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Kindred Healthcare, Inc. (NYSE:KND)

February 26, 2013 2:15 pm ET

Executives

Paul J. Diaz - Chief Executive Officer, Director and Chairman of Strategic Development Committee

Analysts

Gary P. Taylor - Citigroup Inc, Research Division

Gary P. Taylor - Citigroup Inc, Research Division

Thank you. Good afternoon, and thanks for joining us for Kindred Healthcare. Kindred is the nation's largest post-acute provider, annual revenues of over $6 billion, they're in 46 states, 117 LTAC hospitals, over 200 nursing rehab centers, over 100 hospice and Home Health sites, 100 rehabilitation sites and then over 1,600 facilities serviced by the RehabCare rehabilitation business. So full continuum on the post-acute side.

And we have Chairman and CEO, Paul Diaz, with us this afternoon. So Paul, thanks for being here.

Paul J. Diaz

Thank you.

Question-and-Answer Session

Gary P. Taylor - Citigroup Inc, Research Division

Appreciate it. Kind of first just big picture question, want to talk about a little bit, the theme of our conference is value. A lot of discussion throughout the provider continuum about how long can you preserve this space? Over the next 5 to 10 years, how much movement do we see from private and government payers to trying to pay for value versus just paying for volume of service that's being delivered? So one, do you see that impacting Kindred in the next 2, 5, 10 years? And what parts of your strategy are addressing that?

Paul J. Diaz

Thank you. Well, we're clearly leaning into those changes. We are starting to see them amass at themselves at different rates with both speed and different marketplaces. Those markets where you have more physician-driven managed care organizations, you see a lot more activity. I think the physicians are a critical part of it in terms of the speed at which change happens. And obviously, you see the payers leaning into the physician component as well, as well as the hospitals. So I think that the physicians play a big role. For us, and it's part of -- it's sort of core to us, for the fifth year in a row, we publish the Quality and Social Responsibility Report that we issued Monday, and that full report is about value and us demonstrating value. That -- and where probably you and I have talked about is that one of the ways we create value is to get patients home faster with good clinical outcomes, and the level of function and health whether or not bouncing back to the hospital in terms of rehospitalization. Well that kind of undercuts our days and bets, our senses. We are already sort of challenged and -- but believe at our core in terms of our mission that our job is to help patients recover and move through whatever delivery setting they need, get them to the most appropriate setting and get them home with the highest level of function. Now today, we're being rewarded with that with good organic growth and in an old-fashioned way. So we are being awarded that in terms of being more cost-efficient, in terms of how we care for those patients. But tomorrow, I think that there's a commitment among commercial payers and CMS and others to move to a more value-based payment system, whether it's a post-acute bundle or new pace for performance measures. I think companies that are preparing for that, we're all going to be successful as networks tighten, and the companies that don't prepare for that are putting themselves in a competitive disadvantage.

Gary P. Taylor - Citigroup Inc, Research Division

In some ways, I think the whole cluster market strategy you've had and you've been focused on really sets us nicely for a future where either providers are taking risks down the continuum or post-acute is being carved out as a bundle in your managing all the way down the continuum. Do you see -- are you entering any risk-bearing arrangements today with either other providers or payers directly to take that post-acute patient? And then you're in charge of which part of your continuum may end up in managing that? Or is that still -- are you doing some demonstration projects?

Paul J. Diaz

It seems that we're -- we've been approved for one of the CMS bundled payment demos, in terms of post-acute care in Cleveland and we're working with the Cleveland Clinic on that. We're supporting each other's demonstration. There are 3 other markets where we are moving from discounted Medicare fee-for-service arrangements with pay-for-performance measures, with a goal of moving to a bundled payment type of arrangement or gain-sharing type of arrangement. So I would expect in the next 2 to 3 years, that we will be at risk for post-acute patients in 3 or 4 different marketplace. And a prerequisite for us in that is to develop capabilities where we add value and to take advantage of the capabilities of our partners, whether it's on the physician side or with a payer partner in terms of understanding the actuarial process of managing risk. So what I think has to happen here for us to do this is historically, we've all tried to build the same capability, and for us, we're trying to build out the Home Health, the Hospice capability, managing a patient through an episode of care, but do that in conjunction with our physician partners, hospital partners, the payer partners.

