Operator Good morning, everyone, and welcome to Encompass Health Third Quarter 2020 Earnings Conference Call. At this time, I would like to inform all participants lines will be in a listen-only mode. After the speakers’ remarks, there will be question and answer period. [Operator Instructions] Today’s conference call is being recorded.

If you have any objections, please disconnect at this time. I will now turn the call over to Crissy Carlisle, Encompass Health's Chief Investor Relations Officer..

Thank you, operator and good morning, everyone. Thank you for joining Encompass Health Third Quarter 2020 Earnings Call.

With me on the call today are, Mark Tarr, President and Chief Executive Officer; Doug Coltharp, Chief Financial Officer; Barb Jacobsmeyer, President, Inpatient Rehabilitation Hospitals; Patrick Darby, General Counsel and Corporate Secretary; and April Anthony, Chief Executive Officer of Encompass Home Health & Hospice.

Before we begin, if you do not already have a copy, the third quarter earnings release, supplemental information and related Form 8-K filed with the SEC are available on our website at encompasshealth.com.

On Page 2 of the supplemental information, you will find the Safe Harbor statements, which are also set forth in greater detail on the last page of the earnings release. During the call, we will make forward-looking statements, which are subject to risk and uncertainties, many of which are beyond our control.

Certain risk and uncertainties, like the magnitude and impact of the COVID-19 pandemic that could cause actual results to differ materially from our projections, estimates and expectations are discussed in the Company's SEC filings, including the earnings release and related Form 8-K, the Form 10-K for the year ended December 31, 2019, and the Form 10-Q for the quarters ended March 31, 2020, June 30, 2020, and September 30, 2020, when filed.

We encourage you to read them. You are cautioned not to place undue reliance on the estimates, projections, guidance and other forward-looking information presented, which are based on current estimates of future events and speaks only as of today. We do not undertake a duty to update these forward-looking statements.

Our supplemental information and discussion on this call will include certain non-GAAP financial measures.

For such measures, reconciliation to the most directly comparable GAAP measure is available at the end of the supplemental information, at the end of the earnings release and as part of the Form 8-K filed yesterday with the SEC, all of which are available on our website.

Before I turn it over to Mark, I would like to remind everyone that we will adhere to the one question and one follow-up question rule to allow everyone to submit a question. If you have additional questions, please feel free to put yourself back in the queue. With that, I'll turn the call over to Mark..

Thank you, Crissy, and good morning to everyone. We have a proven track record of working through difficult situations. Since 2009, we have successfully managed through an economic recession, regulatory changes, sequestration and Medicare payment freezes and cuts and now, we can add a global pandemic to that list.

Our teams are doing an extraordinary job in managing through the various COVID-19 challenges. While our operating environment remains difficult due to the pandemic, we remain confident in the prospects of both of our business segments and in our ability to overcome these challenges. It's what we do. We adapt, we persevere, and we continue to grow.

Let's talk first about our Inpatient Rehabilitation segment. Our Inpatient Rehabilitation volumes recovered substantially in the third quarter of 2020, while total discharges were down 1.5% compared to the third quarter of 2019, this number improved significantly from the 10.7% decrease in volumes we experienced in the second quarter of 2020.

The remaining lag to returning to prior year volumes primarily is related to orthopedic and lower extremity joint replacement cases. Many of our markets continue to have limited elective surgeries, particularly with elderly patients with complex medical conditions.

These patients are the ones that tend to need inpatient rehabilitative services post surgery. To put this in perspective, full same-store discharges for the third quarter of 2020 decreased by 1,311 patients, compared to the same period of 2019.

In the third quarter, we treated 1,316 fewer orthopedic and lower extremity replacement patients than we did a year ago, accounting for the entire same-store Q3 decline. We also continued to experience COVID-related challenges in certain geographic markets, specifically, Florida, where we have twelve inpatient rehabilitation hospitals.

We experienced a 12.8% year-over-year decline in patient discharges in Florida in the third quarter of 2020. Factors such as limited elective surgeries and restrictions on when positive COVID patients can be transferred from an acute hospital to a post-acute setting played a significant role in this volume decrease.

It's important to remember that these factors are temporary responses to the pandemic and are not indicative of structural shifts in the market. Net revenue per discharge is being positively impacted by the temporary suspension of sequestration and by a higher acuity patient mix resulting from the pandemic.

We saw the acuity of our patients increase in the second quarter of 2020 and continue in the third quarter, and we expect this trend to continue in the fourth quarter. As you can see on Page 10 of the supplemental slides that accompanied our earnings release, our expenses did increase as a percent of revenues, primarily due to the COVID-19 pandemic.

Our hospital teams have done a tremendous job managing our most significant cost, labor. For the third quarter of 2020, our employees per occupied bed, which we use as a metric to measure our efficiency was 3.44, compared to 3.48 in the third quarter of 2019.

This is evidence that our technology and real-time data, combined with our clinical knowhow makes us a best-in-class operator in any environment. We know how to effectively and efficiently manage our hospitals and can adjust our staffing levels to our volumes.

We've also taken aggressive actions to obtain, what we believe are adequate supplies of personal protective equipment, even at the elevated utilization levels associated with the pandemic.

While some facilities in the post-acute space have faced significant challenges with COVID-19, our inpatient rehabilitation hospitals have been able to help, recovering patients return to their independence. These patients, many of whom spent time on ventilators have endured extended stays in acute care hospitals.

They are extremely weak and require intense multidisciplinary rehabilitation to regain both their strength and cognitive abilities. Since April, we have treated over 3,000 recovering COVID patients, returning 80% back to the communities following the rehabilitation.

In the fourth quarter of 2020, we expect limitations on elective procedures in certain markets to continue to impact volume growth, but we believe these volumes will return. It's a matter of when, not if. We remain confident in the long-term outlook for our hospitals.

So much so, that we've continued to expand our national footprint throughout this pandemic. We have opened three new hospitals thus far in 2020 and we expect to open another one in Toledo, Ohio, in mid-November. In addition, by year-end, we expect to have added approximately 120 beds to existing hospitals with 89 of those already added.

