Good morning, everyone and welcome to HealthSouth Third Quarter 2017 Earnings Conference Call. At this time, I would like to inform all participants that their lines will be in a listen-only mode. After the speakers' remarks, there will be a question-and-answer period. [Operator instructions]. Today's conference call is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the call over to Crissy Carlisle, HealthSouth's Chief Investor Relations Officer.

Thank you, operator, and good morning, everyone. Thank you for joining HealthSouth's third quarter 2017 earnings call. With me on the call in Birmingham today are Mark Tarr, President and Chief Executive Officer; Doug Coltharp, Chief Financial Officer; Barb Jacobsmeyer, Executive Vice President of Operations; Patrick Darby, General Counsel and Corporate Secretary; Andy Price, Chief Accounting Officer; Ed Fay, Treasurer; and Julie Duck, Senior Vice President of Financial Operations. April Anthony, Chief Executive Officer of Our Home Health and Hospice segment, also is participating in today's call via phone. Before we begin, if you do not already have a copy of the third quarter earnings release, supplemental information and related Form 8-K filed with the SEC, are available on our website at www.healthsouth.com. On page two 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 risks and uncertainties, many of which are beyond our control. Certain risks, uncertainties and other factors that could cause actual results to differ materially from management's projection, forecasts, 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, 2016, and the Form 10-Q for the subsequent quarters. 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. Statements made throughout this presentation are based on current estimates of future events and speak only as of today. The company does 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 related press 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 joining today's call. The third quarter was another strong quarter for HealthSouth, with good performance in both segments. In spite of the disruptions from three hurricanes, there were positive trends in volume and pricing. Discharge growth of 3.8% in our inpatient rehabilitation segment and admissions growth of 15.5% in our Home Health and Hospice segment, drove topline growth of 7.4%. Our company's success is a direct result of the skills and dedication of our employees. The most recent example of this was demonstrated when hurricanes Harvey, Irma and Maria impacted Texas, the southeastern portion of the US and Puerto Rico. Our main priority throughout these storms was the safety and well-being of our patients and employees. Our employees stepped up in this time of need, working around the clock to care for patients and each other. Many of our hospital employees remained at the hospital for days at a time. Our Home Health and Hospice staff continued making home visits and caring for patients in the affected areas when conditions were safe. The accounts of selfless compassion and leadership exhibited by these employees, are numerous. I can't begin to express my appreciation to, and admiration for our employees who put the care of their patients ahead of themselves throughout the stressful and exhaustive experience. Our company is extremely fortunate to employ industry leading clinicians and professionals who provide a high level of care to our patients and are supported by the service oriented professionals in our home office. I thank you all for your compassion, professionalism, and perseverance. 21 of our hospitals, 34 of our home health agencies, and four of our hospice agencies were impacted by these storms. We have completed our preliminary assessment of the financial impact of these hurricanes.…

Thank you, Mark and good morning everyone. As Mark highlighted, Q3 was another very solid quarter for our company, with both businesses performing well, in spite of the disruptions related to three hurricanes. I’d also like to echo Mark’s comments and extend my appreciation to our many associates who did a phenomenal job, both preparing for and then responding to these storms. This episode served as an example of the strong culture in place at our company. Turning to the results for the quarter, our consolidated revenues increased by 7.4%, and consolidated adjusted EBITDA grew by 3.1%. Including in consolidated adjusted EBITDA were $3.8 million of operating expenses related to rebranding and TeamWork’s clinical collaboration. Also included were approximately $3 million in expenses related to the hurricane activity. Please also recall that Q3 2016 benefited from the $4 million IME credit at one of the former Reliant hospitals. Adjusted free cash flow for the first nine months of 2017 was $376.1 million. Free cash flow in Q3 was better than expected, largely due to a decrease in working capital related to improved AR collections. As can be seen on slide 18 of the supplemental slides, we have updated our assumptions for 2017 adjusted free cash flow, and now anticipate a full year range of $360 million to $430 million, as compared to previous expectations of $350 million to$400 million. We continue to deploy free cash flow to fund high quality growth opportunities in both of our business segments, devoting approximately $115 million to such projects over the first nine months of the year. These investments were complemented by year to date shareholder distributions of approximately $105 million. As previously disclosed and as outlined on slide five, during Q3 we amended our senior credit facility, extending the maturity date to 2022,…

[Operator instructions]. Your first question comes from line of Whit Mayo of Robert W. Baird.

