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Kindred Healthcare, Inc. (NYSE:KND)

Q4 2013 Results Earnings Conference Call

February 21, 2014 10:00 a.m. ET

Executives

Paul Diaz - Chief Executive Officer

Benjamin Breier - President and Chief Operating Officer

Stephen Farber - Executive Vice President, Chief Financial Officer

John Lucchese - Senior Vice President and Corporate Controller

Hank Robinson - Senior Vice President, Tax and Treasurer

Pat Watson - Corporate Communications

Analysts

A.J. Rice - UBS

Joshua Raskin - Barclays

Rob Mains - Stifel Nicolaus

Christian Rigg - Susquehanna Financial Group

Frank Morgan - RBC Capital Markets

Gary Lieberman - Wells Fargo

Gary Taylor - Citi

Kevin Fischbeck - Bank of America Merrill Lynch

Operator

Good day, everyone, and welcome to this Kindred Healthcare 4Q '13 Conference Call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Mr. Pat Watson with Corporate Communications. Please go ahead, sir.

Pat Watson

Thank you and good morning. Welcome to the Kindred Healthcare fourth quarter conference call. This is Pat Watson with Corporate Communications.

Before the company's presentation, I would like to read a cautionary statement. This conference call includes forward-looking statements as defined in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which involves a number of risks and uncertainties. Such forward-looking statements are based upon management's current expectations and include known and unknown risks, uncertainties and other factors, many of which the company and its management are unable to predict or control, that may cause the company's actual results or performance to differ materially from any future results or performance expressed or implied by such forward-looking statements. The company cautions participants that any forward-looking information is not a guarantee of future performance, and that actual results could differ materially from those contained in the forward-looking information.

The company refers you to its reports filed with the Securities and Exchange Commission, including the company's Annual Report on Form 10-K, the company's other reports filed periodically with the SEC and its press release regarding the fourth quarter operating results for a discussion of these forward-looking statements and other factors that could affect these forward-looking statements. Many of these factors are beyond the control of the company and its management. The company cautions investors that any forward-looking statements made by the company are not guarantees of future performance. The information being provided today is as of this date only and the company disclaims any obligation to update any such factors or to announce publicly the results of any revisions to any of the forward-looking statements to reflect future events or developments.

Certain references to operating income or EBITDAR and core free cash flows, as well as other non-GAAP disclosures, have been reconciled to the company's consolidated operating results and are available on the company's website, www.kindredhealthcare.com.

It is now my pleasure to introduce the participants in today's call. Paul Diaz, Chief Executive Officer; Ben Breier, President and Chief Operating Officer; Stephen Farber, Executive Vice President and Chief Financial Officer; John Lucchese, Senior Vice President and Corporate Controller; and Hank Robinson, Senior Vice President, Tax and Treasurer. Mr. Diaz will begin the call.

Paul Diaz

Thank you, Pat, and good morning everyone. In our November conference call we detailed the significant steps that we have taken to aggressively reposition the company in the context of healthcare reform, the growing demand for integrated post-acute care at a local level, and the clear preference by consumers and payers for more patient centered home-based care model.

In particular, we made a significant move to exit a number of non-strategic nursing centers that were underperforming and not critical to our Integrated Care market strategy. At the same time, we accelerated development of our home health and hospice business Kindred at Home, which now has annualized revenues exceeding $350 million, 209 sites of service and over 6,300 employees. Kindred at Home is a part of Kindred's new Care Management division which was formed in August of 2013. The goal of the Care Management division is to improve care transitions and patient outcomes by further developing Kindred's capabilities to deliver integrated care across various care settings

New division will grow Kindred at Home health and hospice business, test new delivery and risk-based payment model and develop capability to support Kindred's Integrated Care market and the continued care strategy. These capabilities include physician coverage across sites of service, care managers for smooth care transition, information sharing and IT connectivity, and tools to ensure appropriate patient placement and condition specific clinical programs and outcome measures. While our repositioning path over the last few years has been operationally challenging, today we are in dramatically better place in terms of the quality of our ongoing asset base and we believe the trajectory of our business prospects are much improved.

We now have an industry leading hospital business with annual revenues in excess of $2.5 billion. Our second largest business, RehabCare, the high performing rehabilitation therapy division with nearly $1.3 billion in annual revenues and consistent, solid operating performance. Our smaller but clearly more promising today, nursing center division, with over 300 facilities when I began with the company in 2002, is now just over 100 facilities and $1.1 billion in revenues but is much better strategically positioned. And our growing Care Management division including Kindred at Home, as I said, has grown to over $350 million in annualized revenues and we expect significant growth in this division going forward.

We are also well positioned to execute on the second phase of our repositioning plan, the growth phase. In the fourth quarter we acquired Senior Home Care, a premier provider of 47 home health locations in Florida and Louisiana, and entered into an agreement to acquire real estate of nine previously leased nursing centers that will further reduce our rent obligation and improve our overall capital structure. We continue to evaluate various opportunities to redeploy our management capabilities, industry-leading infrastructure and financial resources as we move forward with the growth part of our plan.