Gary P. Taylor - Citigroup Inc, Research Division

And what do you think from the major Hospital business, I guess in a view of the world where we actually care about the cost of consumption and less just about unit and volume? We've known -- everyone has known for years and years and years that a day in LTAC is cheaper than a day in ICU, and a day in patient rehab is cheaper than that, a day in hospital is cheaper than that, and that Home Health visit is cheaper than that. So as we've seen the hospitals, particularly the nonprofit hospitals, increasingly organizing their systems in an integrated way and in preparation of taking risk-bearing contracts, what are they doing with the post-acute piece? Are they saying in our market, you're the best guy clinically and cost-wise, and we're going to have a contractual relationship with you? Or are they saying we need to buy something or build something, have it inside the umbrella?

Paul J. Diaz

Well, I think 80-20, 80% of folks do not view post-acute care within their skills sets and capabilities. Both -- whether clinically or whether they want to invest capital, if they want to invest capital in the hospitals, they want to invest capital in the physician -- primary physician group and information technology to take risk and do that. So we have a number of partnerships and I think we'll be expanding the partnerships with nonprofit and proprietary hospital systems around the country in our integrated care market. I guess I would comment that, I think, we're in the early stages. Many of the large nonprofit systems are more confederations than they are systems. They've got a long way to go in terms of actually integrating their service. And I think most important integrations are going to be in local level. And I think many of them are far along there, but we're increasingly participating in discussions, both locally and nationally, with large systems about this very issue. And I think for those things I've mentioned in terms of where do you want to spend your capital, in human or in financial? What capabilities do you want to buy or build or partner in? And I think they're looking for a new partnership arrangement for post-acute care.

Gary P. Taylor - Citigroup Inc, Research Division

Shifting gears a little bit, you reported earnings last night for the fourth quarter, I was introducing companies all day, so I didn't get to listen to the call. I think you could see that related requests, those cutting questions, right. So anything on the quarter that you want to point out? I mean, obviously, you did pretty well, revenue, EBITDA, looking to where you talked about volume being pretty good in December and carrying over into January. Any other highlights from the quarter you want to...

Paul J. Diaz

Yes, thank you. Well, I mean, it was a solid year. I mean, I would keep focusing folks in our free cash flow. I mean, net free cash flow of $97 million and our estimate for this year of $90 million of free cash flow probably, and we certainly hope to beat that. We came in at the high-end of our guidance. It was a tough year though. We worked through a lot of challenges, particularly from the rehab headwinds that we faced at the end of the year. So we're really proud of our team, really proud of the quality outcomes that we posted in our quality report. And as we think about '13, we've got $100 million worth of reimbursement headwinds that we're working our way through. My partner, Ben Breier, our President and Chief Operating Officer, is making great progress in advancing Project Apollo, which is a -- should yield $60 million to $70 million of cost savings this year, and over $90 million going into '14, once those savings are annualized to mitigate those reimbursement headwinds. And lastly, this is going to be an important year for us in terms of repositioning the company. We're moving forward the divestiture of 54 fantastic facilities. We've talked about that we're in the market to divest a number of other nonstrategic Transitional Care hospitals and nursing rehabilitation centers. So I think this is a year where, despite some of the external things, we're going to be moving very aggressively to reposition the company for '14.

Gary P. Taylor - Citigroup Inc, Research Division

Your cost cutting program, Project Apollo, my recollection was when we started talking about this early in the year, you were looking at $20 million to $30 million of cost base and last night, you said $60 million to $70 million, and by '14, $90 million. So I just thought maybe where we're...

Paul J. Diaz

Yes. There's a little bit of geography in that. And originally, when we first started talking of Project Apollo, it came out of the process that we've set up for the RehabCare integration and the synergies that we found there. And what we learned from that project management office at NOI, we've given them some help. We've kept that project management office up, and we've been moving very aggressively to a shared service model in things like sales and marketing, and human resources, and centralize billing and other things. The reason the scope of that has expanded is we've included in that our total rewards program for compensation across the enterprise, the benefits of the merit-free set that we put into place this year. And there is a fairly substantial change in our health insurance program, again, in anticipation of the Affordable Care Act implementation and other things. But in total, I thought it would be better to talk about all of those cost savings in that aggregate bucket and to think about the enterprise just around those things that way, too. So we've brought all of the cost savings measures across the enterprise into that project management office and then both expanded the scope and the numbers that we think we can achieve.

