Ensign Group Inc (ENSG) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for your patience. You have joined The Ensign Group's third-quarter 2016 earnings conference call. (Operator Instructions) As a reminder, this conference may be recorded. I would now like to turn the call over to your host, Mr. Chad Keetch from The Ensign Group. Sir, you may begin.

Thank you, Latif. Welcome, everyone. Thank you for joining us today. We filed our earnings press release yesterday, which can be found on the investor relations section of our website at www.ensigngroup.net. A replay of this call will also be available on our website until 5 PM Pacific on Friday, December 2, 2016.

Before we begin, I have a few formalities to cover. First, any forward-looking statements made today are based on management's current expectations, assumptions, and beliefs about our business and the environment in which we operate. These statements are subject to risks and uncertainties that could cause our actual results to materially differ from those expressed or implied on today's call. Listeners should not place undue reliance on forward-looking statements and are encouraged to review our SEC filings for a more complete discussion on factors that could impact our results. Except as required by federal securities laws, Ensign and its affiliates do not undertake to publicly update or revise any forward-looking statements where changes arise as a result of new information, future events, changing circumstances, or for any other reason.

In addition, any operation we mention today is operated by a separate, independent operating subsidiary that has its own management, employees, and assets. References to the consolidated Company and its assets and activities; as well as the use of terms we, our, or us are not meant to imply that The Ensign Group, Inc., has direct operating assets, employees, or revenue; or that any of the various operations -- the service center, the real estate subsidiaries, or our captive insurance subsidiary -- are operated by the same entity.

Also, we supplement our GAAP reporting with non-GAAP metrics. When viewed together with our GAAP results, we believe that these measures can provide a more complete understanding of our business, but they should not be relied upon to the exclusion of GAAP reports. The GAAP to non-GAAP reconciliation is available in yesterday's press release and is available on our Form 10-Q.

And with that, I will turn the call over to Christopher Christensen, our President and CEO. Christopher?

Thanks, Chad. Good morning, everyone. Thanks for joining us today.

Yesterday we reported GAAP earnings per share of $0.21 and adjusted earnings per share of $0.32, which was consistent with our expectations. While we expect to do much, much better, we are also very pleased that we have increased revenue and earnings and are optimistic that we remain on track to achieve our 2016 annual guidance.

As we anticipated, the sheer number of transitions, including the Legend acquisition and related collection challenges, along with pressures on occupancy and skill mix in a few of our markets, all combined to impact our results. And to be clear, when we revised our guidance last quarter, we expected to see the lion's share of our remaining 2016 performance to come in the fourth quarter. This fourth-quarter surge is typical for us, as we always see our best occupancy and skill mix increases, as well as the effective rate increases, in the last three months of the year.

We continue to integrate a significant number of new operations across our organization, and as we have done so, we have been particularly careful when taking the necessary steps to set these operations up for success over the long-term. Our talented local leaders are building exceptional clinical systems to attract higher-acuity patients, growing occupancy and rightsizing expenses one operation at a time.

All of these efforts obviously impact our short-term performance in our newly acquired and transitioning operations, but also impacts our same-store results. Given our very field-driven approach to transitions, the leaders of our same-store operations have been working tirelessly on the fundamentals in our same-store operations while simultaneously integrating 74 recently acquired and 29 transitioning skilled nursing and assisted living operations into our organization.

We are as excited as ever about each of our acquisitions and believe that as each of these carefully selected additions are fully integrated -- and as networks continue to narrow -- that we will capitalize on the organic growth potential inherent in our entire portfolio. As we have proven in the past, over time and with the help of the right leaders, we expect to tap into the exceptional amount of organic growth potential inherent in our operations. And remember, we have never had more organic growth potential in our newly acquired operations than we do now.

As we have discussed over and over again, our results are not symmetrical on a quarter-by-quarter basis, and we continue to focus on the fundamentals of our ever-changing business and driving clinical and financial performance over the long-term. Although we expect some of the lumpiness we have experienced recently to carry over into 2017 as referral and managed care networks continue to narrow on varying timelines, we are very confident in our results-oriented approach to healthcare and look forward to the rewards that will come to quality providers.

We also see several positive developments on the horizon. For example, most of the softness in occupancy that we experienced was limited to a few geographies, as we also had several strong pockets where our operators are performing ahead of schedule. In addition, the recently announced 2.4% net increase in Medicare rates took effect on October 1, and we will receive the majority of the improvements in Medicaid reimbursement in many key states in the fourth quarter.