Can you maybe just talk a little bit about your stroke and neuro mix, how that trended in the quarter? I know that you’ve deemphasized joints in Ortho in recent years, but just curious generally how those patient categories are growing and maybe what newer initiatives you have in place.

Yes. Whit, we continue to see stroke and neuro continue to be a strong component of our overall patient mix in our IRFs. Together, they make up almost 40% of our discharges. Stroke is right at 18%, with the remainder of that in what's known as being the other neurological categories. Over the past several years, we have done a lot in terms to accommodate the stroke population to handle a higher acuity patient. As matter of fact, this last quarter, our total acuity was the highest I can ever remember it being for our hospitals. Our case mix index was 1.38 in total. And I attribute a portion of that because of our growing stroke and neuro mix. We now have 101 hospitals that have the joint commission accredited stroke program that I think enhances our ability to continue to grow our stroke population. As you know, the American Hospital, American Stroke Association came out a year and a half ago now with the independent survey and study that showed if a stroke patient is going to be treated in inpatient setting, they are best served by being treated in an IRF. So we think this continues to be a growth opportunity for us. There are still a large percentage of the stroke patients being discharged out of acute care hospitals that are not going to IRFs, that are instead going to skilled nursing facilities, that would be better cared for in an IRF.

And Whit, just to give you some specifics on there. If you compare the patient mix in Q3 of this year to Q3 of 2016, together stroke and neuro were up about 200 basis points and knee and hip replacement was down 100 basis points. So that reflects the shift.

Got it. And maybe a two part second question. Is there any way maybe to potentially size the opportunity or the addressable market that you see within the stroke population? And then if you could elaborate a little bit more on the Cerner relationship and what you're doing, what the feedback from the hospital partners has been? I’m just curious if there's any additional color to put this initiative into perspective.

Well, if you look at 2015 Medicare claims, there were approximately 368,000 total stroke cases in acute care hospitals, of which 67,000 of those patients that were discharged from acute care hospitals, 18% were treated in IRFs, and 24% were treated in a skilled nursing facility. So we believe the opportunity to go out and take additional market share and treat a higher percentage of the stroke patients being discharged out of the acute care hospitals, is a primary focus for us.

With regard to the Cerner relationship, one of the reasons that we moved forward with the formation of the Post-Acute Innovation Center is because as we were out speaking to our existing joint venture partners, and as we were engaging in discussions with new joint venture partners about potentially entering those markets, we were getting increasing requests from those partners to take on a broader role that involved really helping them manage their entire post-acute network needs, whether it was by having more services that we were providing directly, or by helping them understand and coordinate which of the post-acute providers in their markets were most effective. So we're going to be working with Cerner. Obviously the formation of the Post-Acute Innovation Center was only announced in late August. So we're really still very much in the assembling the bodies and putting the priorities in place. But we have a list of priorities which we're going to address and we're going to begin piloting some of the tools that we've developed out of the post-acute center by as early as mid-next year, probably starting with a market like Tyler, Texas where we're working on a pilot around hip fractures with our joint venture partner there.

You’ve heard us talk about our predictive modeling capabilities in the past, and we've been working with our medical - a group of our medical directors on what we call our ReACT program or initiative to help identify patients that are at high risk for acute care transfers. We’ve been doing that now for a couple of years, but this partnership with Cerner will help us take that to the next level and tapping into their extensive database. Working with our physicians and our clinicians as a whole, we think it will put us in an extremely competitive position going forward.

Your next question comes from the line of Frank Morgan of RBC Capital Markets.

Good morning. Hey, I appreciate all the color surrounding the impact of those hurricanes. I’m just curious, like for example in this, the Manati Puerto Rico facility being closed completely, is that something that will ultimately be covered under business interruption insurance? Or just any color on that would be my first question.