As I think about our core results of $0.94 in '13 and our core free flows of $130 million for the full year before dividends, we are well positioned in terms of our balance sheet and we believe we have a solid base to achieve higher levels of earnings and growth as we go forward.

Finally, I want to introduce our new Executive Vice President and Chief Financial Officer, Stephen Farber, who just joined us a few weeks ago. Many of you know Stephen, who has extensive experience in a number of healthcare businesses over the years. We are very excited to have him as part of our team and we believe he will contribute meaningfully to our growth phase of our strategic plan. Stephen, welcome.

Stephen Farber

Thanks, Paul, and good morning. As Paul said, there are a lot of people on this call that I have worked with before and I just want to say hi to all of you. It's great to be working together again. And for the folks that I haven't met yet, I am looking forward to meeting all of you over the coming months and working together. I think Kindred is a really exciting place and I am very pleased to be here. I think there is a huge opportunity to grow the company and create value. I am just super excited to be part of it.

I have spent a few weeks at Kindred now and frankly, extremely impressed with the team, and I am not talking just about the senior team on this call, I am talking about the folks that you don’t typically get to see. Up down and across the enterprise, at the divisional level to the local level, to our individual caregivers, that just permeates the organization with a sense of quality and ambition in a way that I am very glad to see.

So thanks for having me. I am really glad to be here. I am looking forward to meeting all of you as we drive Kindred to the next level. And with that let me turn it over to John to walk us through the quarter.

John Lucchese

Thanks, Stephen. Our fourth quarter core diluted EPS of $0.15 was in line with our $0.10 to $0.20 guidance range. For the full year, our core EPS of $0.94 is a solid base from which to grow and provide transparent pathway to our 2014 earnings guidance.

In terms of our discontinued operations, we have exited, sold or agreed to exit 139 facilities with annualized revenues of approximately $1.3 billion. Operationally, our hospital division experienced soft volumes in the fourth quarter while our RehabCare and nursing center revenues were relatively flat from a year ago. The Care Management division results reflect one month of Senior Home Care operations. Our fourth quarter results include non-cash rent increase of approximately $5 million or $0.05 per diluted share in connection with an agreement to renew leases with Ventas that we entered into last September.

In terms of our cash flow, our core basis bash flows before payment of dividends of $13 million, were up 23% from a year ago at $130 million. We continue to believe that our routine capital spending will decline over the next couple of years as we focus more resources in our RehabCare and Care Management division.

Credit availability under our revolver stood at nearly $400 million at December 31. And finally, we announced in yesterday's release that our core 2014 earnings guidance range was maintained at $1.05 to $1.25, including $0.05 to $0.10 of earnings attributable to our ongoing capital redeployment activity. Free cash flows of $125 million to $145 million before the payment of $26 million for estimated dividends, are expected for 2014. Ben?

Benjamin Breier

Thanks, John. Good morning everyone. I was reflecting on 2013 results that I would take a few moments to step back and consider all the progress we made here at Kindred over the last year. We certainly learned in 2013, how difficult it is to downsize a portion of our company and yet at the same time aggressively grow our care management division.

But as I look back on the year, our team did a very good job of working through some very difficult circumstances. $40 million of sequestration cuts that affected us in 2013, nearly $30 million of cuts related in our Rehab business around MPPR and Part B caps. And $20 million related to budget neutrality in our LTAC business. All that along with the divestiture of $1.3 billion in revenue and what we have spoken about, a difficult volume environment, yet we were able to maintain our focus on people, on patients and on customers. And I want to thank our loyal and professional caregivers all across the country for staying so focused on our patient needs in what was clearly a very difficult environment.

So the work continues now into 2014 and I would like to add a little color on a few of the ways that we are thinking about the next phase of our strategy. First, we have made some very positive additions to our executive team. In addition to, Stephen Farber, our new CFO who you just met, we moved one of our veteran hospital operators, Steve Monaghan, in to the role of Hospital Division President. Steve's prior experience of successfully running one of our toughest regions has been a stabilizing force in the division.

Last summer, we announced that Jon Rousseau would join the company and took over the leadership of our Care Management Division. Jon's already making great strides in the standardization of processes and systems in this division and creating a better operating model in our growing home health and hospice business Kindred at Home. Also last summer, Steve Cunanan joined our organization as the Chief People Officer, adding more depth in this critical area. Steve has been very effective in our journey to reposition our business and he has helped us better manage change and better connect with our teammates.

And finally, our recent announcement this week that Scott Blanchette has now joined Kindred as our Chief Information Officer, continuing our best in class IT tradition here at Kindred. As we look forward, I really am very excited about the new members of our senior leadership team gelling with our existing experienced group.

Next are some important core initiatives that we need to continue to execute at a very high level. First in 2014, we need better operating fundamentals in our repositioned nursing center division. Having dealt with a lot of noise in this business over the last two years in the context of repositioning, it's now time to deliver better results on a stronger base of assets. Second, the standardization work at Kindred at Home needs to come together to help drive better operating performance. While 2013 was a year of assimilating several acquisitions completed over the last couple of years, we have now reached the size and scale in this business that we believe core operating improvements will lead to higher earnings for the enterprise.