We continue to remain financially sound, with one of the lowest debt ratios and the strongest balance sheets in the industry; a solid cash position; and very manageable real estate costs. Even after the most acquisitive years in our history, Ensign's rent-adjusted net debt to EBITDAR ratio, after capitalizing our leases at 8 times, is down to 3.8 times as of the quarter-end. And as EBITDAR and our cash flow from our newly acquired operations catch up, our balance sheet will be healthier and healthier.

Before we provide more detail on our financial performance and individual operations, I would like to have Chad give some additional detail on our acquisition pipeline. Chad?

Thank you, Christopher. During the quarter the Company announced the acquisition of the operations and real estate of Riverbend Post Acute Rehabilitation, a 152-bed skilled nursing facility located in Kansas City, Kansas. Riverbend, which had been previously operated by a nonprofit organization, adds to our growing presence in a market where we have a strong cluster of healthcare resorts and adds Medicaid beds to our short-term transitional care operations.

Ensign also announced that Cornerstone Healthcare, Ensign's home health and hospice portfolio subsidiary, acquired the assets of Kinder Hearts Home Health and Hospice in Abilene, Texas, effective September 1. This strategic addition to our home health and hospice operations combines with our three skilled nursing, assisted living, and independent operations in Abilene and allows us to offer a full continuum of postacute cares to our patients and referral sources in that area.

In addition, during the quarter Ensign-affiliated operating companies opened two healthcare resorts, including The Healthcare Resort of Waco, with a 70-bed licensed transitional care operation and 30 private assisted living suites; and The Healthcare Resort of Topeka, Kansas, with 70-bed licensed transitional care operation and 35 private assisted living suites.

These new constructed healthcare campuses add an important strategic service offering and will complement our growing number of healthcare operations in several markets. This brings our total number of healthcare resorts to seven, with four in the Kansas City market; two in Texas; and one in Colorado.

We also recently announced that our urgent care subsidiary, Immediate Clinic Seattle, Inc., agreed to sell substantially all of its assets relating to its 14 urgent care operations in the greater Seattle market. The asset sale includes 14 clinics, and together with the Integrity Urgent Care transaction in Colorado which was sold in the third quarter, represents all of the remaining Ensign-affiliated urgent care operations. We are making good progress on the process and expect to consummate the sale on December 11, 2016, upon satisfaction of certain closing conditions.

We continue to actively seek transactions to acquire real estate and to lease both well performing and struggling skilled nursing, assisted living, and other health-care-related businesses in new and existing markets. And since the spinoff of our real estate in 2014, we have acquired the real estate in 35 of our operations and have purchase options on 24 of our leased operations.

We recently exercised a purchase option on 15 assisted living operations and expect to close on that purchase before the end of the year, which will bring our number of owned assets to 50 properties. We continue to see many opportunities to grow in the postacute arena. However, we believe that the pricing expectations for many sellers continue to be unrealistic.

In addition, we have been extra picky lately as we have been taking a much-needed breather from the rapid pace of growth we have experienced earlier this year and last year. As a result, our local operators have been waiting on the sidelines while preparing for the many attractive opportunities we expect to see in 2017. We do see signs of changing market conditions, and we fully expect that uncertainty around reimbursement models and other forms of postacute care will lead to more and more attractive opportunities over the next several years.

In the meantime, thanks to the health of our balance sheet, we have ample liquidity available to us to grow in a significant way. And we will remain patient as we see these changes result in many opportunities in new and existing markets. We have found a few diamonds in the rough and expect to close on a few transactions later this year and early next year.

And with that, I'll hand it back over to Christopher.

Thanks, Chad. As we said before, our performance is seldom the product of any one thing, but rather reflects the aggregate effect of dozens of factors across the many varied geographies we serve. This quarter is another example that illustrates that our results are often impacted by a number of small things rather than any one big headwind.

As we anticipated, many of the same challenges we mentioned last quarter carried over into the third quarter, including a slower than usual transition of the Legend operations in several of our newly acquired operations; typically higher bad debt on newly acquired operations, which was exacerbated by the sheer volume of transitions; and softness in same-store occupancy, which was partially offset by a solid tick upward in managed-care days. And as those of you who have been following us know, the Legend acquisition is the largest single transition we have completed to date. That acquisition was on the heels of our largest growth here in our history in 2015.