For 2021, we've announced plans to build eight new hospitals. We've also announced eight new hospitals scheduled to open in 2022 and we're not done making that. All of this fully demonstrates our commitment and confidence in our future. Let's move now to our Home Health and Hospice segment.

Our Home Health volumes recovered substantially in the third quarter of 2020, while same-store admissions were down 4.6%, compared to the third quarter of 2019, they improved significantly from the second quarter of 2020 when we saw a 17.3% decrease in admissions.

And we came out of the quarter stronger than we entered it with year-over-year same-store admissions growth of 2.2% for the month of September. We achieved this success even with our year-over-year admissions related to elective procedures down approximately 20%.

Additionally, continued facility access restrictions has negatively impacted the volume of patients admitted onto our service who reside in assisted or independent living facilities. And these admissions down approximately 40% year-over-year.

We also continue to experience COVID-related challenges in certain geographic markets, specifically in Texas, where admissions were at 95% of our 2019 levels in the third quarter of 2020, mostly due to limited elective procedures.

While admissions in Florida dipped to 91% of historic levels in August, they rebounded nicely in September to finish the quarter above 100% of Q3 2019 admissions. Even in the face of restricted access to some of our historic referral sources, and with limited elective procedures in many of our markets, we continue to perform at a high level.

Cost controls remains strong in Home Health with our cost per visit down almost 4%, in spite of COVID-related expenses associated with PPE and staff in quarantine. Our most significant decline in volume has been in the physical therapy discipline due to the decline in elective procedures and being shut out from assisted living facilities.

To adjust for this, in May, we made a shift in our compensation structure for therapists, lowering each therapist’s base pay by 20%, and in turn, lowering their productivity expectations for each pay period by 20%. This change allowed us to save cost and do so in a manner that did not result in any broad furloughs, layoffs or terminations.

We plan to keep this compensation structure going forward as it allows us to better flex our therapy staffing and allows our therapists to earn additional compensation by exceeding their productivity levels.

Although the pandemic has made some collaboration efforts more difficult and necessarily virtual in nature, we believe there is a strong interest in partnering with Encompass Health Home Health & Hospice segment among ACOs and Medicare Advantage payers seeking value-based payment arrangements.

We have partnered with more than 100 Medicare shared savings program, ACOs around the country, adding nine new ACOs to this list in the third quarter of 2020. A recent analysis of 2019 claims data revealed that we grew our share of ACO beneficiaries by 16% in 2019 versus 2018, whereas the rest of the home health industry remained flat year-over-year.

Similarly, our continued efforts to enter value-based payment arrangements with Medicare Advantage payers yielded the addition of two new contracts in Q3 with more discussions ongoing and anticipated to result in additional contracts over the coming quarters.

With the combination of the industry-leading hospital readmission rates resulting in more healthy days at home for our patients, success in prior risk-based payment arrangements and a commitment to scale and density at the regional level, Encompass Health is the clear choice for organizations engaged in risk-based payment models for America's seniors.

And after several months of unusually slow M&A activity in the home care sector, we are encouraged that the pipeline of acquisition opportunities is rebuilding, particularly for hospice. Despite the pandemic, we are continuing to find new and effective ways to provide care to our patients and support our clinicians in both business segments.

Reducing readmissions remains a focus for us. As many of you know, our ReACT model focuses on preventing acute care transfers, while patients are in our inpatient rehabilitation hospitals.

This month, we rolled out our Readmissions Prevention program, which uses information from more than 400,000 patients who have been through our inpatient rehabilitation hospitals or home health agencies to estimate a patient's risk of hospitalization after discharge.

We use this score, combined with social determinants of health and our clinical judgment to estimate and act on a patient's overall probability of being hospitalized and hopefully prevent a readmission from occurring.

In our overlap markets, our hospital and home health teams are working together to ensure a smooth transition to the home and have established clinical protocols to help mitigate the need for both emergency care and hospitalization for high-risk patients.

This is another way we are using data from our electronic medical records from both segments to predict a potential decline in health status and act in a timely manner to prevent it. This is good for patients and payers.

While many uncertainties continue to exist, our visibility has improved and we have more information and experience in managing our operations during the pandemic. Therefore, we had issued guidance for the fourth quarter of 2020.

You can see this guidance in our earnings release, as well as on page 17 of the supplemental slides that accompanies the release. We expect to be in a position to provide full year 2021 guidance and a longer term outlook when we report our Q4 and full year 2020 earnings at the end of January.

While many uncertainties still exist, our company is well-positioned to drive long-term growth. As I mentioned at the beginning of my comments, we have a proven track record of adapting to and working through challenges including this pandemic. Our business fundamentals aren't changing.

In fact, the pandemic has created an even stronger awareness of the high level of care we provide in our inpatient rehabilitation hospitals and the value of our home health and hospice service lines. And as the population ages, the demand for our high-quality care will increase. I believe our future is bright.

Before I end, I want to thank all of our employees who continue to make Encompass Health, a leader in integrated healthcare. 2020 has been an unprecedented year. Our nation has been through a lot and yet our employees have continued to care for our patients, striving for better outcomes, compared to those of other care settings.

I can't thank them enough and I know our patients are grateful for their efforts too. With that, I'll turn it over to Doug..

Thanks, Mark, and good morning, everyone. Let me reiterate what Mark just said, we are very proud of our team’s response to the ongoing pandemic, and we're very pleased with the resiliency our organization has demonstrated. This is evidenced in the continued improvement of our financial results.

For Q3, our consolidated net revenues increased 1.1% over Q3 2019 to $1.174 billion and our consolidated adjusted EBITDA for Q3 was essentially flat to the prior year period at approximately $230 million. Even in these challenging times, our business continues to generate strong cash flow.

Our Q3 adjusted free cash flow of $124.1 million increased 13.2% over Q3 2019, bringing our year-to-date adjusted free cash flow to approximately $367 million. Our strong and consistent cash flow supports our complementary strategies of investing in growth opportunities and making shareholder distributions.