Hey Frank, it's Doug. First of all, I enjoyed your appearance on Squawk Box this morning. Yes, we do believe that much of that will ultimately be recovered through our BI insurance. As you can imagine, there's a lot of this activity going on right now and it takes time to develop the claim information. We’re keeping close track of all of the expenses that we’re incurring with regard to all three of the storms. We’ll be filing claims under both our property and casualty and our business interruption insurance, but recoveries under those claims will be in subsequent periods, hopefully sometime in 2018, and it's too early yet to determine the magnitude of any such recoveries.

Okay and I suppose when that happens, that will just all be recorded sort of as a lump sum, it will just all hit in one - mostly hit in a quarter?

It's hard to say because you've got a lot of different insurers involved. And so as it comes in, we will be calling it out through the course of next year.

Got you. Okay. Just one other and then I’ll hop off. As it relates to this switchover to Palmetto from the Cahaba, is there any sense or any concern about any incremental costs that you may have that occurs during that process, or do you have any sense of - I think you made some comments that things had gotten better in the last few months, but how do you really think that relationship plays out through the final transition? Thanks.

You know, it's very difficult to tell on two fronts. One again, our experience with Palmetto as a MAC on the IRF side is quite limited. As I pointed out in my comments, it's more extensive on the home health side, and our experience on the home health side has been very positive, but we don't know if that will extend to the IRF side. We’re hopeful that it will. The second is, this is by far our largest MAC with 75 hospitals impacted. So the movement is very substantial. Cahaba is based here in Birmingham. They employ quite a large number of folks who have been handling our claims, as well as the claims of other providers within the jurisdiction. We don't know how many of those employees will ultimately be retained or if the facility will be retained in Birmingham. We also don't know what kind of capacity Palmetto may have within its existing administrative areas. So I think there's probably less risk of a lot of additional administrative costs on our part, although some incremental cost is possible. I think the greater risk would be a temporary slowdown in the processing of our claims, which could result in a temporary build up in working capital. But again at this point, that’s all kind of subjecture [ph].

Your next question comes from the line of Sheryl Skolnick of Mizuho Securities.

Good morning everyone and really, really nice job. It’s impressive that you reported these results including the hurricane. Never mind that you took such good care of patients and each other during the difficult times there. Not everybody is doing that so it deserves to be called out.

Thank you.

I wanted to - you’re welcome. I wanted to focus a little bit more on actually two things. The first is a very simple follow up to the Cahaba situation. Given that transition, do you anticipate that there could be a delay in processing of claims as a result? And then the second question is a question about HHGM. So if we could answer the first and give me leave to ask part two, I'd appreciate it.

Sheryl, on the first one, it's hard to say obviously because we haven't been through any kind of change in a MAC jurisdiction of a magnitude like this where 75 of our hospitals were included. I do think that there is a risk that just based on the administrative turnover, there will be a temporary slowdown in the processing of claims, and a temporary increase in working capital, but I would think that it would be fairly short lived. We do know that Palmetto is widely perceived to be a highly competent MAC, and I think that's probably the reason that this contract is transitioning to them. We’re going to start working with Palmetto very soon here and are going to do everything on our part to help make sure that the administrative changeover goes as smoothly as possible.

Yes, good idea. Okay, thank you. And on the HHGM side, so obviously no one knows what this rule is going to include, and it's not helpful to speculate, although it's probably a Wall Street analyst’s job to suppose. But I want to talk a little bit about the process that you might help us to understand that you'll go through once you do know what the final rule includes, and under the assumption that some form of HHGM is going to be implemented because my concern and what I'm getting at here is, it seems to me we haven't heard from any of the companies perhaps prudently what the impact would be on their business. And I don't know if it’s because you can't get at the data or you just don't want to say until it's final. But can you walk us through when we might anticipate you get the final rule, you know what the situation is, there's going to be some form of HHGM, whether it's budget neutral or not ‘19 or ‘20. When or how long would it take you to be able to assess the impact and then give us a view of the raw impact and potentially the mitigation that you could do/

Sheryl, I'm going to ask April Anthony to answer that. Her and her team have spent a lot of time evaluating the options and what the mitigation strategies would be. So I’m going to ask April to comment.

