Kindred Healthcare, Inc. (NYSE:KND)
Q2 2016 Earnings Conference Call
August 05, 2016 10:00 AM ET
Pat Watson - Corporate Communications
Benjamin Breier - President and Chief Executive Officer
Stephen Farber - Executive Vice President and Chief Financial Officer
Gary Lieberman - Wells Fargo
Frank Lee - Susquehanna Financial Group
Sheryl Skolnick - Mizuho Securities
Josh Raskin - Barclays
A.J. Rice - UBS
Kevin Fischbeck - Bank of America Merrill Lynch
Good day everyone, and welcome to the Kindred Healthcare's Second Quarter 2016 Conference Call. Today's call is being recorded.
At this time, for opening remarks and introductions, I would like to turn the conference over to Mr. Pat Watson. Please go ahead, sir.
Thank you and good morning. Welcome to the Kindred Healthcare's second quarter 2016 conference call. Before the Company's presentation, I would like to read the 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 on 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 and 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 second quarter operating results for the 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 publically the results of any revisions to any of the forward-looking statements to reflect future events or developments. Certain references to core EBITDAR, core operating cash flows and core diluted earnings per share 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 on today's call Ben Breier, President and Chief Executive Officer of Kindred; and Stephen Farber, Executive Vice President and Chief Financial Officer.
I will now turn the call over to Mr. Breier.
Thanks Pat. Good morning everyone. Let me start as I usually do by extending my deep appreciation on behalf of the entire leadership team to our now more than 100,000 teammates across the country. Each day our partners of Kindred work hard to improve the lives of the more than one million patients we care for annually. The excellent care delivery and clinical outcomes we generate are the direct result of their efforts.
Last night, we reported strong second quarter results. Our revenue was in line with our plan, our core EBITDAR beat our guidance midpoint and our core earnings per share was at the upper end expectations. We had strong cash flow and further strengthen our balance sheet during the quarter which Stephen will discuss in a few minutes. We also reaffirmed our full year guidance for 2016.
Our results in the second concluded strong first half of 2016. As we now begin our transition into LTAC criteria in the third quarter, we are relentlessly focused on execution and on progressing a wide range of initiatives to advance our enterprise. In addition to our focus on operational performance, 2016 has been a very active year for Kindred from a transactional perspective. We’ve made meaningful progress reshaping our LTAC hospital portfolio. In June, we closed several LTAC facility swaps with Select Medical allowing us to focus our attention on markets more essential to our strategy.
We also expect to close our previously announced sale of 12 LTAC to Curahealth an affiliate Nautic Partners in the third quarter.
With the completion of these transactions, we will have reshaped our LTAC portfolio from a highpoint of a 116 LTAC facilities three years ago to a little more than 80 facilities one the Nautic transaction is closed.
With rationalized concentrations in core Kindred markets, we are well positioned for our forthcoming transition into LTAC criteria. We’ve also been busy with transactions to grow our home, health and hospice business. Over the past few months, we’re part to integrate recent acquisitions in South Carolina, North Carolina, Florida and Ohio. In this past Monday, we closed a very significant transaction the acquisition of the home, health, hospice and personal care business previously operated by the Arkansas Department of Health, which expanded our presence in the state from six offices in four counties to 76 offices in 72 of the 75 counties in Arkansas. And we obtained certificate of need licenses to provide services across the state. This transaction transforms Kindred at home overnight into the largest home, health, hospice and personal care provider in the state of Arkansas.
I’m very appreciative of the trust in Kindred demonstrated by Governor Hutchinson in the Arkansas Department of Health and we look forward to caring for Arkansas patients in need for years to come.
We also recently announced new joint venture inpatient rehabilitation facilities with Palomar Health in San Diego and CHI Franciscan Health in Tacoma, Washington and we continue to build and manage a large and very active JV pipeline.
We’re looking at both additional IRFs and a range of other potential local and regional combinations that will advance the availability of coordinated post-acute care across a range of geographies. As those who follow us know there’s a great deal of change taking place across healthcare and particularly in the post-acute sector. And we continue to move swiftly to transform Kindred.
Before I turn the call over to Stephen, let me spend a few minutes on each of our four divisions, starting with Kindred at Home. Kindred at Home which comprises our home, health, hospice community care and home base primary care businesses now drives more than one third of our revenue and half of our consolidated earnings. Remarkable growth story for a company that as recently as three years ago, it just begun to engage in this business.