Third, we need to continue to push for ongoing performance improvement with our efficiency initiatives inside the company, known well to many of you as Project Apollo. In 2014, we will establish a permanent project management office to ensure that we are pursuing every opportunity to do better as an organization and further develop our culture around performance improvement, innovation and change.

Finally, and very importantly, we must maintain the consistently strong levels of both quality and operating performance out of our two largest divisions, our hospital division and RehabCare. We have got a lot to look forward to in 2014 and we have a lot of levers out there that we think we can use to achieve our goals. Things like a best-in-class technology-enabled sales force, a vertically integrated managed care apparatus that drove really solid Medicare Advantage and commercial growth rate in 2013, and our ongoing Project Apollo initiatives that continue our focus on cost cutting and performance improvement. Our group has a high degree of confidence in our ability to meet these challenges and we look forward to doing so in 2014. Paul?

Paul Diaz

Thanks, Ben. I want to make a few wrap up remarks before we open up for questions. First, as Ben described, we continue to focus on our core operations diligently to improve the quality of care and clinical outcomes for our patients. And improve the employee satisfaction and engagement throughout our organization. As Ben said, it's been a tough environment for all.

As we have discussed on previous calls, our strategic plan is to build out our capabilities to build a full continuum of post-acute services in our integrated care markets throughout the country. We are more convinced than ever that this is the right strategy, as an increasing number of hospitals and physicians, employers and health systems and managed care payers, are coming together to form accountable care organizations and other integrated care networks to manage an episode of care from hospitals to home.

We are working with many of these systems in our integrated care markets to help manage these care transitions and deliver higher quality of more cost effective care. A very important part of the strategy is the continued growth of Kindred at Home and the selective development of new transitional care hospitals and transitional care nursing centers in our integrated care markets. It will better enable us to continue the care of our patients in a variety of settings.

Finally, we continue to aggressively pursue acquisitions that fit our strategy and that provide us for the opportunities to deploy our management capabilities, robust technology infrastructure and financial resources.

That’s concludes our formal remarks and we are happy to take the questions now.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question will come from A.J. Rice with UBS.

A.J. Rice - UBS

Maybe just to ask you on the regulatory headwind front, first of all. I think previously you said about $0.20 regulatory headwind and it was baked into your 2014 guidance. I am assuming that’s mostly sequestration. But we have had the delay on the 25% rule, since I think you gave that. And I wondered if you would change that. And can you just give us what it ended up being for 2013 in your estimations so we can compare how much of a regulatory headwind you face.

Paul Diaz

I think Ben walked through those numbers, when you go back and check the transcript, A.J. You know we still have the next year budget neutrality adjustment in our hospital division. We still have the roll forward on sequestration. We are still dealing with the MPPR changes in RehabCare in terms of annualizing those numbers. So clearly, we will be growing more but for those headwinds. And as we talked about and we are happy to talk about more and Ben can talk about our sales initiative, we are still working through what's been a very tough volume environment across healthcare services.

A.J. Rice - UBS

Okay. All right. Well, maybe I will follow up off line then. I got the high level stuff, I didn’t get the EPS impact of those but anyway. On the docfix upcoming, I am trying to figure out, given the criteria bill and the savings associated with that, is it your sense as you think ahead to that that LTACs at least should be off the table? And any other thoughts or discussions you are having that you care to give us any flavor about.

Paul Diaz

Well, I think that the docfix issue clearly has been reported, everybody would love to fix it. This seems like the year and the pay-fors are always a challenge. I think there is certainly risk in it, in terms of everyone in healthcare services to some extent. I think they are looking for different creative ways to do it. And I certainly think it matters that many of our service lines have contributed meaningfully to paying for the Affordable Care Act and to deficit reduction, including LTACs most recently in terms of the last patch. Kindred at Home, in terms of rebasing. Budget neutrality adjustment for LTACs that rebase LTACs. And as we know our skilled nursing businesses had more than its fair share of reimbursement cuts over the last couple of years.

So we will just have to wait and see. I mean certainly there is, the default often is looking to market baskets but I don’t believe they will find the $150 billion to do a permanent docfix. We certainly -- we cheer them on to use overseas contingency funds or other things, or savings etcetera. But within healthcare the cupboard is pretty bare. So I think more likely we are going to see folks risking some small cuts in the context of a nine-month patch. I think that’s the most likely outcome.

A.J. Rice - UBS

Okay. And then maybe just a final, more operation oriented question around the fourth quarter. In aggregate you came in about where we were looking for on the EBITDAR and operating profit, but skilled nursing, the 8% increase was a little better than we were expecting. In the Rehab down about 20% year-to-year was a little worse. Were there anything going on in either one of those that are worth highlighting more than what you said in the prepared remarks or is that more where you were thinking they would come in.

Benjamin Breier

A.J., this is Ben. Just I will make a couple of quick comments. I think the nursing center is showing some sequential improvement in Q4, is all about the dust settling on all the changes we made in that business. I think that investors should expect for us to continue to see sequential improvement in that business now as we have talked about with our new base of assets. So not surprising that we saw a little bit of improvement there.

