Updated from 8:22 a.m. EDT

HealthSouth

(HRC) - Get Report

founder Richard Scrushy defended stock sales he made prior to a company profit warning in late August, and said the firm remains financially sound despite a 71% drop in its stock price.

"The company and I personally have been subjected to ... unfounded rumors and frivolous lawsuits," Scrushy said during a conference call Thursday. "Today we want to turn the lights on and get the facts out."

His remarks came after the firm issued a press release saying that the

Securities and Exchange Commission

has launched an investigation into the company following an Aug. 27 profit warning that sent its shares plunging.

28 Days

The Birmingham, Ala.-based company, which operates rehabilitation hospitals, clinics and outpatient surgery centers, said last month that its profits could take a $175 million hit because of changes in some of its Medicare billing practices. It also suspended earnings guidance for the rest of the year.

The news came less than a month after Scrushy sold back 2.5 million shares (48% of his holdings) to the company in order to repay a $25 million loan from HealthSouth.

The stock, which sank 25% at the open on news of the SEC probe, recouped some of its losses following the conference call Thursday morning and was last down 17% to $3.45. Still, HealthSouth is down a whopping 71% since the day before the initial warning.

Scrushy said that the company still expects to end the year with $1 billion in EBITDA despite the $175 million pretax, or $108 million after-tax, hit. Meanwhile, William Owens, who replaced Scrushy as CEO Aug. 27, says the firm has no liquidity problems and that all of its financial ratios, including interest coverage and debt-to-EBITDA, are well within bank and bond covenant constraints.

"The company is in solid financial health," Scrushy said, adding that the firm should provide updated guidance on 2003 by mid-December.

Review Planned

In a press release earlier, HealthSouth said it has hired law firm Fulbright & Jaworski and formed a special litigation committee to review issues related to recent lawsuits filed by shareholders, and other matters. Shareholders are alleging that Scrushy knew about the Medicare billing changes as early as June.

Indeed, Owens has said in the past that the firm was aware of a problem on June 6 but that he and Scrushy thought the issue related only to physical therapy clinics and that the effect on earnings would be immaterial. When it became clear that the policy applied to all of its outpatient services, the executives said they informed investors.

The billing rule, which was discovered by a reimbursement lawyer, stipulates that physical therapists must bill Medicare at a lower "group" rate if more than one patient is being treated at the same time -- even if the patients are receiving different therapies. Previously, HealthSouth had been charging a higher, individual rate.

Medicare officials say their policy hasn't changed for more than three years and that it was merely clarified on May 17 -- a point that HealthSouth disputes.

Expiration Overhang

On the call, Scrushy said he still owns stock and options representing about 3.5% of HealthSouth's total outstanding shares and he noted that the company continues to buy back both equity and debt.

In addressing a 5.3 million-share stock sale that he made in May, Scrushy said he was exercising options that he'd held for 10 years and that were about to expire. With regard to the second transaction in July, Scrushy said that he sold the shares amid pressure from analysts, shareholders and board members.

"Given the market sentiment against loans to executives, we started to discuss ways that we might be able to get all those loans paid back," he said, adding that the loan wasn't due to be repaid until September 2006.

Despite the damage control Thursday, Prudential Securities analyst David Shove cut his rating on the stock to hold from buy, saying that while there is value in the franchise, "the SEC investigation and its headline risk will be overwhelming in the coming months." He also lowered his price target to $4 from $10.

Other analysts also expressed concern about possible retroactive payments that HealthSouth may be asked to make, given that the Center for Medicare and Medicaid Services is claiming that its policy hasn't changed since January 1999.

Still, HealthSouth said the federal agency isn't seeking retroactive payments and that the company is working with Congress to have the rule changed.