We believe strongly that to the extent clinically appropriate medically possible people want care delivered in their homes and we transformed Kindred in light of this view. Every day 126,000 people receive homecare from us. And more than 13,000 hospice patients depend on us in their most critical time of need. I’m extraordinarily proud of our caregivers and the help they give to all of our patients.
Three specific trends continue to fuel the outside growth in this business. First, consumerism clearly continues to drive patient placement choice. Our national brand, covering markets in 40 states continues to be a place consumers are choosing.
Second, macro healthcare economic conditions driven by Medicare advantage, conveners and bundled initiatives are pushing healthcare consumers into the lowest cost setting of care home. And third, our clinical integrated technology enabled process for continuing the care is allowing Kindred to benefit from keeping patients in our high performance networks at record levels.
Given the choice, our patients are increasingly opting to stay within the Kindred continuum. We’re seeing approximately 13% growth over the first half of the year in Kindred admissions coming from Kindred discharges and other care settings. And it’s not just from our SNF, LTAC and IRF facilities to home health, but from our home health branches back to those facilities and to our hospice services.
For the second quarter, Kindred at Home delivered core EBITDAR growth of 6.3% over the same quarter last year on revenue growth of 3%. Kindred at Home’s core EBITDAR margin for the quarter was 17.2% up 60 basis points over the second quarter of last year. Our home health service line saw 3.5% episodic admission growth in the quarter and core EBITDAR growth of 4%. Our average revenue per branch has increased significantly as our home health branch network has been optimized. And 427 sites of service at the end of 2014 to 384 sites of service today. Average home health branch revenue grew 13% over the last 12 months.
Our hospice operations also had a very solid quarter. Core EBITDAR was up 12.3% on a revenue increase of 4.3%. Hospice patient days were up 4% on hospice admissions growth of 4.6%. We ended the quarter with hospice average daily census of 13,611 up significantly since our acquisition of Gentiva. As of the case with the Home Health segment, we consolidated our hospice branch network from 193 sites of service at the end of 2014 to 177 today and with revenue per branch up 6.1% over the last 12 months.
Also driving Kindred at Home’s performance is an important part of this business our community care business, which is a community based delivery model that plays an important role in managing complex patient population health issues. This business makes terrific sense for at risk patient population. Including the Arkansas community care business just acquired, our community care business now boosts annual revenues of nearly $300 million. We look forward to continue grow this business as payers in states embrace the value of community care in a population health environment.
Now moving to the Hospital Division which in our view had a very solid second quarter building on the strength of its first quarter results. Hospital Division core EBITDAR for the quarter came in at $125.9 million, same store revenues increased 2.3% on 0.6% Medicare admission growth and revenue per admission growth of 1% over the prior year second quarter. These study results are encouraging as we approach our September first implementation into LTAC criteria.
As we’ve talked about at length for some time now, we’ve devoted enormous amounts of time and energy into preparing our teams from top to bottom and our referral sources for the implementation of criteria. We’re prepared, we’re ready and we’re excited to bring on the challenge.
And as previously mentioned, each of our LTACs are executing individualized market specific criteria implementation strategies. In other words, they each have their own unique playbook. These playbooks provide strategies specific to retaining and seeking both additional post intensive care patients and medically complex patients that are clinically appropriate for LTAC, but with relatively shorter lengths of stay. After two years of preparation for this change, we’re pleased to be getting on with it and we’ll report back as this transition unfolds over the coming quarters.
Turning now to our Rehab Services Division, KRS, we had an excellent quarter in this division. KRS continues to show itself as a growth driver at Kindred. As a reminder, KRS comprises our Kindred hospital Rehab Services Segment or KHRS and our Rehab Care Contract Therapy Services Segment. KRS reported revenue $366 million and core EBITDAR of $63.7 million for the quarter.
Starting with KHRS, which houses our freestanding inpatient rehab facilities, as well as the acute rehab unit that we manage inside community hospitals. KHRS had an impressive quarter, revenues up 11.3% and core EBITDAR up 13.3%. This growth comes from a combination of three IRF facilities now at 19 facilities up from 16 last year. Acute rehab unit site growth of 6% and same hospital discharge growth for our freestanding IRFs of a solid 4.1% compared to the same quarter last year.
The combination of our freestanding and managed inpatient rehab business now generates $170 million of revenue in the quarter and contributed $50 million of core EBITDAR. It continues to garner significant interest from health systems all across the country, looking to partner with Kindred, comprehensive post-acute joint venture activities.