On RehabCare we had guided investors that in the fourth quarter, you would really start to see the full effect of what Part B caps, what the effect of Part B caps might be in Q4. And you know productivity dipped a smidge in Q4 to have us accommodate that. But all in all, the RehabCare division -- and Pat Henry did a great job in terms of leadership of that division and I think they get very high marks for their performance for the year and we expect them to have a strong year again this year.

Operator

Next we will hear from Joshua Raskin with Barclays.

Joshua Raskin - Barclays

I got Jack [ph] here with me as well. So I just had one question, I know Jack [ph] had a follow up as well. Just staying on the volume environment, I think you guys, obviously difficult environment last year etcetera, but we saw an uptick in at least two of the divisions on a sequential basis. They were modest but they were certainly improved relative to what we saw in the third quarter. And then I think you spoke about that stronger start for the year. And I would have though weather etcetera, seems like there hasn’t been a very good environment so far to start the year. So I am just curious, what's driving those better trends and any indications as to where you think first quarter volumes can be. Do you think we will see sequential, and without putting you on a number, but just sequential improvement expected from 4Q etcetera.

Benjamin Breier

Hey, Josh, this is Ben. Let me make a couple of comments on volume and I will start with the hospital division specifically. The nursing centers we can talk more about but obviously I think in light of all the changes in movement there, that’s been one of the cause and effects obviously of their volume. On the hospital side we had, as you all have pointed out, year-over-year declines in volume in the fourth quarter. Yet, as you pointed out, sequential growth in the fourth quarter. Some of the cause of that is related to a couple of markets and I think we spoke about this in the last call, Houston, Las Vegas and Chicago, in each of those three markets we had a specific event, where we have big volumes plays there that caused some of the year-over-year result to look a little bit skewed.

But we are pleased that we saw some sequential growth in the fourth quarter from the third quarter. And we have been reading the same reports you have around the large acute hospital systems and the struggle they have had with the mild flu season and with some of their in-patient volumes. Yet, we are starting to see ourselves come back up off of our base and see sequential growth and year-over-year growth in the first quarter. It's still too early in the first quarter to give you a full sense of guidance. But we do think that we are starting to see volumes come back.

What I will also mention about our hospital division, I think it's important for investors to note, is that not only did you get some of the sequential volume growth, but when you start to look at the way our length of stay strengthened and solidified in that business on a year-over-year basis, particularly in our commercial book of business. And when you look at rates, commercial rates on PPD basis, both commercial and on the Medicare Advantage side, on a year-over-year basis in the hospital division, almost 5% increase in commercial rates. That along with the management of costs that we have been able to control within the hospital division is why you have seen such good result. And it's why we are so excited as we head into 2014 that as we start to see these volumes come back in our business, that mixed with good commercial rates and good management of costs, we expect to have a good year.

Joshua Raskin - Barclays

Okay. Excellent.

Unidentified Analyst

Hey guys, it's Jack. Just two questions for me. I want to get back to patient criteria and love the details that you provided in January. As you start to weigh out the framework around what sort of operating leverage you can get with the flexibility around the 25 day length of stay, have you start to think about for your typical MA life or the new site neutral live. How much improvement do you think you can generate on the length of stay side or just operationally what do you think you can do there?

Paul Diaz

Jack, you know the best answer for that today is kind of what Ben just alluded to. We have a maturing Managed Care team and strategy led by Franke Elliott. Ben is putting tremendous amount of energy into that and our sales and marketing initiative. In that context, we see now an emerging value proposition. I mean our commercial business has always been strong. As strong, if not stronger than anyone else in our space. The clarity around the criteria, the ability to better match the high acuity patients that we care for, as you saw in that table, and length of stay and outcomes. Our biggest struggle has always been, Ben just talked about it, the reason our length of stay is so high in our LTACs is because we are taking good care of very, very sick medically complex patients.

These patients are already being case managed. So that part of the criteria gives us, over the next few years the ability to grow our commercial business, expand our value proposition beyond the traditional LTAC ventilator case. We are doing more and more transplant patients and other kinds of patients. And we are going to need every bit of that to manage the margin compression that will also come with patients dropping into this new category in the Medicare program. So a little early to model out or give you much guidance on what might be a net benefit, but we certainly have a great path for growth and for mitigation of the savings that will happen within the Medicare program as we expand our service base here.

Unidentified Analyst

Got you. That makes sense and still a couple of years to go there. And then just last one. Obviously you initiated the dividend last year and just thinking about capital deployment. We obviously have much better visibility now that we have do have patient criteria for the LTAC, which is a little over half the business. When would you think about increasing the dividend payout? Would you reevaluate that and what would the timing be around that?

Paul Diaz

Probably after Q2, as we get a sense of how we are trending towards the back half of the year. As we said before, it's our intent to have our shareholders participate in the growth of the operating cash flows of the company. We also are excited about what we think will be an emerging acquisition pipeline in the back half of the year as well. And Stephen is going to be looking at our debt structure and looking at the opportunities we would have there to refinance and give ourselves even more flexibility. You know Rich and Hank did a great job with that last year but credit markets are still strong and we are really good at growing. I mean it's been, as Ben described, it's been tough divesting $1.3 billion and having to adjust our cost structure and overhead to that. It's a lot more fun taking this thing like we did when we did RehabCare on the road and growing.