As we said last quarter, due to the sheer number of newly acquired operations in certain pockets of the organization, the transition of Legend is expected to take longer than it usually takes us. As I mentioned earlier, this has not only impacted the results of these newly acquired operations, but it is also impacted our same-store results in Texas, as the integration has taken the full focus of our best and brightest in the field and from our service center.

We are encouraged by the improvements that we have started to see in these operations, even if the financial outcomes have yet to fully materialize. We are confident that these operations are on the right track and will strengthen us in Texas because of how they have been transitioned, with a relentless focus on the fundamentals and the long-term success of each and every one of them.

As we discussed last quarter, because of the delay in billing and collections that is inherent with every change in ownership process and the sheer number of acquisitions, we continued to see an increase in our bad debt during the quarter. This has also been exacerbated by her participation in various Medicaid programs in Texas and Utah that require a temporary delay in billing. Over the next few quarters we expect these bad debt levels to trend down towards our same-store averages.

We continue to be pleased with the progress that we are making with our managed-care relationships as they continue to grow in most of our markets. During the quarter, managed-care patient days grew by 1.3% for same-store and by 7.2% for transitioning operations, a trend that has been consistent over many years.

In some markets it takes longer to see the increased volumes from our managed-care relationships. However, we expect to see that improvement as the pace for narrowing networks accelerates in certain markets. Our local leaders have been and remain determined to become the preferred provider in all of our markets, and we are seeing that occur systematically as they continue to drive superior outcomes.

While there are many tangible and intangible metrics that we use to demonstrate the high-quality outcomes to the healthcare communities we serve, we're also pleased to report that the number of skilled nursing operations achieving four- and five-star ratings has improved again.

As of the end of the quarter, 86 of those operations carried that designation, representing an increase of 11.5%. These improvements continue despite the recent changes in the CMS star rating system that have made it more difficult to achieve four- and five-star ratings. And we remind you again: the vast majority of the facilities that we acquire are one- and two-star facilities at the time we acquire them.

On the reimbursement front, CMS has announced a 2.4% market basket increase in Medicare rates for our skilled nursing operations, and we expect to see some increases in our rates for hospice services. In addition, several of our operations continue to participate in various bundled payment programs and capitated rate programs across several markets. Due to the size of these pilots and the small amount of revenue it currently represents, the impact of these early-stage programs is immaterial to our financial results.

To be clear, we do not see the shift to value-based payments as anything but a positive based on our results so far. While the results very month by month and diagnosis by diagnosis, our participation in these pilot programs has allowed our team of clinicians to redesign our care delivery models, gain efficiencies in care, and enhance referral networks.

This continuous effort has included our nurses, operators, therapists, finance and information systems teams across the organization. Together, an interdisciplinary team of experts have been working together and analyze data and to coordinate with caregivers across the continuum to drive improvements in performance, all on a condition-by-condition basis.

As we have done so, we have experienced a net positive from our participation in Model 3 bundles when comparing the CMS target price to put we would have been paid under a traditional fee-for-service model. We have learned many lessons through this process and have proven again that our locally-led approach to all aspects of our business have and will serve us well in any reimbursement system, including value-based payments.

As always, we would like to highlight a few operations that have seen significant improvement as our leaders have helped to shape the healthcare landscape in their respective communities. At Horizon Post-Acute and Rehab Center, a five-star-rated transitioning campus and part of us since 2014, CEO Brian Lorenz, together with COO [Kelly Couzia] and Director of Rehab Services, [Abby Marshman], have aggressively marketed their deficiency-free survey record, their newly renovated building, and state-of-the-art therapy technologies. Despite the fact that their competition is closer to the major hospital they serve, the entire Horizon team has been able to gain the trust of Banner Health, the major managed-care system in greater Phoenix. As a preferred provider with Banner's ACO network, Horizon has demonstrated to their partners over and over again that they are capable of producing consistent outcomes while appropriately managing length of stay.

As a result, Horizon's EBIT is jumped almost 44% over last year's quarter. In addition, their managed-care days were up 48% and their skilled mix revenue was up over 550 basis points. Horizon has also been a participant in BPCI Model 3, which is also resulted in a net positive during the third quarter. Most importantly, Horizon has become an example of culture and leadership to our entire organization and recently won our most coveted award as a flag-flying operation within our organization.