RehabCare our skilled nursing rehab segment continues to work through the contract losses experience in the first half of 2015, but this just shows signs of stabilization and improvement in the first quarter and this trend continues into the second quarter.
As a result, core EBITDAR increase to $13.3 million for the second quarter, up from $12 million for the first quarter. We are encouraged by our clinical outcome measures, competitive positioning and margin enhancement efforts.
Moving now to our nursing center division, our performance was largely consistent with last quarter. We saw a continuation of some of the volume impairments trends we’re seeing similarly in the rest of the industry. Our nursing center revenue was down slightly with revenue per patient day growth of 0.6% offset by patient day decline of 1.2%. Like to stay, continue depressed with care intensity more concentrated in shorter days. Our team continues to focus on addressing these industry trends to achieving a higher degree of clinical integration across our sites of care.
And with that, let me turn the call over to Stephen. Stephen?
Thanks, Ben, and good morning. As Ben mention and you all saw in our release last night, we had a solid second quarter and we’re very pleased we’ve had the first half of the year as unfolded. We’ve had a tremendous amount of activity and with LTAC criteria starting in a few weeks and a number of transactions and projects we’re working to advance and close the back half of the year has a very busy agenda.
Before we get into the financials for the quarter, I want to make a couple of general comments about the earnings release we issued last night. As you’ve seen with many of the companies that have reported, we made a lot of changes to respond to the recent compliance and disclosure interpretation from the Securities and Exchange Commission. We worked extensively with outside counsel our auditors and other experts to understand this information and have made a number of meaningful changes in the presentation and content of our release. By way of example, we have discontinued reporting adjusted core diluted EPS from continuing operations.
We view this as an ongoing process and you should expect that over the coming quarters, we will continue to learn more and change more as we and really all public filers adapt and evolve towards this reason guidance.
Now turning to the quarter, let’s first hit some key line items on the consolidate financials. I want to focus on cash flow, which was terrific this quarter, discuss our capital structure and the finish with some thoughts on guidance for the third quarter and balance of the year.
Starting with revenues, for the second quarter, revenues were $1.84 billion, up about a half point year-over-year. Our revenue for both the quarter and the first half were in line with our internal plans, as we mentioned in our releases, we’re on track with our 2016 revenue guidance of $7.2 billion to $7.3 billion.
As a reminder, our guidance has not yet been adjusted for the previously announced pending sale of 12 LTAC to Curahealth which we’re working to close later in the third quarter. When we announced that transaction, we indicated these hospitals have annual revenue of roughly $215 million. Our revenue guidance also does not take into account the Arkansas home health and hospice transaction we completed earlier this week which will provide a roughly $40 million offset to the revenue sold to Curahealth.
Let’s move now to core EBITDAR. For the second quarter, core EBITDAR came in at $268 million, up 2.3% over the prior year period and ahead of our guidance midpoint and consensus. Strong results from Kindred at Home in our IRF business and a continued performance recovery of the hospital division more than offset the headwinds we’ve been working through in our skilled nursing business.
We are on track that where we planned to be for the first half of the year. And as we saw in our release last night, we are reaffirmed our full 2016 guidance.
For the second quarter, rent was $100 million, up from $98 million sequentially. D&A was $40 million for Q2, essentially flat sequentially both rent and D&A are running consistent with our expectations for the year.
Moving now to interest expense, we reported 58 million for the quarter which is in line with our estimated range for the year of approximately 230 million to 235 million. This estimate includes approximately 15 million of non-cash amortization of differed financing fees.
Moving now to taxes, our second effective core book tax rate came in at 30.6%, down from our first quarter, effective core book rate of 32.2%, again calculated as a percentage of pretax income before non-controlling interest. We continue to expect our effective annual core book tax provision to be in the 32% area and to move around some quarter-to-quarter particularly after we finalize and file our 2015 returns this fall.
Please remember, as I’ve mentioned on previous calls, for the next couple of years, our effective cash tax rate should be less than one tenth of our effective book rate. I’ll go over this in more detail when we get to cash flow.
Moving now to non-controlling interest, core NCI was 14.5 million for the quarter, up from 11.7 million in the prior year. This increase was driven primarily by growth in our IRF JVs. This number has some seasonality to it and will move around a bit quarter-to-quarter.