Gary P. Taylor - Citigroup Inc, Research Division

And on the health care plan, benefit design chain, is that with your...

Paul J. Diaz

Significant benefit design chain moving really everyone to a consumer-driven plan, high deductible, significant emphasis on wellness and teammate engagement around that, HSA contribution and that also has the impact essentially of -- on the P&L would be flat in terms of our health insurance cost year-over-year. But I think in the outlier years, we'll, as we've seen in the last 3 or 4 years, really arrest the cost there. So our health insurance costs have been going up 4% to 6%. And I think we can keep it at that level, and I think that's just an important structural piece of what we're trying to do.

Gary P. Taylor - Citigroup Inc, Research Division

Got it. So some good news, Project Apollo has been sized up and the goal is receiving more savings. I guess the bad news is it's kind of been unresponsive to the fact that this reimbursement headwind again to deal with a couple of things. First, what do you see as incremental risk, if any? This week, with sequestration into the month continuing resolution, May into -- debt ceiling, critical wall.

Paul J. Diaz

Well, when we've told our teammates and when we told our investors, is that, that our view, our producer responsibility was to maintain quality, continue to invest in our strategy, and to assume the worst and hope for the best. So essentially, we're -- assuming sequestration happens, we know the budget neutrality adjustments in our LTAC have happened. We've got $30 million worth of cuts in the rehab business. So all of that is factored in, and we're going to work off of that base. So I think it's -- what I think I've had investors takeaway is, notwithstanding all of that, I still think we're going to do $90 million to $100 million of free cash flow this year and $250 million of operating cash flow. And if we get greater clarity in Washington, then our ability to deploy free cash flow and grow in Home Health and Hospice. And to think about the more shareholder-friendly activities like a dividend and other things that we've been thinking about, I think it'll be a great opportunity for us going into 2014.

Gary P. Taylor - Citigroup Inc, Research Division

Got it. And just specifically on one of the reimbursement issues, is the therapy cap and the changes you were seeing last fall. I'm thinking at the time you were saying you were hurting by $1 million a month or so. Are we -- given that we've recycled the calendar year, we've restarted counting against some of those caps and then -- where do we start to see, just seasonally, some of that impacting the...

Paul J. Diaz

Q2 and a few more in Q3. So we have, to the best of our ability, taken a fairly conservative position on kind of what we saw. We certainly are still working through the process. I mean, we're pretty good at navigating these changes. And there's still a tremendous amount of manual processing with the fiscal year and mid-year is there. And at the same time, the big policy cut under and my view is, you got an HSS settlement talking about medical necessity and the benefits of rehab services as against this cold rationing, these hard caps on Part B services. So I think there's a broader policy conversation that's going to happen about the benefits. And something that we've talked a lot about in our quality reports are the benefits of rehab services to these patients. But nonetheless, that's in our guidance, and I think we'll improve in our ability to work through those new rules. And I think the expectation of the doc fix and the therapy caps will be addressed later in the year, might give us more clarity going into '14 on those issues as well. And maybe we can get some of these administrative issues addressed or something to support.

Gary P. Taylor - Citigroup Inc, Research Division

Got it. On the outside side of the business, what are you seeing out there development-wise and consolidation-wise? I mean, is all of that activity at a relative being still because we're kind of waiting to see what the next iteration out of CMS is in terms of reimbursement policy and LTAC-specific clinical criteria, et cetera or is it...

Paul J. Diaz

No, I think, certainly, some of those things would rightly give folks some pause as they think about that. But I think the people are being a lot more careful about the demand side of it. And I know we are and I know some of our colleagues are that we are looking at LTAC demand through even the proposed criteria and other ways that criteria might be implemented as we think about the investment in new LTAC beds. Now we have a number of projects where we see there's still a significant amount of LTAC bed need. And we're rationalizing that need with hospital-based subacute units as well in many of our hospitals and our transitional care hospitals where we have both LTAC services as well as subacute services. And I think that will evolve over the next few years as well.

Gary P. Taylor - Citigroup Inc, Research Division

On the Home Health side, I mean, that's an area you want to invest in. We've talked about a lot of the -- even the pure-play nursing home companies are saying, well, we're not really investing a lot on this side of the business now, but we really want to do Home Health and Hospice. What are some of the, I guess, the advantages you see Kindred has either building or buying Home Health versus the plethora of players that say they want to do the same thing?