Through the first three quarters of 2020, we have made approximately $159 million in growth investments and provided approximately $89 million in shareholder distributions.

We continue to proactively manage our capital structure to ensure adequate liquidity and flexibility to navigate our business through any challenges and to capitalize on the attractive growth opportunities we see in all three of our service lines.

In late September, we again accessed the debt markets, raising $400 million in senior unsecured notes with a coupon of 4.625% maturing in 2031. This transaction settled in early October and thus is not reflected on our EO Q3 balance sheet.

The proceeds from this offering will be used together with approximately $300 million of cash on hand to retire the balance of our 5.75% senior notes due in 2024, resulting in both lower interest expense and a longer duration of our debt capital.

Our net leverage at the end of Q3 was 3.6 times, and we finished the quarter with no amounts drawn on our $1 billion revolving credit facility. Both of our business segments have continued on an upward trajectory following the nadir in our volumes reached in mid-April.

This has been accomplished in spite of the COVID case surges in some of our most important markets. Beginning with the IRF segment, total revenue increased 3.1% over Q3 2019 as inpatient growth of 3.8% was partially offset by a 25.3% reduction in outpatient and other.

The decline in outpatient revenues stems from permanent unit closures in 2019 and the intermittent suspension of certain units in response to the pandemic in 2020. Q3 discharges declined 1.5% with a 2.8% drop in same-store discharges, partially offset by new store contributions.

Much of the same-store decline was attributable to our facilities in Florida and to a lesser extent Texas, where the effects of the pandemic have been high. As can be seen on Page 6 of the supplemental materials, our patient census increased throughout the quarter.

We continue to see strong growth in our Medicare Advantage business with MA discharges increasing 40.6% in Q3. As Mark stated, we continue to experience higher patient acuity in Q3. The increase in average acuity, together with the Medicare sequestration suspension were primarily responsible for our 5.4% increase in revenue per discharge.

The higher acuity drove an increase in our average length of stay, which partially offsets this pricing benefit. Our revenue per patient day for Q3 increased 2% over the prior year. IRF segment adjusted EBITDA for Q3 of $209.2 million declined less than 1% from Q3 2019.

Our hospitals continue to manage labor productivity and operating expenses very effectively during the quarter. These efforts notwithstanding the effects of the pandemic caused SWB in Q3 to increase 20 basis points as a percent of revenue over the prior year period and supplies to increase 80 basis points as a percent of revenue.

Home Health & Hospice segment revenue in Q3 declined 5.1% from the prior year period. Home Health revenue decreased 6.5%, based on the 3.3% decline in admissions, and a 2.3% drop in revenue per episode.

The decrease in revenue per episode is primarily attributable to the implementation of PDGM, the effects of which have been exacerbated by the pandemic. Home Health revenue per episode in Q3 benefited from the suspension of the Medicare sequestration, as well as the increase in admissions late in the quarter. Our Q3 Hospice revenue increased 1.6%.

Hospice same-store admissions in Q3 were up 15.8%, but patient days declined 2.1% due to a lower average length of stay resulting from a change in our patients mix.

During Q3, the percentage of our referrals from institutional settings, which typically have a lower average length of stay increased, while the percentage of referrals from senior living facilities, which typically have a higher length of stay decreased.

This is due to access restrictions in many senior living facility referral sources owing to the pandemic. Within Home Health, our continued focus on labor productivity, combined with compensation structure changes implemented earlier this year drove a 270 basis point reduction in cost of services for Q3.

Business per episode declined from 17.3% in Q3 2019 to 16.4% in Q3 2020 and cost per visit declined $75 from $78 in the prior year period. This effective cost management led to segment-adjusted EBITDA in Q3 of $51.8 million, an increase of 2% over Q3 2019. As Mark stated, we have issued guidance for Q4.

The guidance and the key considerations on which is based can be found on Pages 17 and 18 of the supplemental materials. The Q4 guidance includes an adjusted EBITDA range of $225 million to $240 million, as compared to $238.2 million achieved in Q4 2019.

As noted on Page 18, adjusted EBITDA in Q4 last year benefited from $9.5 million of items we do not expect to repeat this year. And now operator, we'll open the line for questions..

[Operator Instructions] And your first question comes from the line of Whit Mayo of UBS..

Good morning, Whit..

Hi, Whit. .

Hey. Thanks for all the color this morning. I wanted to start with just the Home Health volumes. If we adjust for the assisted living, the senior referral declines, what would the year-over-year volumes be? I mean, if we just isolate, I mean the 40% decline just strikes me as very high and I get that COVID makes forecasting difficult.

But I am curious maybe to hear from April, any experiences that you could share in markets outside of Florida or Texas that might be trending more favorably? And does that make you more negative or optimistic on the outlook for volumes going forward?.

Yes, Whit. So, I think that, the AL/IL community impact has been pretty significant and pretty consistent across the country. We haven't really had certain regions that have just come in openly, welcome in. It's been pretty much a lockdown consistently across the country.

As things begin to kind of ease up in the August, late July timeframe, we start to get a little bit greater access.

But now, as we kind of move a little bit into a period of spike, it definitely feels like we are, again, sort of seeing, particularly in certain markets in the Northeast, again, beginning to see some lockdowns and they're saying, we'll let your nurse in, but not your therapist, we'll let your nurse in and hospice, but we won't let your chaplains or social workers in.

And so, it's just been a little bit of a mix bag market-by-market. And I think that market is probably one that we think is going to continue to be challenging for a bit.

What we've done, I think, pretty well, though is, create some mitigating opportunities by really going out and using that disruption to cause us to look for some new sources of revenue.

We've got a much increased flow from alternative surgery centers that are starting to pick up some of these electives and in the area of electives, we are seeing a lot more positive movement pretty consistently from month-by-month, July, August, September, even into the first three weeks of October where it looks like our decline in electives is down as we compare to a pre-COVID levels, down only about 12% from where it was in the January, February timeframe.