Sheryl, those are all great questions and I wish I had an objective answer for you. The reality is, in our efforts in Washington, we've been pursuing strategies with CMS, with OMB as well as with the Hill. And so I do have some concern that even when we know we may not fully know right away. So if the rule comes through the traditional process and it gives us all the definition that you would expect in a normal rule situation of exactly what's going to come into play, then I think that’s probably a 30 to 60 day window just home that through. If it ends up taking a different path or a different route and ends up having a legislative element, it’s very possible that we will have some directional guidance, but that there will still be time given the implementation timeline of it to work through some of the details, which we will have less opportunity to have a very pinned down answer for you pretty quickly. And so it's really, I would hope that by the middle of next week, we will have a much better sense of where this thing is headed, but at the moment it's very difficult to exactly estimate what that's going to look like. From a mitigation strategy perspective though, I will say that as an industry, I do think that there has been a lot of work done to understand the implications of 30 day episodes, how that would potentially impact care models and patient care. And so I do think there's some preliminary work being done, both here at Encompass and across the industry to understand what a 30 day episode period would look like and how that would impact care of patients, communications with physicians and the like. But we're going just to have to kind of wait another couple of weeks and figure out exactly where this thing's headed before we’ll be able to firmly answer those questions.

Your next question comes from the line of Kevin Ellich of Craig-Hallum.

Morning guys. Thanks for taking the questions. I guess kind of following up on the HHGM, given this, a little bit of an overhang, what are you guys seeing in terms of valuations for home health deals? And I guess on top of that, what sort of benefit, if any, should we be expecting from value based purchasing next year?

Yes. So I would say that we have really not seen multiples move one way or another yet as a result of the risk of HHGM. We continue to see activity in the market. We continue to see multiples remaining pretty consistent. There were certainly some things that you would look at in light of the potential for HHGM and say oh, that may be a higher risk transaction. So it may cause you to sort of walk away from a few deals that maybe would have been more intriguing before this overhang was there. And so far I would say it's been a pretty minimal impact on the market. As to your second question, I'm sorry, refresh me. I had a momentary blank on that.

Sure. Sorry, April. Value based purchasing, what sort of benefit do you think we should see next year?

Yes, very good. On value based purchasing, it’s still early in the process. It’s the 2016 experience that’s affecting the 2018 rates. I think we expect our locations that were in the non-value based purchasing states were recently acquired as of the 2016 timeframe. So we expect very minimal impact, maybe a very, very slight negative of just a couple hundred thousand dollars next year. We do believe that as we get to 2017 activity, which will pay out in 2019 if that turns back in a positive direction, that our states we would see new entrants in 2016 when that rate was impacted. We’re a big believer that value based purchased is a long term positive for high quality providers in the industry and would be a big advocate for expansion of value based purchasing program to a nationwide approach.

And Kevin, just one follow up on April's comments regarding multiples. Bear in mind that we are not paying publicly traded company multiples for the acquisitions that we're looking at within the home health space. Typically and we do see a wide disparity, because sometimes we’re really just buying a CON or a license to operate in the new geography. But typically we're more in the range of five to six times run rate EBITDA on our acquisition activity.

Your next question comes from your end of Chris Rigg of Deutsche Bank

Morning. I was hoping to get a little color on sort of the evolution of your relationship with the Medicare Advantage plan, sorry in the home health business, how that’s really - if it has changed materially over the last year or so with the plans.