Paul J. Diaz

Well, first -- I guess it's a big country, with 50 million Medicare beneficiaries that need to be cared for, and 60% of them with an episode of care that need Home Health. So it's a great opportunity for patients, which is kind of where we start at it. And I think it's a great opportunity for our business mix, because, obviously, it's a lower capital-cost-intensive business. And I think it has much stronger organic growth rate in the 6% to 8%, excluding branch expansion and development. So we started at it, Gary, we just looked at the opportunity to continue to care for these patients to home. It's what our patients and families are asking us to do. And so we look -- a great benefit to the patient and a great way for us to grow in a very patient-centered way. From a development standpoint, we've got a 12-year history of incubating businesses and putting teams together, and process and systems. We did it in the pharmacy business. We did it in the rehab business for many, many years, even before RehabCare. And we've done the same thing here. We -- about 5, 6 years ago, we put a team together. We started analyzing what systems we wanted to use. We did some de novos to learn about how we could manage patients and how we could care for patients. And now we're at 200 million. And I would be disappointed if we did not triple the size of that business over the next 2 or 3 years.

Gary P. Taylor - Citigroup Inc, Research Division

Got it. In the last 6 months or so, you created a C-suite position for basically a commercial contract or managed care contracting. Can you talk a little bit about -- well, the goal is obviously, to get paid as much as you can be reasonably paid, I'm sure. But can you talk about, what is the opportunity you see there? And is there any early successes or anecdotes you want to share?

Paul J. Diaz

Yes. So -- in the lessons learned for me, over the years, is to not be more aggressive on change and whether it's Home Health or how we look at payer relations and payer contracting. And every time we've hired up in the organization, whether it's my partner Ben or other folks, the return is 10x. And so Franke Elliott, he's our new Chief Managed Care Officer, who worked with Bill Altman, our EVP for Strategy, full-time, are trying to do the things we talked about earlier. Figure out in every market where the relationships we want to build on, how do we do a better job on payer contracting, where we've got almost $2 billion of commercial business today. So if Franke can deliver 1 percentage better payment, he's more than paid for himself. And as we explore new payment relationships, we needed somebody -- he spent a decade at HCA, he spent the last decade with HealthSpring and Aetna. So he brings to the company a DNA that we don't have, a perspective that we didn't have. And we've got, basically, a shared-service model of 40, 50 people working with him now. And I would expect that volume, rate and new payer relationships will benefit. And that $2 billion line item is going to continue to grow.

Gary P. Taylor - Citigroup Inc, Research Division

Got it. Obamacare. I think investors have been attracted to the thought that or can understand this pretty easily, but do you fear hospital, by law, you'll to take care a lot of uninsured patients and now a portion of those are going to be covered? There's new revenues coming into you and cuts on the other side of it. How do you see Obamacare impacting LTAC and SNF and Home Health in the post-acute continuum? There's not an obvious, sort of bad debt, uninsured play or opportunity, but we are expecting that you get 20 to 30 million people covered under some new volume and maybe the answer is you should see the tailwinds of some of that volume coming through. But any other...

Paul J. Diaz

Well, that's the answer. I mean, if you look at our December, January and February volume, because of the flu season, when the hospitals are busy and people want to clear beds out for surgery procedure, or clear the ICUs and trauma centers out, we get busy. And so we expect that the demographic tailwind, the influence of chronic disease and the expansion of coverage will drive the volume opportunity for post-acute care. And as payers and hospital systems are increasingly concerned about rehospitalization penalties and where these patients are going, then we can be a differentiating partner to them on quality and value and things like we have already.

Gary P. Taylor - Citigroup Inc, Research Division

Got it. You've kind of penalized me for a few months with the thought that Kindred's in a good position to pay a dividend, potentially if it chose to...

Paul J. Diaz

Did I mention a dividend?