So, we are pretty encouraged about the trajectory that we are seeing everywhere other than AL/IL, which should continue to seem to be a little bit of a roller-coaster, but still consistently on the downstream..

So just to be clear, if we could exclude the assisted living referrals, is there a number to think about in terms of how the business would be declining or increasing right now?.

I don't have that – I don't count it that way, right off the top of my head, but we can certainly look at that detailed information and try to get back to you with something..

Okay. And just one last one, just for both businesses, the monthly ADC disclosures are helpful.

Is there any spot number Doug, to kind of look at for October at this point, just to get a sense of how we may be trending versus what appears to be a better September exit rate?.

Trend line is good..

Okay. I'll take that. Thanks, guys..

Sure. Thanks, Whit..

Your next question comes from the line of Kevin Fischbeck of Bank of America..

Morning, Kevin. .

Good morning, Kevin..

Good morning. Actually, this is Joanna Gajuk filling in for Kevin today. So appreciate taking the question here. So, thank you very - for the explanation of the volume trends in Home Health.

Can we talk about a little bit about pricing trends in Home Health? So, I guess it worsened a little bit, it was down like 2% after being down 1% in Q2 year-over-year.

So, can you just flag any items there? Is there any change in mix or anything around PDGM, which probably is hard to parse out? But any kind of color you can provide on that will be great..

Sure. Well, obviously, the revenue per episode is affected pretty significantly by those electives - elective procedures tend to be one of the joint replacements in particular tend to be one of the higher revenue sources even under PDGM. Although PDGM, that category is lower than it was under PTS back in 2019.

So, when we see that decline in electives, and we compare 2019 to 2020, you have to kind of look at a combination of two factors. One, PDGM would have made those procedures worth less than they had been in the prior year; but secondarily, we've also, in 2020 got a lower proportion of those, this is still higher than others.

And so, it's kind of a combination on the rate side of both the PDGM implications and the proportional decrease that we see in elective procedures, which are relatively high revenue sources.

Does that make sense?.

Yes, that makes sense. And if I can just follow-up on the commentary on the other side – on the other segment on the inpatient rehab, in terms of, obviously, very impressive plans – new development plans for the IRF segment.

So, is that fair to say that you are not seeing much of a slowdown there in terms of any of these COVID cases spiking in some of these markets – in terms of actually completing these projects on time? Thank you. .

So, we do not. We think the basic fundamentals on the IRF side of the business continue to be strong, both near-term and long-term. We see COVID as just a near-term challenge for us that we will get through.

As a matter of fact, if anything, COVID has given us an opportunity in marketplaces to show the caliber of the high-level of acuity care we can provide to our patients. So, we don't see any impact with COVID on our development efforts..

Great. Thank you..

And your next question comes from the line of Matt Larew of William Blair..

Hey, Matt. .

Good morning, Matt..

Hey, good morning. Doug, thanks for all the detail on the guidance for Q4. I did want to ask about just a little bit on the pricing side. Obviously, the last couple quarters have been very strong for IRF and now moving into the IRF calendar year that starts in October, you get a nice pricing boost.

So, could you just maybe help us understand or quantify some extent what acuity and sequestration benefit were in the quarter? Maybe that can give us a window onto what pricing growth might look like in the fourth quarter for IRF?.

Yes. So, the sequestration is pretty straightforward, right. That's the 2% that you see. With regard to pricing, it's a little difficult to separate out the amount that is specifically related to the patient acuity that may be driven by COVID acuities.

We've got few things that are going on with regard to acuity that are COVID-related and Mark reviewed this in his comments.

The first is, you've got a portion of the patients that are coming in that are recovering from COVID and there is an extra co-morbidity payment that comes along with those payments or with those patients that will boost the revenue per episode.

But you've also got the change in the patient mix because we're seeing relatively the same number of stroke and neurological patients, but we've dropped out those lower acuity orthopedic patients that Mark talked about. We expect those trends are likely to continue in the fourth quarter. Those had about – if you combine those.

And then the other thing I wanted to throw into the mix is, there is an element of this, that is still the adoption of Section GG and it's difficult to separate out the impact of patient mix from COVID from GG. But together, we think those were responsible for about 190 basis points of the lift in revenue per episode for Q3..

Matt, just a little bit more color to back what Doug's talking about. If you think about just from a case mix index, we ran for a number of years right at the 1.36, 1.37 case mix index. Starting this year, in Q2, and carried over into Q3, we ran a 1.44 and a 1.42 case mix index.

So, it's just indicative of the acuity that we are seeing that's coming out of acute care hospitals. Remember, 9% of our admissions that come into our IRFs come directly from acute care hospitals. So these patients are just sicker and whether they are specific to COVID or not, we're just seeing a higher acuity across the board..

Yes. Thanks, Mark. That's what I was looking for. And then, maybe speaking about 2021, you mentioned you'll give guidance early next year. But I think about half the locations in terms of IRF coming on board next year are in Texas and Florida.

Any reason at this point to think that the sort of on-ramp of those facilities might be any slower? And then I think you said you are going to update the long-term plans and my take away from this call is that it sounds like nothing about your long-term outlook has changed, at least qualitatively?.

Yes. I think with regard to the ramp up of the new facilities that are coming on board, most of those are scheduled to come on board in Q3 of next year.

We've got some that are opening late in Q2 and I think it's either our expectation or our hope or the combination of the two that we are going be largely on the other side of the effects of the pandemic by that time. So, we're not really anticipating anything different with regard to the ramp up there.

And absolutely, nothing has changed regarding our enthusiasm and commitment to the long-term growth prospects and the businesses that we are in. And so, we will continue on the course that we have started down with regard to the development of an increased de novo pipeline in the IRF segment..

Okay. Thank you..

And your next question comes from the line of Brian Tanquilut of Jefferies..

Good morning, Brian..

Hey, Brian..

Hey. Good morning, guys.

