carried over waiting for this to finalize, but that was more for corporate people. As we went through this process, as you can expect, no executive payments were made or payments to some other people as we finalized the numbers that were based upon company-wide results. But the individual practices, we knew the numbers and those should all have been paid out.
Bill Bonello - Analyst
Okay, great. So that won't be a big swing factor in the cash flow then?
Karl Wagner - CFO
That's correct.
Bill Bonello - Analyst
Okay, thank you.
Operator
(OPERATOR INSTRUCTIONS). Rob Mains, Morgan Keegan.
Rob Mains - Analyst
I have a very similar question. Now that we are on the other side of this options thing, were there any -- are there any acquisitions in your pipeline that were specifically waiting for audited financials for any reason?
Dr. Roger Medel - CEO
No, that's not been an issue.
Rob Mains - Analyst
Okay, that's all I needed to know. Thank you.
Dr. Roger Medel - CEO
That's it? Okay, well, if there are no more questions, then thank you for your participation this morning and we will look forward to speaking with you again next quarter. Thank you, operator.
Operator
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