I think we're certainly seeing some continued progress in the Medicare Advantage world. We’re seeing both progress on the front of those that are paying episodically, which is certainly our preference. Even if it’s at some discount to the Medicare rate, we prefer the episodic approach. But even in the per visit relationships we have in Med Advantage, we've seen our rate per visit rise consistently over the last few years, and I think that's because we've been able to really show the value of our solution. We’ve also been able to do some creative things with a handful of our Medicare Advantage plans and create some shared risk plans where we get paid a base rate, but then we have an opportunity to receive a premium if we're able to control cost on a bundle of patients. And so we've got a lot of creative things going on that front. And I think it's one of the things that we're encouraged by at the moment, that there is a lot of opportunity with a little better than 30% of the nation's seniors being in that Medicare Advantage world. We see this as an area for growth and expansion if we can get the right relationships and the right structures in place. And we’re beginning to feel better about that opportunity and we're seeing that grow as a percentage of our total revenue at a disproportionate pace.

We’ve had that same experience, Chris when you look at it on the IRF side, particularly with stroke population. Our value proposition, we've gone out now for several years and talked about our quality outcomes and the lower percent of patients that get readmitted back in acute care hospitals and considerations for total cost versus just per diem cost. And it may not stick the first time you go in and meet with the MA plans, but over time we've seen some nice progress in both of our segments.

Great. And then just one follow up. On the IRF JV side, has the competitive dynamic there, or has it just gotten more competitive to get the JVs? Or is most of the time HealthSouth negotiating exclusively with the hospital partners? Thanks.

I would say and we've been doing this now for many years relative to the JV business model as we evaluate opportunities for growth in our hospitals. Matter of fact, a third of our hospitals are partnerships. Our business development team have done an outstanding job, particularly the last several years in going out and reaching out with the proposition and proposals from our side of it. I would say that at least half of those times we are in a competitive situation where we're not the only provider being considered. But I would say it's not gotten any more competitive the last couple of years than what it was three or four years ago.

I’d just add a little bit more color on that. About half of our development pipeline right now is JV activity, and about half of it is solo. And so if about half of the JV opportunities are competitive situations, that suggests that only about 25% of our IRF development pipeline faces any kind of competitive situation. And even in those competitive situations, we feel pretty good about the value proposition and the track record that we're putting on the table.

Your next question comes from the line of Dana Hambly of Stephens.

Good morning. Thanks for getting me in. Just on the - where would you rank the - or where do you think hospitals rank the post-acute strategy in their list of priorities? And then my follow up would be, how does your post-acute innovation center business model differ from the existing convener models that are out there already?

So I think in terms of where they rank it as a priority, it depends entirely on the situation of the hospital. So if you've got a well-run hospital that's already doing well on a lot of its other quality metrics and it's controlling its admissions and so forth, then they probably have been more proactive in thinking about the additional improvements that they can make in a post-acute strategy. What we actually find is, and it's been a very effective tool for us from a business development perspective, is frequently they haven't thought a lot about the impact of just kind of randomly choosing post-acute providers, is having things like the length of stay in their hospital and under readmission rate. And we have developed a very effective analytical tool that goes by the acronym of (PAXA) where we go in and we take all of the Medicare claims data that is specific to that hospital and to the other providers in the market, and we show them the effectiveness of them versus competitors in terms of moving patients out to a post-acute setting on a timely manner - in a timely manner, and ultimately what the cost and what the trajectory is of those patients in their post-acute network. With regard to what's different between us and the conveners, it's the marriage of a very, very powerful data analytics firm in Cerner, which is able to access great amounts of information and to synthesize that data in a meaningful way with the clinical expertise of an actual post-acute operator. One of the things that Remedy and naviHealth and those other conveners do not bring to the table is the knowledge that comes from operating the largest IRF provider and the fourth largest home health provider in the marketplace. And we think it's a very powerful combination.

Dana, it's difficult be good at all things in healthcare now and we're seeing more and more acute care hospitals figure that out and know that they can't be good at all their acute care programs and also expand into post-acute and be highly competitive in all different areas and keep up with all the changing regulations, which is very time consuming and resource considerations. So those are all driving the effort for our development side in reaching out to all the acute care system and driving our pipeline of opportunities.

[Operator instructions]. Your next question comes from the line of Sheryl Skolnick of Mizuho Securities.

Welcome back, Sheryl.

Thank you. So I wanted to follow up with April about her intriguing comments about a legislative component. Would you care to elaborate on that with respect to the HHGM please?