Just a follow-up on Matt's question, I guess for both of you guys, if we are thinking about the growth algorithm, right, I mean, without going into guidance for next year, if I am using kind of like the Q4 as – Q4 guidance as a baseline, is it right to assume that you should be able to grow on top of that? And what would be the drivers of that growth as I think about 2021?.

I think the continuing effects of the pandemic aside because, again, it's our anticipation that you are going to have those at a pretty significant level in Q1 and probably lingering through much of Q2. We've put some capacity in place over the course of 2019 and 2020 that provides room for organic growth.

I mean if you look at the bed additions we made in 2019 and then another 120 bed additions coming on board in 2020, those are vehicles for same-store growth in 2021. And then, we certainly would expect a recovery, particularly in some of these harder hit markets as COVID works its way through its system.

So, we think there are good prospects for growth, particularly in the back half of 2021..

Got it. And then, I guess the question I have for April, how are you thinking about your PDGM mitigation efforts, right? Because I think the guidance for Q4 calls for a 2% to 3% headwind from PDGM and I know when we started the year, we’re thinking about a gradual mitigation to where we get to zero mid-year to exit of 2020.

So, is there anything that's changed? Or just curious how you're thinking about that and also the sustainability of that $75 cost per visit? I mean, I know you changed your comp structure, is that the right number to be thinking about going forward?.

Yes. So, I think as it relates to PDGM mitigation, I am pretty proud of what we've been able to do in spite of the challenges to see the revenue down 5%, but the earnings up 2% really speaks to the mitigation that we were able to do whether it be volume-based or rate-based in the quarter.

Now, obviously, some of the things that we had planned to do from PDGM perspective has proven to be exponentially difficult in a pandemic environment. For example, we were going to try to realize some of that assumed behavior change as it related to lupus that has been actually going the other way on us during the pandemic.

So, there have been a number of our strategies that we would have said were in place in January that have gotten to be particularly difficult in a COVID environment. But we've been able to do other things and as you know, one of those significant things has been the comp adjustment that's resulted in improved cost per visit.

I do think that within the therapy discipline, we are going to continue to see those savings coming through as we go forward as we maintain that comp plan. However, I think we are going to see some mitigation of that savings as it relates to the nursing discipline. As you've likely heard, nursing staffing across the country is particularly challenged.

We are seeing compensation rates go up. And so, we would expect that we'll see some increases in cost per visit in the nursing disciplines that may mitigate some of the savings we picked up on the therapy side of the equation. So, probably a little bit of cost climb as we move into 2021 and throughout the year..

All right. Got it. Thank you..

And your next question comes from the line of Matthew Gillmor of Baird..

Good morning, Matt. .

Hey, Matt..

Hello, Matt. .

Matt, your line is open if your phone is on mute..

Hey. I am sorry. I was muted. Good morning, everyone..

Very good morning..

I was hoping to ask about the fourth quarter guidance. It's a relatively wide range on EBITDA for you all, which is certainly understandable, given the pandemic. I was hoping either Doug or Mark can maybe give us some sense for what you are assuming from a volume standpoint within the guide.

So, we could just sort of understand how you are approaching it..

That's kind of the wildcard and the reason that we have a broader range is, this is the thing that is most difficult to predict in this environment is the impact on volumes of any surging case experiences that was related to COVID.

So, the top-end of our range assumes that we continue to see the type of gradual volume recovery, both of the business segments that we've experienced through Q2 and Q3 and the bottom-end of the range assumes that there is some pullback..

Okay..

But as we said, we certainly came out of Q3 stronger than we went into and we are very pleased with the progress made in September and that momentum has carried over into October.

So, we – like Doug said, I mean, the wildcard is the assumptions or the surge around COVID, but we are certainly pleased with the momentum that we made through Q3 and have carried over into Q4..

The other thing that injects some variability into the EBITDA range for Q4, Matt, relates to the self-insurance accruals. So, as we indicated on the guidance considerations, we had $7 million in positive accrual adjustments in Q4 of 2019.

And this year is a little bit difficult to predict if I recall in the second quarter, we had a nice lift from lower claims activity in both group medical and workers' comp. We had expected that we would see claims activity under both of those programs, pick up in Q3 for different reasons.

One is, as the medical system began to open up and there was some deferred demand, we expected our employees and their families who were beneficiaries under the group medical plan to start to go out and have more maintenance services and including some elective surgeries.

And we did see that, not fully back, but we did see it come back pretty substantially. And we also knew that we were seeing a larger number of workers' comp claims related to people who acquired or employees who acquired COVID in one of our facilities. So, that was work-related.

But what we know is that even though there is a higher number of those claims the payout on those claims is substantially lower, because they tend not to be severe cases and they tend to be short-term in nature. So, we are not sure what to think about those claims activities as we move into Q4.

And that against the favorable accrual adjustments that we had in 2019 creates a little bit more variability and that was embedded in our thinking with regard to a broader range for Q4 than we normally have with regard to the EBITDA..

Okay. And then, one follow-up on the Medicare Advantage mix in the IRF segment. I think you said, MA volumes are up 40% and certainly, that's a big acceleration from where that trend was prior to COVID. And then, I think maybe in the past, you said that some of these plans were waiving preauthorization requirements.

So, just hoping to get some insight into the sustainability of that trend, if you can?.

Yes. So, what was driving the higher MA volume and remember, we were up 66% in Q2. So that came down a little bit to 40%, but remains very high in Q3. It was both an increase in referrals and an increase in admits based on a higher conversion rate.

So, for Q3, our referrals were up 23% over Q3 last year and admits were up 38% based on a 170 basis point increase in the conversion rate.

That was done largely without the preauthorization waivers in place for most markets during Q3 and it's our expectation that the preauthorization requirements that are in place right now, because they've essentially all been reinstated are going to stay with us into Q4.

We expect based on these, what we saw with regard to the monthly trend throughout Q3. We expect to see a normalization in our payer mix in Q4, which means the MA growth rate is going to remain high, but it's going to come down.

And if I were to just give you an estimate right now, I would expect to see MA discharge volume growth in Q4, probably closer to the 15% to 20% range.