At Vista Knoll Specialized Care facility, a five-stare-rated operation with us since 2003, located in Vista, California, our CEO, Clay Gardner; and soon-to-be COO [Jed Nacional] have dramatically expanded their highly regarded neurological behavior program, which caters to patients that also struggle with brain and other injuries. Vista Knoll's unique behavioral capabilities and their willingness to care for the most difficult and complex cases have made them a trusted partner to community hospitals.

While Vista also excels in providing traditional skilled nursing services, they have developed this unique niche in direct response to demands of the local healthcare market. As a result of the talent of these local leaders, Vista Knoll's Medicare days were up 13.8%, their revenue is up 13.2%, and their EBIT has jumped almost 54.7% over last year's quarter.

Finally, at Mission Care Center, a five-star rated skilled nursing operation in Rosemead, California, acquired in 2005, Executive Director Kip MacMillan; and Director of Nursing, Xavier Suva, have become outstanding examples of how to develop a true partnership with the medical community. Together with their amazing team of caregivers, Mission has developed a reputation of being capable to taking care of the most complex patients.

They have consistently opened their doors to high-acuity patients, clinically complex patients, and have achieved outstanding clinical outcomes. At the same time, they have maintained excellent survey scores. During the quarter they grew their skilled mix revenue by 241 basis points, increased their total revenue by 13.3%, and improve their EBIT by 152.3% while maintaining their five-star rating. All of these examples demonstrate that even in an ever-changing environment, through the right partnership and superior outcomes, we are able to drive significant organic improvements in all of our operations, be they same-store, newly acquired, or transitioning.

Next, I would like to ask Suzanne to provide more detail on the Company's financial performance. Suzanne?

Thank you, Christopher. And good morning, everyone. Detailed financials for the quarter are contained in the 10-Q and press release filed yesterday.

Here are a few highlights for the quarter when compared to the third quarter of 2015: consolidated GAAP EBITDAR for the quarter was $64.3 million, an increase of 19.7%; and consolidated adjusted EBITDAR was $68.1 million, an increase of 19.4%.

Same-store revenue for all segments grew by 4% to $251 million, and same-store TSA revenue grew by 3.3% to $233.6 million. Transitioning revenue for all segments grew by 4.6% to $62.4 million, and transitioning TSA revenue grew by 5.6%.

Cornerstone Healthcare, our home health and hospice subsidiary, grew its segment income by 10.6% and revenue by $4.3 million to $29.5 million for the quarter, an increase of 16.9%. And consolidated GAAP revenue for the quarter was up $77 million to 21.9% over the prior-year quarter to $428.1 million, and consolidated adjusted revenue for the quarter was up $66.5 million to 19.3% over the prior-year quarter to $411.2 million -- all of which resulted in a GAAP diluted earnings per share of $0.21 and adjusted earnings per share of $0.32.

Other key metrics as of September 30 were cash and cash equivalents of $40.4 million and $290 million of availability on our $450 million credit facility, with an accordion of $150 million and 32 unlevered real estate properties.

Operating margins were impacted by a number of factors, including 196-basis-point decline in same-store occupancy, which was partially offset by 126-basis-point increase in managed care days. In addition, we continued to see growth in our other skilled days and assisted living patient days, with an increase of 750 basis points and 67 basis points, respectively.

As we discussed last quarter, after we acquire a skilled nursing facility, we experience temporary delays in our ability to collect on our receivables. More specifically, following the transfer of ownership we enter into a process with Medicare, Medicaid, and managed-care agencies to transfer the contract and billing codes to an Ensign-affiliated account.

This process results in delays in the receipt of payment for our services provided at our recently acquired operations. As a result, we experience temporary spikes in our accounts receivable following each acquisition while we wait for the paperwork to be completed, which can take a number of months. This temporary delay in collections results in an increase in our accounts receivable and can result in negative free cash flows, which is consistent with what we would expect during periods of significant growth. In looking at the fourth quarter, we typically see our best occupancy and mix as well as positive effects of our annual rate increases, including a 2.4% Medicare market basket increase.