And so I think you will see us being assertive, thoughtful but deploying cash in the back half of the year to drive growth in to '15 and '16, but also making sure that our investors participate in the near-term through the expansion of the dividend.

Operator

Next we will hear from Rob Mains with Stifel.

Rob Mains - Stifel Nicolaus

One question on guidance. The top line went from $5.1 billion in the last press release to $5.2 billion now. Anything you point to there?

Benjamin Breier

No.

Rob Mains - Stifel Nicolaus

Okay.

Paul Diaz

We will try to give you better answer offline. I mean, you know, we have just continued to firm up the difference parts of the guidance as we finalize the budget. The clear takeaway is we feel better about it today than we gave it you in October, clearly. And it's a number of different pieces including the initiatives that Ben talked about and, again, on our nursing center division and our Kindred Home division. We expect improvement in the back half of the year for sure.

Rob Mains - Stifel Nicolaus

Okay. And then, Paul, you said the guidance includes acquisitions. You still feel fairly confident that those will come and provide the accretion that you're looking for?

Paul Diaz

You know the guidance included $0.05 to $0.10, that could be some additional real estate buy-ins. That could include the benefits of the refinancing in the back half of the year. Again, we are not going to chase $0.05 or $0.10 but given our history and track record, we think that’s achievable. It could be some other bolt-on home health acquisitions in the back half of the year that will contribute to that. So there are a variety of ways that I think we could see that come through the P&L as we are moving into '15.

Rob Mains - Stifel Nicolaus

Okay. And then one nuts and bolts question on the contract therapy business. You said that during the fourth quarter you kind of bore the brunt of both MPPR and the new caps. I assume that since the cap year's calendar, that kind of resets in the first quarter. Is there anything that you learned in your experience in 2013 that would suggest that what we saw would be the pattern that you might get some margin deterioration as the year progresses, just because you start bumping against some of the harder caps now?

Benjamin Breier

I think that’s possible, Rob. I think that 2013 could be, sort of seasonally speaking, indicative of what you might see in '14. They will bounce back in this quarter. I am sure we will see productivity bounce back up to the levels that you saw in the first and second quarter around the management of the Part B cap. I would say our folks improved the management of that cap as the year went on. Expanding our base of patients that we were able to offer Part B services to, providing, I think really good, solid quality care inside of these rehab gyms. But I think seasonally speaking, you'll probably see what you saw this year.

Operator

Chris Rigg with Susquehanna Financial Group has our next question.

Christian Rigg - Susquehanna Financial Group

Just want to make sure. Is there something obvious that's going to change from the first half to the second half of the year in the M&A pipeline or is that just you guys holding back a little bit, given activity last year?

Paul Diaz

I think, as we have discussed, we really think we have a core base of assets now that we want to get to full potential. We still are in the operational part of transitioning the 59 nursing centers. So that work continues. So while that is disc ops, we still own the quality and the care and the operation. I will say that the working relationship in that process with Ventas is going exceedingly well. They have identified a third party tenant and we believe that transition will go better for patients, for Ventas, for those operators, for those all hands on deck there, including RehabCare that Ben just spoke to.

So the Senior Care acquisition, we are a couple of months into it. January looks pretty good, as we are closing the first month there. And we are still in this first quarter, completing the standardization of home care, home base etcetera. So I think it's good for us, Chris, to be very, very picky as we really focus on getting the nursing centre division back on track. We have a couple of new facilities that we have broken ground on, that we hope to open in the back half of the year and early next year. So I don’t think you will see a lot of M&A in the first couple of quarters, and that may pickup in the back half of the year. But our guidance is set, our cash flows are set. That we do not have to do any deals this year that we really don’t want to do. Even as we are going to be opportunistic, looking to grow and do deals to accelerate growth going into '15.

Christian Rigg - Susquehanna Financial Group

Okay. And then just can you help frame out the potential for lease buyouts? When we look at your leased facilities right now, I mean what's sort of the optimal mix? Or is there an optimal mix? I'm just trying to get a sense for how many facilities over time you'd love to sort of buy out the lease and just finance them traditionally? Any way you could put parameters around that would be helpful.

Paul Diaz

Well, you know, that’s an opportunistic process. Again, there is nothing inherently wrong with leases, it's just financing. And I think actually, again as I alluded to, we have had great relationships with HCP and Ventas, and Health Care REIT and Sabra and the other REITs, MPT and others. I think the macro environment is going to call upon us all to kind of look at how we do lease financing a little bit differently in the next ten years than we did the last ten years. Escalators are going to have to be more in line with the true underlying growth of the businesses. We are going to have to be better aligned on how we invest in the assets in terms of routine CapEx and CapEx to reposition assets for what consumers want. And there needs to be better alignment between financing sources and the operators in terms of that.