So, slightly elevated from, maybe the level that we averaged in 2018, 2019, but still growing at a good clip and probably something that we would deem to be in the sustainable range, at least into 2021..

Okay. Thanks a lot..

And your next question comes from the line of A.J. Rice of Credit Suisse..

Good morning, AJ..

Good morning, AJ..

Hey. How are you, guys? First of all, I just – you have a slide 20 in your deck that talks about the acquisitions and the de novos. And I am just curious, because I think you still have in there, $50 million to $100 million in M&A in 2020 and maybe I've missed it. But I think that's new and – but is that – I think there hasn't been any so far.

So, does that mean you see something in the fourth quarter coming? And is there any update? You had $97 million on de novos year-to-date.

And I think at one point, you would assume the $180 million to $190 million is that just the COVID process has slowed it down? Or is there going to be a bolus of them coming in, in the fourth quarter on de novos, as well?.

Yes. So, I'll start with the second part first, that is there has been a little bit of an impact on pacing related to COVID this year.

But we would still expect that based on what we are doing in the fourth quarter to see the range for that de novo number still fall into $180 million to $190 million in 2020, which means we are going to be pretty busy in Q4 and we are pretty busy on numerous projects.

Then on Home Health, as Mark mentioned in his comments, we have seen a pickup in the acquisition pipeline. There is some activity that's out there right now. It's more heavily oriented toward Hospice than it is Home Health.

But this $50 million to $100 million reflects perhaps the degree of optimism that we are going to be able to get a deal or two done in the fourth quarter..

Okay. That's good. And maybe my follow-up question would be, there have been some studies that have come out, and there have been some proposals from individual legislators in Congress about potentially looking at rolling back the behavioral adjustments that was in the original PDGM legislation or regulations rather.

And I don't know, I'd be interested to know your discussions, whether you are seeing any momentum behind that? Do you think, as we come out of this election season, the prospects have improved and maybe we'll see some favorable developments on that front?.

I do think that we're having some good conversations and that they are very data-driven conversations in Washington. What I would say, I don't expect is it will affect the 2021 rate. We expect that rate proposal to come out perhaps as soon as Friday, but certainly within the next 10 to 12 days.

And so, I don't think we are going to see recognition of the behavior change assumptions being flawed for this coming year's rate. But I do think that we're in a very good position to have the 2022 rate be adjusted for that. .

Okay. Alright. Thanks a lot. .

And the data provided by Dobson and DaVanzo and others is very strongly in support of the fact that the assumptions were not well founded and have not proven to be accurate, even if you try the COVID adjust them, I think their data would suggest they were way off the mark..

Interesting. Okay. Thanks a lot..

And your next question comes from the line of Ann Hynes from Mizuho Securities..

Good morning, Ann..

Hey, Ann. .

Hi, good morning.

So, my first question has to do about with the eight new hospitals opening in 2021, from an EBITDA contribution perspective, should we view that class as being a negative EBITDA drag or positive? And can you remind us just with the de novos, how we should view the EBIT contribution and margin expansion over the first two years after you open the de novo?.

Yes. Ann. So, I would expect a class that they are going to be an EBITDA negative in 2021. You know from information that we've historically published that our pre-opening expenses associated with the hospital which typically begin about six months in advance of the opening date, run at about $1 million per facility.

And we don't expect that to be any different with regard to this class. And then with regard to the ramp up rate, we’d refer you to the slide that we've included for a long period of time, the investor reference book, which shows our historical activity in terms of hospitals achieving four-wall positive EBITDA.

And depending on the market, depending on other circumstances related to the market, the earliest that typically happens is about nine months. And usually, it'd be odd if we didn't hit kind of a four-wall EBITDA positive contribution within 18 to 20 months. So, it's somewhere in that range..

All right. Thanks. And then, my second question. Obviously, you are not giving 2021 guidance. But can you maybe address some other key headwinds and tailwinds that we haven't discussed yet on the call? And in particular, can you address ongoing PPE costs? Thanks. .

Yes. I know everybody is anxious to start thinking about 2021. We are – there is nobody on this call who is done - ready to be done with 2020 and get into next year. So, we certainly share that view.

Probably, like a lot of other companies and maybe even the business you are in, normally, we would be very late into the budgeting process, both in terms of the formation of our operating budgets and the capital budgets by this time.

And we've essentially deferred the whole budgeting timeline by about two months, because we felt like, depending on the course of the pandemic, we could find ourselves in a position where we had done the budget base, which is a lot of work based on one set of assumptions, only to find that as we entered the new year, there was a new set of assumptions.

I just want to throw that out there as a caveat as to why we're not giving more color regarding 2021 during this call. With regard to the expenses, we think we've got a pretty good handle on expenses right now.

So, if we think about the pandemic continuing into the first half of 2021, the kind of runrate that we are experiencing right now is probably a pretty good proxy for what we’ll see in the first half.

And then, as we move beyond the pandemic in the second half, we would expect to be able to realize some efficiencies with regard to both labor and with regard to supplies cost..

And we put – check out to slide 25 and in our earnings slide book, we try to expand on the PPE cost and then and I'd just say that we are in a much better position now than we were even six or eight months ago relative to PPE and our team has done a great job going out and finding secondary suppliers to help meet our demand needs..

Yes. No, I did see that slide.

I was just wondering if, do you think it would be a headwind for all of 2021 and even going into 2022? Or do you think this extra cost is more transitory in nature?.

I think the bulk of it is probably more transitorial, though, as we've said previously, my guess is that, none of us in the healthcare world are going back to pre-COVID normal. That there is going to be some heightened use of PPE that stays with us on a go-forward basis. And I think in this organization, we believe that's absolutely prudent..

All right. Thanks..

And your next question comes from the line of Pito Chickering of Deutsche Bank..

Hey. Good morning, guys. Thanks for putting me in here. A couple of quick questions for April. There are some moving parts about what you are talking about on the cost per visit as it relates to nursing disciplines going forward.