As Christopher mentioned, we are reaffirming our revenue and earnings guidance for 2016. We are projecting $1.625 billion to $1.66 billion in revenue and $1.35 to $1.42 per diluted share. The 2016 guidance is based on diluted weighted average common shares outstanding of approximately 52.6 million, the exclusion of acquisition-related costs and amortization cost, the exclusion of losses associated with the development of new operations and startup operations which are not yet stabilized, the exclusion of costs related to system implementations, the exclusion of results at a single closed facility, the inclusion of anticipated Medicare and Medicaid reimbursement rate increases net of provider tax, a tax rate of 38.5%, the exclusion of stock-based compensation, the exclusion of an insurance reserve in connection with settlements on claims, the exclusion of the gain on sale of the urgent care centers, and the inclusion of acquisitions closed to date.

We are also affirming our 2017 earnings and revenue guidance. We are projecting $1.818 billion to $1.842 billion in revenue and $1.62 to $1.70 per diluted share.

The 2017 guidance is based on diluted weighted average common shares outstanding of approximately 54.2 million and a 36% tax rate. Both of these reflect the adoption of a new accounting standard that will become effective in January of 2017, which we class as a tax benefit associated with the stock-based compensation from the diluted share calc to the tax rate on the tax expense, the exclusion of acquisition-related costs and amortization costs related to patient-based intangibles, the exclusion of losses associated with the development of new operations and startup operations which are not yet stabilized, the inclusion of the anticipated Medicare and Medicaid reimbursement rate increases net of provider tax, the exclusion of stock-based compensation, and the inclusion of acquisitions closed to date.

In giving these numbers I would like to remind you that our business is not symmetrical from quarter to quarter. This is largely attributable to variations in reimbursement systems, delays and changes in state budgets, seasonality and occupancy in skilled mix, the influence of the general economy on our census and staffing, the short-term impact of our acquisition activities, variations to insurance [accruals] related to our self-insurance programs, and other factors.

And with that I'd like to turn back over to Christopher. Christopher?

Thanks, Suzanne. We want to again thank you for joining us today and express our appreciation to our shareholders for your confidence, trust, and support. We also want to express our appreciation to our colleagues in the field and the service center for making us better every day and for all the work they have put into helping us improve.

I guess before we close, if we can turn the Q&A portion of our call over to Latif -- do you mind instructing everyone on that, Latif?

(Operator Instructions) Seth Canetto, Stifel.

Can we just drill down a little deeper into the low occupancy in limited geographies? Can you guys attribute that to anything specific and maybe talk about exactly what geographies those are?

Yes. I think, frankly, the majority of it was in Texas. And it was related to some of the things that we said in the script: the transition of the enormous number of facilities -- not just the Legend facilities, but also some other acquisitions we've taken over the last year and a half.

And it has just been a bit of a strain, I think, on the resources that we have. And as a result, as you might imagine, we have adjusted some things, and increased some things, and put in some additional resources so that that is not the strain that it has been. And I think we feel pretty confident that we will see a good strengthening of occupancy in Texas in the fourth quarter.

All right. So you wouldn't attribute any of the low occupancy or underperformance to distractions, really? It's not like efforts are in Texas, so other geographies are underperforming? Nothing like that, right?

No. I think most of our other markets saw an increase. We did see -- for different reasons that I won't get into because they are not material, in a market in Washington, in a market in Utah, and a market in -- but, you know, select markets, but the vast majority of it was in Texas.

Okay, great. And then just switching to pricing, last quarter it sounded like there was different views where sellers wanted to anticipate a high takeout and buyers were looking at take advantage of the fragmented market. It sounds like we have reached a turning point. Did I get that right -- in the opening remarks?

Yes. I think that that's -- I'll let Chad correct what I say here, but I think from our perspective, I think that's more of an intermediate term. But I think it will happen. I think over the next several quarters, we're going to see that opportunity. But Chad, you can correct what I've said.

Yes. Look, I think a lot of the transactions that are out there are sort of larger portfolios and several dozens of assets that have been out there. And typically, those larger portfolios tend to attract more competition and more aggressive multiples.

But I think with a lot of the smaller sellers, there has been some expectation to receive a premium that maybe the larger portfolios are getting. And while we see some of that persisting, we do see some of that changing as well. But we're just at the beginning stages of that.

We definitely think, Seth, that as this -- the value-based payment takes greater hold in more markets and those that didn't prepare for it begin to realize that it's here to stay, that there definitely will be an opportunity for consolidation.

Okay, great. And then touching on the guidance, that was reaffirmed, so that's good to see. The large ramp -- I know if you look at, like, 2014 and 2015, you can see that large ramp in 4Q. Is it mostly seasonality? Or are you guys expecting improvement from Legend portfolio? And it just sounds like a number of factors from Medicaid reimbursement as well. Is that correct?