But we regularly have leases that come up for renewal. Sometimes we have purchase options, sometimes we don’t. We just go the folks and say, instead of renewing a lease can we buy it out. And, again, as Rich and Hank and now Stephen will do, we are going to take advantage of the credit markets to make that trade of rents to lower cost amortizable interest and funded debt, whenever we can. And we will certainly have a few opportunities to look at that later in the year, nothing active right now to speak to though.

Operator

Our next question comes from Frank Morgan with RBC Capital Markets.

Frank Morgan - RBC Capital Markets

Want to go back to the patient criteria again. When you think about the opportunity here, do you see it more really on the world of compliant cases opening up and therefore more volume on the LTAC side, or you really view it as an opportunity of more on the site neutral patient category? And, really, how profitable do you think a site neutral rate patient can be?

Paul Diaz

Well, it depends on whether we get paid the IPPS rate or cost, and cost isn't just cost, it kind of depends on what point in time and care management and outcomes we can drive and what the length of stay is. And so there are probably ten variables that we would have to figure out to answer that question. And it's just premature to do that. What I would say, Frank, and reiterate consistent with our prior comments. For our operators and for discharge planners and for the chief medical officers of regional managed care plans, the clarity around the role that LTAC can play in the context of an episode, the ability for us to continue the care from LTAC to skilled nursing. You know 37% of our LTAC patient continue the care or complete their recovery in a skilled nursing environment. Over 50%, 60% of our patients continue the care in a home care environment. This is where we are going to be able to add up tremendous amount of patient value over the next five years. And there is obviously a great business opportunity.

The one of the most exciting things at Kindred right now is the opportunity to do good and do well as this patient opportunity intersects with the business opportunity. And the clarity that we have or the improved clarity, it's not perfect, to do that for commercial payers in our LTAC business, our transitional care hospitals. To add more hospital based sub-acute units as the market consolidates, to put our excess capacity of LTAC hospitals to work. Given the investments we have made and expanded ICUs and other investments that we have made in ProTouch in our hospitals. You know this is what operators crave, some operational clarity to go after volume to better manage patients and cost. And so we are exceedingly excited about those prospects over the next few years.

And still, there will be margin compression on some patients within Medicare fee for service, as those patients drop to the site neutral rate. But we have the opportunity to better manage the length of stay and cost there and so we will mitigate some of that. But the program is not going to find $3 billion worth of savings without savings coming from somewhere. Certainly we think most of those savings are going to come from providers who are not better able to manage that transition. And we have a whole program management office that has been established to begin that process. We are going to have beta site hospitals and we are all over this, and we have got time.

Operator

Next we will hear from Gary Lieberman with Wells Fargo.

Gary Lieberman - Wells Fargo

Have you guys seen any impact of the two midnight rule on any of the nursing admits?

Benjamin Breier

None really to report on. We are keeping a close eye on it but I would say, at this point, sort of negligible in terms of its effect on us.

Gary Lieberman - Wells Fargo

Okay. And then how should we think about the patient day mix in the nursing division going forward? Should we expect it to remain the same or should we see it shift as you continue the focus on Rehab?

Benjamin Breier

Well, I think what you have seen in the industry is this continued evolution away from Medicare fee for service and into Medicare Advantage. Our Medicare Advantage and private pay has been relatively stable now over the last couple of quarters. But I think that you will continue to see more of these patients shift into the MA side of the world. We have done a pretty good job inside of our nursing center business. I think of being ahead of what some others out there have done in terms of our abilities to negotiate rates and have a pretty stable rate environment on the MA side. So I think certainly in terms of the shift of mix from Medicare and the Medicare Advantage you will continue to see that.

Paul Diaz

The only thing I would add is, as we go into '15 while we are not focusing local operators attention on transitioning 59 facilities new, all private room, sub-acute oriented facilities and we are leveraging our commercial relationships that Ben just spoke to, as between all of our sites of service. Kindred at Home, our hospital. We certainly expect queue mix to improve in the nursing center division and have a better offering of service to the emerging Medicare Advantage groups out there. And so that is clearly part of the opportunity we see. As '14, the rest of the repositioning gets completed in '14 and we are really focused on growing that business.

Operator

(Operator Instructions) We will hear from Gary Taylor with Citi.

Gary Taylor - Citi

Just a couple of questions. First, with all the moving parts, and it looks like most of all the financial disclosure and statistical disclosure is pro forma for the invested assets, etcetera. I just wanted to look at LTAC. The fourth quarter LTAC EBITDA year-over-year on a same-store basis, looks like it was down 4% or so from about $96 million to $84 million and that's adding back charges etcetera. Is that right? Am I interpreting that approximately correctly?

Benjamin Breier

That’s probably about right. It's down on a year-over-year basis and most of that is driven by some of the volume declines. Rates obviously held that up some, but that’s probably pretty close to right.

Gary Taylor - Citi

Okay.

Paul Diaz

Gary, it was a tough fourth quarter. We will go back and check to give you a crisper answer. But there is no doubt that the fourth quarter was tough. But this business has got a lot of legs and a lot of leverage and so you will see a rebound in Q1 and better focus going into this year.