Conceptually, should we view the $75 per visit as a starting point and grow it at 3% or 5% over the next 12 months? Or can you help us just conceptualize how that works?.

Yes. As Doug mentioned, it really wrapped up our budgeting process and our planning for next year and I think we feel like there is some significant challenges on the staffing side, but they are saying that are going to drive costs out. I can't say that we are seeing that everywhere and broadly yet.

But certainly in certain markets, we are seeing some of that. So, I think it's reasonable to assume that it will be a little bit of a playing up over the course of 2022. If this pandemic goes away quicker, we may see some nurses that have previously retired, return to the market and things could sort of like ease up a little bit.

But I think it's probably reasonable to assume just a little bit of a steady playing of increase in the nursing discipline throughout the course of 2021..

Okay. Great. And then, visits per episode were relatively unchanged in the third quarter versus first quarter. I would have assumed that with the MetaLogics rollout, we would have seen some reductions in these visits.

How should we be thinking about sort of that – the visits per episode declining over the next sort of 12 months or so?.

Yes. As we mentioned in prior calls, our deployment of the MetaLogics tools got a little bit delayed as a result of the pandemic. I think we didn't get it fully deployed until June-ish timeframe.

And then, it just takes a little while to change practice and get people in, especially when your deployment was a virtual deployment versus a hands on face-to-face training approach.

So, I think we have not really began to scratch the surface fully of the opportunity with MetaLogics and that we will continue to see improvement quarter-over-quarter as we get that fully baked into our processes, our thinking and our approach..

All right. Great. And then, last quick one here for you. What percent of your business is tied to assisted living? I apologize if I missed that. And looking at 2019, what percent of your growth came from that type of business? Thanks so much. .

Don't have specific data right in front of me, right this second, but the AL/IL communities have been around 20% -15% to 20% in the past, and that category is one that's kind of off in the 20% to 25% range in the COVID world for the reasons we discussed earlier..

Okay. But ballpark is assisted living, is this like a 5% of your exposure? Is it like 25%, is this – just something there would be helpful..

I think we were saying 15% to 20% of our total patient volume resides in AL/IL communities..

All right. Great. Thanks so much guys. Nice quarter..

And your next question comes from the line of Frank Morgan of RBC Capital..

Good morning, Frank..

Good morning, Frank..

Good morning. Hey, I want to go back to, I guess, tail-end of an AJ question about the likely M&A activity. You certainly mentioned in your opening remarks, you expected a pickup on the Hospice side. And I'm curious, I would have thought by now that maybe you would see more on the Home Healthcare side.

But, just curious on your thoughts about why you think you are seeing it more on the Hospice side versus the Home Healthcare side? And then secondly, I appreciate the color to Whit's question about sort of the ending point for Census.

A lot of our other provider calls have indicated that September ended on a strong note, but a lot of them are talking about, they are starting to see a COVID surge again. So just any color there, I would appreciate that as well. Thanks..

Thanks. We are on the first part, and then I'll turn it over to April. Hospice has, generally speaking, been significantly less impacted by the events of 2020 than Home Health. So you've got a better run rate and it's easier to engage in price discovery for a buyer and a seller.

And the two things that we would point to is, one, Hospice was not subject to a payment system, form like PDGM. And then, Hospice volumes were less impacted at any point in time by COVID.

And so, when you layer on everything that's going on with regard to COVID on top of PDGM and with the pandemic having come into play before providers had an opportunity to establish a new base rate – a new baseline, I should say, under PDGM, it just makes getting to a runrate EBITDA in which to have meaningful discussions regarding a potential transaction, very difficult, and those same limitations don't exist in Hospice.

And for both businesses, I think that there is an awareness that there is very favorable growth opportunities and that's reflected in the multiples. So, if you are an owner of one of those businesses and have been thinking about transitioning out, right now, it's a pretty good time to do so from a Hospice perspective..

Frank, I want to ask both April and Barb Jacobsmeyer on what they are seeing in the current marketplace relative to just COVID..

Yes. Well, and so, I would also say on the Home Health side, I think we came into this year expecting PDGM to really disrupt Home Health providers and for that to create a wave of opportunity in acquisitions.

And with the PPP loans, the advance payments and then the CARES Act Fund, a lot of those smaller midsized agencies that we thought would see a significant level of disruption did not feel that disruption in spite of COVID.

So, the combination of the complexity, as Doug mentioned and then all this secondary support that is not going to continue long-term, we think it's just really kind of kick the can down the road here for some of that Hospice – excuse me, Home Health disruption.

So we still expect that we'll begin to see some of that to kick back in, in 2022, particularly as some of those advanced payments have to start being repaid here pretty shortly..

And I would say on the census side for the IRF side, I mean, October is certainly looking similar to the year-over-year that we've seen in September. But what I would say is what we've experienced really throughout COVID has been market-by-market challenges and those certainly are continuing.

So we see a decrease in one market and then it pops up in another market. So, that has not changed. We are continuing to see that affect us on a pretty regular basis..

And maybe April could address that same question. Thanks..

Yes. Sorry, I overlooked that part of the question. And so, yes, I think like Barb, we definitely are seeing sort of ebbs and flows by market. I think our biggest challenge has really been that about 37% of our total admission volume comes from two states, Texas and Florida, both those states being hit pretty hard with both first wave and second wave.

And so, we are encouraged in both states that we are seeing progress from the third quarter, really even into the first three weeks of October. And so, we think we have learned to create some new referral sources.

As I mentioned earlier, we are looking for ways to mitigate losses that we are experiencing from the lack of electives, as well as from the AL/IL impacts.

And so, I feel encouraged by what we are doing and think that that would suggest that when we do start to see a return of norm in those two states and particularly with electives and AL/IL, we've got a sustainable trend to maintain new sources while adding back some of our old sources.

So, I think we are going to continue to see noise from the COVID situation, probably for the next six months. But we are working hard to create new avenues for growth and feel pretty positive about the trajectory that we are on..

But Frank, I certainly would never want to characterize it as routine.