Well, since you brought up 2014 and 2015, I think historically it is partially seasonality. And usually that's when -- you know, if there are any rate increases, that's when we see them, although they haven't been tremendous before this year, or in recent memory.

But part of it is what you said, as well. Part of it is the expected improvement in Texas and the expected improvement in a couple of other markets that are still doing well but can do much better.

But the fourth quarter -- as you said correctly, it has always been better than the second and third quarter, historically. And that is partially due to seasonality.

All right, great. That's it for me. Thanks for the answers.

(Operator Instructions) Frank Morgan, RBC Capital Markets.

I was hoping to get a little more color on some of the markets where you are expecting to see the benefits of this narrowing of networks. You obviously called out that -- I think it was the Horizon and the Banner example. But what gives you confidence that you will get this patient flow, hopefully starting sometime in the fourth quarter, and build into next year? But maybe just a little color there to start with?

Yes. For certain reasons, I won't tell you all the details. But some of them are formal contracts, signed and that have been delayed. Some of them are narrowing of networks and formal arrangements that are just starting now.

And then some of them are more informal, just a group of -- you know, one hospital system selecting a few dozen facilities where they used 10 or 12 dozen in the past. But we've already seen that. You mentioned Horizon; we've already seen that in places like Arizona and California, where they are -- I guess it depends on how you look at it, but they are ahead of the game in terms of value-based payment and in terms of some of the hospital systems.

But the places that we haven't seen as much of it that we expect to see in the future are places like Texas, and Utah, and some in Idaho. And then we have some smaller markets that are less material. But those are some of our bigger states.

And we will obviously -- Frank, even though we've seen it in California and Arizona, that will continue to expand and grow to other hospital systems. And so we will see the impact in California and Arizona as well. The places we are not seeing a lot of it in the near future are some of the Midwestern states.

Got you. And certainly Suzanne alluded to the rate growth. It looks like the rate growth was really very strong, actually, in the most recent quarter. And I'm just curious: is there anything in there that we should call out? And then how might we think about -- obviously, you mentioned the market basket rate increases for Medicare, but maybe sort of a survey around some of the states where you are expecting to see increases?

So one thing I will tell you, and it's not a call-out; we're trying to figure out a way -- I don't know if you remember a couple quarters ago when we talked about this quality bonus, if you will, that we received in one state, in particular -- California. We are trying to figure out a way to spread that out over several quarters and make it a little bit more equal across time.

So that is in there, but you should see that in there now every quarter. So I hope this is a new norm. But what you saw -- I hope I have the quarters right -- in the second quarter or the first quarter?

In the first quarter and then --.

What you saw in the first quarter was a little bit abnormal. And we didn't want to keep doing that every year. So we are trying to conservatively spread it across time. And hopefully that's a new norm.

It's the clarity that we are getting from the state and able to project it. And so as we have gotten more and more clarity and better tools, in order to incorporate it in, we can actually project it over the year instead of having it all hit all in one given quarter. And so there's a little extra in the Q3.

But as Christopher mentioned, in Q4 we will also be able to take some of [that out], because now we're going to be able to spread it over the entire year.

Okay. So just accrue it now versus waiting on cash receipts? Is that a way of thinking about it?

Accrue a conservative amount of it. It's not -- we are not accruing all of it, but we are trying to make it so it's not this crazy amount in the first or second quarter every year.

Frank, there was also -- we also did receive some increases in California that's in there that -- it's not a one-time thing. And that happened in August versus most of the states that happened in the fourth quarter.

Okay. And what about other states, where rate increases will be helping you in the fourth quarter on the Medicaid side?

Yes. So Arizona is also going to help us in the fourth quarter, so we will have that. And then California. And like Christopher mentioned, there's two months in third quarter, but we'll have a full three months in the fourth quarter. So that actually helps quarter over quarter.

And then the big one that's out there is the Medicare increase, which is the market basket is 2.4%. We will be a little bit higher than that market basket increase, just how our RUGs have historically fallen out. So that will help us as well in the fourth quarter.

Okay. And just any updates -- certainly, I remember from last quarter you had called out some of the impacts, disruption from the IT conversion, I think, to the Workday payroll system related to the whole payroll-based journal. Where are we on that? And are we there yet in terms of its ability to help us manage labor?