Benjamin Breier

There is obviously the regulatory headwind of, you have got no sequestration in '12 and you have got sequestration in the quarter in '13. So we will quantify exactly what the cost of that was but there is [indiscernible]

Paul Diaz

And budget neutrality adjustment. I mean the one thing I want to keep reminding everybody, that 1.5%, 1.75% cut every year, which means we effectively between that and sequestration and production adjustments, we are not getting any market basket here. So we have made it up on the commercial side. We have made it up in some other ways. And we will be giving our team raises this year after freezing raises last year. And that’s obviously contemplated in our guidance.

Gary Taylor - Citi

Okay. And then my second question is, I just wanted to understand the comment in the highlights just about the additional disposition of three assets in the quarter that helped earnings by $0.05. Were those contemplated when you had given guidance back in the fall? Are you saying those are new...?

Paul Diaz

Yes, we weren't sure. Guidance is a range because of that. We had pretty good line of sight on two of three, not the third. And the third, Mt. Carmel, was very expensive in terms of what's been shutdown there. And that’s an asset that has been, somebody reminded me, we put $50 million in to that transitional care center hospital over the last 15 years. Not a lot of return on that invested capital. So that was the one that probably was the most material moving it into disc ops and moving that forward operationally in terms of the closure of that facility. And we weren't sure if that was going to happen in Q4 or Q1. So that was pretty material

Gary Taylor - Citi

So these three assets, so you had a LTAC, were there nursing homes as well? What were they?

Benjamin Breier

There were two hospitals and one skilled nursing facility.

Gary Taylor - Citi

And the revenue impact on the quarter? How much?

Paul Diaz

Hey, Gary, how about if we go through those specifics offline with you, okay.

Benjamin Breier

About $11 million, Gary.

Gary Taylor - Citi

In the quarter? Okay. Thank you.

Paul Diaz

Thanks. Looking forward to seeing you next week.

Operator

We have a question from Kevin Fischbeck with Bank of America Merrill Lynch.

Kevin Fischbeck - Bank of America Merrill Lynch

I guess just to follow up on Gary's question. It wasn’t really clear to me. If it helped $0.05 in the quarter, did it not help guidance as it was already in the numbers, you are saying, or there was a benefit from the guidance but there was something else offsetting it.

Paul Diaz

Kevin, we certainly contemplated it in the context of the '14 guidance. We weren't sure, from the regulatory standpoint, I mean it's pretty complicated to close a 300 bed skilled nursing facility, and similarly on the transitions of the hospital. So we were pretty confident that it would happen by Q1. And so this is why we give a range of guidance both in terms of the year and how you sort of backed into it for the quarter. So the important part, and we are happy to tick and tie numbers offline with anyone, is that we have got these assets now in disc ops. More importantly, operationally we have moved forward and we have got a much better asset base to focus our team on moving forward. And that’s really the thing I guess I am focused on in terms of growing the company.

Kevin Fischbeck - Bank of America Merrill Lynch

Okay. And I guess, earlier today one of the competitors was talking about the ramifications of the new patient assessment criteria. And one of the things that they had pointed out was, in their view you are going to see free-standing rural LTACs be more pressured by this because there may not be enough ICU beds to kind of drive the volume that they need. Meanwhile, there are other markets that are urban where maybe there is overcapacity [ph]. They kind of pointed to Houston as a potential example of that, where there is going to be some real shakeout as far as the players go. And then they made the assertion that HIHs might be better off under this as a criteria because they are smaller, only need a few admissions and they tend to be aligned with a big hospitals that’s got some ICU beds. Do you agree with that kind of a general framework or if not, how do you see different components and constituents within the industry being impacted, urban versus rural and then freestanding versus HIH.

Paul Diaz

I think Kindred and Select are both very well positioned to be successful here. And there is no doubt, neither company has much of a rural presence. We feel very good about the quality of our freestanding transitional care hospitals and we had the best year in Houston we ever had. And we expect that to continue we have a great team down there and great assets and an emerging home health and hospice business, and great relationships with the big systems there and payers. I am not sure if I can be more helpful than that.

Kevin Fischbeck - Bank of America Merrill Lynch

Okay. Do you think there is any structural between HIHs versus freestanding hospitals?

Paul Diaz

There hasn’t been in the 12 years I have been operating them, and so we have been very successful in this business and we don’t see any structural impediment for us to be able to continue to advance our successful model.

Kevin Fischbeck - Bank of America Merrill Lynch

I mean I can understand [ph] what they are saying about the HIHs being well positioned, but you have guys have been kind of on the flip side, converting some of your freestanding hospitals to put sub-acute units in that, and I don’t know if there is more flexibility if you are tied into an HIH model from that perspective.

Paul Diaz

The HIH model works very well. Our HIH has worked very well. We are converting excess capacity to what payers and consumers want, which is most of these patients get care at multiple settings. And so with, I mentioned this earlier Kevin, with 37% of our LTAC patients needing to continue the care or complete a recovery in a more rehab-intensive sub-acute type environment, we are responding to what the patients and the payers need. And so that’s one of the things we lover about our model.