But our staff, and I said it in my opening comments, our teams have just done a tremendous job and, A, learning how to treat COVID patients, learning how to take the mitigating efforts they need to, whether it's in a clinical setting or sales and marketing setting, I think that we have really set ourselves apart from our competitors in the marketplace with our willingness to take COVID patients into our service lines.

And then also the outcomes that we have achieved with them. So, I think it's given us a chance to really endure ourselves even more to referral sources and we talked about MA plans earlier. I think this has given us a chance to show MA plans, the value proposition that we have through our Home Health and IRF hospitals.

So, overall, they have just done a tremendous job mitigating the impacts..

Thank you..

And your next question comes from the line of Sarah James of Piper Sandler..

Good morning, Sarah..

Thank you. Good morning. And I am going to follow-on on that kind of change of thought for M&A here. So, understanding PDGM disrupted what's available and maybe stimulus money is elongating things as well.

But when do you expect the Home Health market to get back to normal as far as the opportunity of what's out there for M&A? And to the degree that you are leaning a little bit more into de novo, can you just remind us what the breakeven timeline is, or ROI differences are for you on de novo versus M&A?.

On Home Health, I would say, that we've probably got another - again, six months before we start to see Home Health really start to get interesting again. Again, it's going to get burnt through the CARES Act Fund, get back into your repayment requirements on advanced payments, if those occurred.

So, I would think that Home Health is going to remain a little bit quiet all the way probably into the second quarter of next year. Hospice, however, because as Doug mentioned, the multiples on that has been very nice in the marketplace. There has been some big announcements recently of high multiple transactions and the disruption has been far less.

I think we'll continue to see a lot of frothiness in the hospice world from an acquisition perspective and would anticipate that over the next six months, that will be where most of our M&A efforts are pointed..

So, with regard to your questions on the IRF side and then the comparison of the returns, Sarah, as we mentioned previously, with regard to the breakeven point or the ramp up in IRF, they typically achieve a four-wall positive EBITDA at the earliest between six and nine months and then probably, on average, closer to 18 to 20 months and that's based on our historic activity.

With regard to return comparisons, couple of data points to have out there. You could probably ballpark our weighted average cost of capital at somewhere, depending on how you want to view the current market conditions, call it, 8%.

So, we are certainly looking to make sure that the returns that we are estimating from any of the investments we make in growth opportunities are going to land north of that, so that we're creating wealth. We tend to use a 13% IRR target for investments that we make.

We've got a very good track record with regard to our de novos meeting or exceeding that target. What you are seeing in Home Health and Hospice is acquisition multiples push up. And as acquisition multiples push up, it becomes more difficult to receive outsized returns.

So, we are being very disciplined as we always have been with regard to that kind of activity.

But if you get to a point where you are paying between 12 and 15 times on a business that isn't significantly impaired in terms of its current level of margin performance or doesn't have outsized organic growth opportunities, then your returns are going to be closer to that weighted average cost of capital than they are going to be to that 13%..

Got it. That's helpful. Thank you..

And your final question comes from the line of Andrew Mok of Barclays..

Good morning, Andrew..

Hi, good morning. I wanted to follow-up on the acuity trends in your rehab centers. Even though acuity remains elevated on a sequential basis, both your revenue per discharge and length of stay decreased, which suggests moderating acuity.

So just wanted to get more clarity on why those numbers are moving lower if you are seeing intensifying acuity in your centers? Thanks..

Yes. I think the – I was checking my own numbers here. But I believe that sequentially, the acuity and the length of stay actually increased. Our acuity in Q2 was 1.49. Acuity in Q3 was 1.52. And with regard to the length of stay, I think we were also....

Almost half a day, I believe. 1.4 of a day..

We were up – I've got to get here some place. Can you just give me a second. We were at 13 even, I believe, in Q3. And we are just putting our fingers on the Q2 number. Only if we had Julie Duck here. .

Okay..

We'll get that for you in just a moment. But I think – oh, here we go. The acuity for – this is not sequential, but acuity for Q3 2020 was 13.2. It was 12.9 in Q3 of 2019. And I think it was about 12.9 in Q2 –.

Length of stay.

Length of stay. .

Length of stay, excuse me. .

Got it. Okay..

These trend lines would be consistent with what you are seeing reflected in the pricing..

Did that give you what you needed on the questions?.

I see, length of stay at 13.2 in Q2 and then, down to 13 in Q3. So, I was just more so looking for color on why that was moving lower. But, if you are seeing intensifying acuity or any reversal of those trends, would love to hear more color on that..

No, we are not at this point..

One of the other factors that we saw early on in Q2 relative to our length of stay and it went over in the Q3 too, it's just the ability to discharge patients from our hospitals to other post-acute settings was delayed in terms of their willingness to accept patients that had been treated for COVID.

So, that played a role in the extended length of stay in our hospitals..

I think what's also important to note is that, when – and I think we talked about this earlier about the patient mix. So, our other orthopedic conditions as a percentage of our patients went actually down 180 basis points, quarter three of 2020 over quarter three of 2019.

That does impact our CMI and our length of stay, because then the patients in-house are much more acute. So if we do see the elective surgeries come back online for these patients that have a lot of co-morbidities and start seeing that come back to our hospital that could impact that CMI and that length of stay..

And so, Andrew, to your point, you are right. Sequentially, we were at 13.2 in Q2 and 13 in Q3, as compared to last year Q2 of 2019 was 12.5. So a delta of 0.7 and Q3 2019 was 0.4 it was up - it was 12.6. So, it was a delta of 0.4.

So the specific length of stay against the higher C&I would have had less of an offsetting impact on the pricing, on how much of the pricing lift benefited us at the margin perspective. But both of those levels on a year-over-year basis are reflective of the higher acuity of the patient..

Got it. That's helpful. Thank you..

And I'll turn the call back over to Ms. Carlisle..

Thank you. If anyone has additional questions, please feel free to call me at 205-970-5860. Thank you again for joining today's call..

And thank you for participating. You may now disconnect at this time..