We are not there yet, but we are much, much better than we were. And I feel confident that by the end of this quarter, we will be in great -- but it's not nearly in the third quarter what it was in the second quarter. And the fourth quarter will be substantially better. And I don't foresee any abnormal challenges by the end of this quarter.

Okay. Actually, I'll hop back in the queue and let somebody else ask.

Ryan Halsted, Wells Fargo.

Just a question back to the managed-care narrow networks. I was wondering if there's anything in place, either contractually or even just informally, regarding some of the SNFs that are one- to two-star-rated that you have recently acquired. What are payors' reaction or approach to those facilities?

If we get them in markets where we have a great reputation and where they know we will move rapidly to that three, four, five star, they may allow us to incorporate those. But most of the time, they are rejected for the first little while. And we have to improve those up to a much higher star rating to be included -- which, on one hand, is more difficult in transitioning these facilities from a managed-care standpoint.

But on the other hand, it ensures that as you have higher quality, it gives you more of an exclusive right to these patients in the future. So I still think it's something we embrace. It may take us a little bit longer to -- I wouldn't say it takes us longer to turn around these challenged operations; it just makes us analyze these things differently.

Because sometimes we might be the only facility in a market that is -- you know, let's say we're in the outskirts of Tucson or something, and we got a great big reputation throughout Phoenix. And they don't have anybody that they feel comfortable with in Tucson. Oftentimes, they will give us a -- what you call it? I guess --

Holiday?

Not a holiday. What am I looking for?

They will give us a time period to say, hey, let's get you -- a grace period, thank you -- a grace period to get us to three, four, five star. And that's what we have seen happen in a few markets. But most of the time, if you don't have that relationship and you don't have the proof in your quality, it's very difficult to be included with a lower star rating.

Yes, I'll just add -- Horizon -- the building we highlighted today was one that we actually were able to include, even though it was not -- didn't meet those star rating requirements at the time we acquired it. And then, obviously, when we are underwriting an acquisition, we certainly take that into effect.

Okay. Any sense of how many you have bought within the last couple years that you have been able to raise their star ratings up to the -- above the threshold?

We could probably get that for you, but I don't know that off the top of my head. Remember that -- you know, I would say that in the first couple of years, we are generally able to increase the star rating by (technical difficulty) -- but it takes -- somebody keeps putting us on hold or something.

It takes three years to meaningfully change the star rating. You can't go from 1 to 5 in a shorter period of time. But I don't know that number off the top of my head. It's several dozen.

Okay. And just the last one on this point -- you have mentioned in the past potentially looking at altering, maybe, your care plan designs. How much flexibility do you think you may have within some of these networks to try to change, maybe, your care design and lower your cost per day?

When you say care design --?

I guess I'm talking about -- you know, I thought you have said in the past that you've looked at, maybe, ways of ultimately reducing your cost per day within a managed-care environment that could potentially maintain your margins.

Well, one of the things we've mentioned in the past is sometimes your revenues are smaller, but your carveouts are better, so that there are some expenses that some of these managed-care organizations pick up. And so your margins can expand that way, because -- under Medicare, obviously, that doesn't happen. There are not really, except for a couple of rare things, there are not any carveouts at all. So that's one of the ways that there is a lowering of costs.

There are other things, too. There are requirements that some of the Medicare Advantage plans have that are sometimes less stringent, I guess -- not on the care side, but in terms of documentation requirements and other things. But there are a number of small things. The biggest one is that ancillary piece, though. And I'm sure that's probably what I was referring to, Ryan, when I talked about that.

Okay, that's helpful. And then maybe, big picture, talking about value-based care, I know there's a lot of attention being paid to it. And it seems more recently some of the other postacute operators, ERFs and home health operators are talking about a greater degree of care coordination -- especially, I guess, including the joint patients, and are citing a reduction in SNF discharges by 400 basis points.

I would appreciate your thoughts on -- is that something -- is that consistent with what you are seeing in some of your markets? And if so, what are the things you are doing to manage through that?

Well, in almost every market that we are in -- not every one, but almost -- certainly every major market, we have both home health and hospice and -- I said both. We have home health, hospice, assisted living, and skilled nursing. And they work closely together to manage through these expectations.

And we do have a few markets, as you mentioned, that are discharging more of certain diagnoses. But it's only certain diagnoses; but somehow, in certain circles, it has been expanded to all diagnoses -- and it is just a couple -- where they are choosing the home health route instead of the skilled nursing route. I can think of one market, in particular, in our organization where that's the case.