Gary P. Taylor - Citigroup Inc, Research Division

You've mentioned it a couple of times. How do you think about -- or walk us through on kind of how you think about what you need to see in terms of visibility in the industry that has forever been under reimbursement pressure. So what level of reimbursement pressure implies enough visibility to move further? And secondly, just kind of thought process around recurring versus special dividend and how one might [indiscernible]

Paul J. Diaz

So special, not in our mindset, but recurring is what's in our mindset. So it's non-GAAP, I get. But we've got guidance at $1.20, mid-point of EPS and if you think about the $97 million of cash flow that we expect to generate, that's $1.83. If you think about the ability for us to pay a $15 million to $20 million dividend when we have operating cash flow of $250 million, $260 million, I look at it as an simple operator, that's about the development of a hospital or a high-end Transitional Care Center, and that, that would be a meaningful return -- or the beginning of a meaningful return to shareholders. So I think it would be nice to know whether we're going to have a $65 million sequestration cut or not. And although I think it's highly likely that a grand bargain would yield bigger cut than that for Kindred, if you just look at all the mathematics. Having that behind us, continuing to de-lever, continuing to get out of capitalized lease obligations as we're doing, all of which position us to be a little bit more aggressive on the deployment of the free cash flow, including a return to shareholders through a recurring dividend.

Gary P. Taylor - Citigroup Inc, Research Division

Great. You've spent some time in DC. I know you're involved in the industry lobby. What is sort of your latest intelligence tip? I touched on this earlier but probability of a grand bargain any -- and if it was, I mean, our presumption, generally, has been sequestration is a win because Medicaid is 0, Medicare is capped at 2, and any alternative is probably worse. Do you agree with that view? And is there anything specific in your post-acute spectrum that you think would be on the table or is it just -- they come for a little bit of money they can be across the top or ...

Paul J. Diaz

I mean, I think you can triangulate all of the different proposals that are out there, and we try to do that. You take the President's budget and -- now we're going to see 3 new data points. We're going to see the President's budget for the year on March 12. We're going to see Senator Reid put out a budget. We're going to see Speaker Boehner put out a budget, and some of those are informed by MedPAC and to some extent. So I mean, there are certainly a number of different policy proposals that one could look at. They don't add up to $65 million, my math for us, for us. And I don't really buy the conventional wisdom that health care providers, with the kind of margins that we have, and the giving that we've done under the ACA and over the last few years in terms of deficit-reduction. And if you look at the Medicare spend numbers that have happened -- that we're seeing the trajectory of Medicare spend, a lot of that is happening because the provider rates have come down. I mean, that's not -- what was the number? $300 billion or $400 billion is the change in trajectory in terms of Medicare spend? I think that's a function of behavior changes and I think that's a function of payment cuts that have happened to providers. For Kindred Healthcare, since 2009, we've had $300 million of reimbursement cuts. We have more than paid our share for deficit-reduction. And well, we tell policymakers that if you want companies like Kindred Healthcare to lean forward into patient-centered integrated care, then we're going to need a margin from which to invest on those things to move forward on. And you're not going to solve the trillion dollar issue continuing to cut providers. The guess is as good as anybody's. I mean, as we sit here right now, it seems like it's a substantial likelihood of sequestration will happen. And that people will assess the political consequences of that, and maybe patch it or maybe not. And -- but I don't subscribe to the lobby of the wisdom that the best thing we can get is a 2% cut. I just -- I'm not going to sign on that. I just don't think that's the right ...

Gary P. Taylor - Citigroup Inc, Research Division

Any questions from the audience. We still have 5 minutes here -- up here.

Unknown Analyst

You mentioned you were looking for some signals from the government on further investment in the Home Health care. Anything specific that you would share that you're looking for in particular signal?

Paul J. Diaz

No. No, I'm not actually looking for any signals from the government in terms of Home Health care. Maybe I misstated something. I think the case for Home Health and Hospice is a patient one, for a patient to want to go where medical technologies is taking us. It's where the cost reduction in risk space relationships, if we reduced length of stay across an episode of care for the short term and speed care hospitals to LTACs, to IRFs, to skilled nursing. It's going to put more demand on Home Health services and Hospice services. And so even today, we see -- I mean, it's been a little noise in the last couple of years, because some of the policy changes in the physician first and those things. But there -- what we see is an underlying growth of 6% organic for Home Health. We see a great opportunity for us in a very fragmented business that is looking for systems and process and culture and quality measure for us to add value. We've got a great team in this already, our IntegraCare. Our professional acquisitions have gone extremely well. We're moving to a Standardized HomeCare homebase platform. So it's sort of -- it's a place where those best of 2 things come together. We think it's a great patient opportunity and a great shareholder opportunity for us.

Gary P. Taylor - Citigroup Inc, Research Division

Any other questions for Paul?

Paul J. Diaz

Thank you, all, for attending.

Gary P. Taylor - Citigroup Inc, Research Division

Thank you.

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