Similarly, those patients come off the sub-acute units and the rehab units and 50% or 60% of them complete their recovery at home. And RehabCare and Kindred at Home is going to be there for them. So it's a big country and there is a lot of different ways to solve to this. And I think both Kindred and Select are going to be very successful operating under the new criteria, given the quality of both companies operations going forward. I think it's going to be a much tougher road for some of the lower acuity operators and some of the non-profits who may not be as nimble in adjusting their operating models to the new criteria.

Kevin Fischbeck - Bank of America Merrill Lynch

Okay. And then the home health impairment charge in the quarter. I mean does that make you think differently at all about how you deploy capital when it does feel like there are probably going to be some more rate cuts within healthcare over the next couple of years as far as docfix's, budget deficit reduction and things like that.

Paul Diaz

Absolutely. We very much think about capital allocation in the context of what we think the reimbursement environment is. And certainly, rebasing for home health has ended up being a little worse than people expected. We were fairly conservative about it. We had always talked about 8% and it obviously ended up being higher. Others were saying 2% or 3%. The organic growth opportunity that I just spoke to, to continue the care, we have proven that that is very synergistic to us. But you are exactly right, as we think about expanding our home health and hospice footprint and now you spoke to that in context of Chris's question. Clearly, the tougher utilization trends and the rebasing and pricing issues are things that we think about as we allocate capital. And that’s why the dividend is so important and that’s why paying down funded debt of buying in real estate are strategic options as well.

Capital allocation is an iterative process. Every quarter we review that strategy with our board. But just generally, Kevin, I would tell you my 26 years, say we are kind of at the end of the budget reduction bashing focused on let's pay for everything out of healthcare providers. We certainly have some more exposure under the docfix but nowhere near what we just went through the last five years. We have had $300 million of reimbursement cuts across this enterprise. I don’t see anywhere near that kind of reimbursement headwind going forward.

And you talk to people on the Hill, they have exhausted themselves in terms of trying to find budget savings out of healthcare providers. So we may not be in the ninth inning but we are certainly in the seventh or eighth inning in terms of that.

Kevin Fischbeck - Bank of America Merrill Lynch

Okay. That’s helpful. And then maybe just last question. I guess speaking of iterative processes. I wasn’t sure, you made some, what I interpreted kind of bullish comments around Project Apollo and standardizing that. And I know you guys have already outlined some cost savings in the '14 and even I guess into '15 around that. But is this commentary meant to say that we should expect to see that '15 savings number grow significantly over the next year as you identify this? Or is this just more iterative, every year we look for cost cuttings to become more efficient? I wasn’t sure if you're trying to signal something bigger down the line.

Benjamin Breier

Look, I think we are looking, Kevin. We have been very vigilant and very successful around here, trying to cut costs away from the bedside everywhere we can. The work we have done with Apollo around our shared service model and around many of the cost savings measures that we have taken have been very important to this organization over the last couple of years and will be into the future. We had $55 million of actualized savings in 2013. We have guided investors towards another, almost $40 million that’s built into our plan in 2014. And we think that we have an opportunity to do more in 2015. We are continually identifying opportunities. I mentioned in my opening remarks that we are about to create a permanent project management office around Apollo and staff that with some folks that can help us keep a continuous eye on process improvement.

And look, we have a pretty deep list of ideas and of things that we want to try and do, and try and accomplish that we can think can help us mostly run our organization more effectively. And I would expect that you see Apollo's savings continue in a pretty robust way into 2015 and beyond. We are by no means done, but the harder work remains even though hard work has already been accomplished.

Paul Diaz

Let me just add two things because I think it's important. So we have invested a lot in technology. We have standardized and upgraded our clinical information system in all of our divisions. We have proven in RehabCare, for example, the leverage in terms of productivity around our handheld technology. We are rolling out a whole new series of iPad Minis there. We have talked about on the Apple call the other day. And what we are starting to see, is as the adoption rates across our enterprise go up, we are starting to see bottom up savings. Including nurses and therapists spending more time with patients and better compliance and better financial integrity around our medical necessity reviews and coding issues, etcetera. So we are running and Ben is leading an effort to bring this into the 21st century. And that we believe will continue to create patient opportunities, compliance and revenue integrity opportunities and cost savings, as we make this project management office permanent and see more bottom up engagement from our teammates in these activities as well. And we are going to need it, because market baskets are not going back to 3% to 4% and we are going to have to continue to give our teammates better raises. And so that's just part of the future for healthcare services in the context of what the pricing environment will continue to be over the next few years.

Operator

At this time there are no further questions. I will turn the conference over to our presenters for any additional or closing comments.

Paul Diaz

Great. Thanks. I thought it was a great dialog this morning. Lots of great questions. And again, we are pretty excited to have '13 behind year. It was a tough year. And pretty excited about the initiatives that Ben and the rest of the team are leading in '14 and have Stephen here to help us grow and look at our capital structure and look at our capital allocation strategies more critically going forward. We thank you all for your support and engagement this morning and we will look forward to talking with you in the weeks to come. Take care, everyone.

Operator

That does conclude today's conference. Thank you for your participation.

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