But one of the things that we are doing collectively with our home health on the skilled nursing front is presenting evidence that the rehospitalization rate is smaller in the case of the skilled nursing as it relates to our skilled nursing facility, not the overall industry. And so there is a joint effort between skilled nursing and home health to show the hospitals that there are times, with certain diagnoses, where they are better off in a skilled nursing facility; and there are times when they are better off in home health.

And it's up to us to show them what the data really is for Ensign -- not for the industry at large, but just for our Ensign operations in each individual market. And I think it's working to our advantage. It's something that would probably be more difficult for us to do if we didn't have the home health operation that operates very independent from our skilled nursing, but they still are interested in helping each other to become better. Does that answer your question, sort of?

Yes, yes. I appreciate that.

Maybe last question for me: you mentioned often in the past just the nurse staffing pressures. Any change in that trend? Or have you made any progress in recruiting and retaining nurses?

Yes, we have made progress on many fronts that I won't share on this call, but from different sources. But it's still a challenge.

The unemployment rate in many of our markets is very, very low. The Texas market, the Utah market, the Arizona market -- I don't know that it's at historical lows, but it's close. And so that brings up some challenges for us that we have to address.

And we are finding ways to recruit locally and outside of our markets, and also finding ways to train and build stronger relationships with some of the nursing schools around us, some of the universities around us. And that has helped us in a big way. And we think it will help us in a bigger way over the course of the next 12 months.

Great. Thanks for taking my questions.

Dana Hambly, Stephens.

Just on the same-store occupancy, can you tell if the bigger impact is coming from the disruption in Texas? Or is it the lumpiness in the narrow networks?

I think it's probably the former, not the latter. The latter is just an additional thing that's -- certainly that's not related to Texas. That's more related to a few other markets, where we've seen a bit of softness that -- I feel like that we did the right thing, but maybe we were premature. And I think that the volumes are only going to increase in those other markets.

But Texas is by far the biggest contributor. And that is not related to the narrowing of networks or the delay of narrowing of networks. I just wanted to add that, because it is impacted our census in a few other markets.

Okay, that's helpful. And I know last quarter you called out -- I think it was three new states that you had entered as kind of weighing on results. Was that less disruptive in the third quarter or not really?

Yes, but they are still not doing what they should be doing. We are very hopeful that those three new states will contribute in the fourth quarter. In fact, I feel somewhat confident that all three of them will, which is a better position than we've had.

We generally have a difficult time as we are building higher-quality outcomes and building relationships that we don't have, and finding the right leaders in those new markets where we don't have a reputation. And so we often -- almost always, frankly, Dana -- are cash-negative in new markets. But I am -- and Suzanne might hate -- but I say -- but I think we will be self-sustaining in every one of those states in the fourth quarter.

Okay. And then, Suzanne, on the cash flow, the operating cash -- one of the stronger quarters we've seen. It didn't look like there was much in the way of tax payment in the quarter. Was there anything else that would be unusual in that number?

And just stronger AR collections. So I think that we had a prepay that we were able to use for taxes, and then just stronger collections for the quarter.

Okay. And then last one: on the adjustment schedule, there's like a $3.7 million adjustment for rent. And I think that's related to new development. Can you just tell me how many new developments are out there, what stage you would expect them to open?

So we have currently seven healthcare resorts that are in different stages. And then one other one that's not -- a non-healthcare resort that are in development. We are going to bring some of those in, actually three of them in, in the fourth quarter. So a portion of that will come in, because they have been open for a year. So I think at that year mark we start to bring them in.

Okay. And are they profitable as they come in?

We expect in the fourth quarter that they will be, yes. In the third quarter, no, they were not.

Okay, great. Thanks very much.

As there are no more questions in queue, I'd like to turn to call back over to Christopher Christensen for closing remarks.

Thank you, Latif. And thank you for your help.

And I just want to thank everyone again. I'm so grateful for the people that are helping us through this time where we are taking on more than we've taken on in the past. And I'm really pleased with how we are progressing. And thank you again for your trust. And thanks, everyone, on this call for your attention. Have a great day.

Thank you, sir. Thank you, ladies and gentlemen, for your participation. That does conclude your program. You may disconnect your lines at this time. Have a wonderful day.