Well, Sheryl, just to say that we are, as I mentioned, working all avenues. So we've had a multiplicity of meetings with CMS and with OMB. And as you try to read the tea leaves, we never want to get ourselves away from having legislative opportunities as well. And so as you know, 50 senators have signed on to a letter opposing HHGM. We now have right at 160 House members who’ve similarly signed onto a letter opposing HHGM. So there's a lot of folks on the Hill who think this is a bad proposal as well. And so we are working all avenues, trying to make sure that we have all of our bases covered and can attack this issue one way or another.

Okay, because when you answered the question, I thought it was in the context of the regulation, that there might be some legislative avenue and I suppose that I understand what you're saying now. Okay, rather than just sit it out there. All right. That was very helpful. Thank you. That was it.

Your next question comes from the line of Kevin Fischbeck of Banc of America Merrill Lynch.

So as far as the home health business, margins improved their nicely, even if you include a couple of onetime items that you mentioned it sounds like on labor productivity. What’s the right way to think about where Home Health margins could be, if we assume the stable reimbursement backdrop?

Well, I think we're doing obviously a very good job in margin management, if you compare the Encompass margins to our peers. We certainly are making the most of our tools and our resources. And so there are just some core restrictions that you have. I don't think there's just tons of margin upside potential from where we are today, but I do think that we're in a place to be able to sustain the margins that we're reflecting, certainly in a flat rate environment. We’ve forgotten what a flat rate environment looks like. It’s been so long since we even had flat. But it - certainly there could be some upside if we could get back to that kind of environment. We’re used to living in a down rate environment, still having to manage margins. So I think it's the things that we mentioned earlier in the year, as we were concerned about rate changes and reimbursement cuts. It’s really about gaining efficiency with our clinical field staff, utilizing a model that has us focusing primarily on salary based field staff. About 75% of our visits are performed by salaried employees who don't have any kind of incentive to do more visits in order to pad their own payroll. And so we've been able to use that model very effectively to build great culture, to drive great quality, to control utilization. And because of the strength of our home care home based tools, we've been able to manage the productivity of those full time staff members in such a way that we have been able to keep our cost per visit very efficient. In addition, our administrative costs on the back office side, which is a growing challenge because of expanding regulations, our team continues to find ways to better leverage our tools and technologies to make that possible. So I'm very proud of the margins that we've been able to deliver, and I think it certainly leads the industry from a margin perspective. But it'll be an everyday job to maintain that and to continue to look for opportunities to expand it over time.

Thanks. I guess let me just go over to the IRF side. It wasn't clear to me. You mentioned a number of things that impacted labor costs. SWB as a percentage of revenue this quarter. And some of them are going to go away as far as Reliant specifically. But you made some comments, you made it sound like you still expect, I don't know, I guess those 50 basis points are kind of core labor pressure and health benefits pressure in the quarter. You made it sound like you expect something similar to happen next year, kind of highlighting that the rates next year will be inflation too. Is that the right way to think about it, or are there mitigating or offsetting factors that you would point to?

So again, Kevin, we provide our regular cycle merit increases on October 1 to correspond with the fiscal year. And so those went in and were very much in line with that 3% item that's in our guidance consideration, and yet the new pricing for IRFs on the Medicare side also went into effect on April 1. And based on MACRA, that holds us to a pricing increase of less than 1%. So just by virtue of that, you're likely to see some delevering. We don't think that there are opportunities to trim clinical staffing. We think that that would be a mistake. So yes, I think some of that margin pressure is going to continue into 2018. I think as we start to look at 2019 and beyond and start to move out from some of the pricing offsets that are embedded in the Affordable Care Act, I think the environment gets better.

Okay, great. Thanks.

Thank you. I’ll now return the call to Crissy Carlisle for any additional or closing remarks.

Thank you. If anyone has additional questions, I will be available later today and Monday. Please call me at 205-970-5860. Thank you again for joining today's call.

Thank you. That does conclude today’s HealthSouth third quarter 2017 earnings conference call. You may now disconnect.