Moving to share count, we ended the quarter with approximately 87.5 million diluted shares. We still expect approximately 88 million diluted shares for the year on a weighted average basis.
Moving to earnings per share, we announced last night, core earnings per diluted share for the second quarter of $0.38 which is at the high end of our guidance range of $0.30 to $0.40 and ahead of consensus.
With that let’s now move to the balance sheet and capital structure. During the quarter, we paid off about $89 million of total funded debt using free cash flow. During the quarter, we also issued 200 million of incremental term loan that is fungible with the roughly $1.2 billion term loan we already had outstanding. We use that fresh 200 million plus free cash flow to repay most of our outstanding revolver balance.
We ended the quarter with $59 million of draw on our $900 million revolver and very solid liquidity.
Moving now to cash flow, our GAAP net cash flow from operations for the second was 135 million, up from a 100 million in the prior year. Our core operating cash flow was 126 million this quarter, up from 98 million in the prior year. There are a number of reconciling items that drive the differences between GAAP and core cash flow; they are broken down in detail on page 20 of our earnings release. Routine capital expenditures this quarter was $29 million, up from 25 million in the quarter last year. There is no trend with this increase is just normal quarter-to-quarter timing.
Our NCI distributions for 14 million this quarter, up from 10 million in the quarter last year; again largely driven by growth in our IRF facility partnerships.
Removing these amounts from core operating cash flow, our core free cash flow this quarter was 83 million compared to 63 million in the prior year period. As an important reminder to our investors and analysts, we had an additional $30 million of cash flow this quarter not included in these numbers. We continue to enjoy additional cash flow from significant differences between book and cash taxes.
If you recall we previously discussed that for 2016, 2017 and part of 2018, we expect to harvest a combination of current period losses and NOL carry-forwards of more than $450 million to offset more than 90% of our book tax provision. During Q2, we enjoyed roughly 30 million of incremental cash flow from this harvest. This is an addition to with the 126 million or core operating cash and 83 million or core free cash flow we’ve reported in the quarter.
In terms of the full year as we have been saying for several quarters and we repeated it in our press release last night, there with the current composition of Kindred’s business, we expect roughly 300 million of core operating cash flows and about half that in core free cash flows.
Our strategic repositioning of Kindred over the past few years and our investments in higher growth, less capital intensive businesses have meaningfully improved the cash flow profile of the enterprise. We feel good about the year so far and are pleased with our success this quarter with cash flow.
Please note and I remind investors and analysts again that these cash flows do not include the extra cash tax benefit which I discussed a moment ago and which we expect to exceed a $100 million in total extra cash across the 2015, 2017 and early 2018 periods.
Before I turn it back to Ben, I want to make a couple of comments about guidance for the quarter and the balance of the year.
As we’ve said before, while we don’t normally give quarterly guidance with all the changes in the service line composition of Kindred and with LTAC criteria starting on September 1, we decided that for this year, we would guide quarterly. To that end, Q3 is normally the slowest quarter of the year and the seasonally weakest quarter for our facilities based businesses.
In addition and as Ben discussed, our hospital division is entering LTAC criteria on September 1 which will also include a billing impact for patients admitted in August if they are still in our facilities on September 1. Including the estimated impact of all this as announced last night, we expect core EBITDAR of 220 million to 235 million for Q3. We also expect core diluted EPS in the range $0.02 to $0.12 for the quarter. Assuming midpoint performance, this would imply a $0.20 Q4 midpoint to get us to the $0.90 midpoint for the year that we affirmed last night.
We’ve had a few investors ask us about our Q3 and Q4 range from the points - from the $0.07 midpoint in Q3 to the $0.20 midpoint in Q4. As a reminder, over the last four years, we’ve averaged a roughly $0.12 increase in EPS from Q3 to Q4. This is due to the seasonality in our business particularly our LTAC business and our guidance has been contemplated even into the criteria headwind that we expect to see in Q1.
One last comment looking forward to the third quarter and it’s about cash flow. We don’t formally guide on cash flow other than the general commentary we’ve made for several quarters now, but I do want to point out that this year because of calendar timing, we will have one extra payroll cycle in the third quarter compared to last year and one less payroll cycle in the four quarter.
A Friday payroll cycle for us is typically about $30 million, so that will hit our cash flow in Q3 and we will benefit from it in Q4 essentially a non-event for the year but it is a timing item to be aware of when we report the quarter. This sort of thing is very common and I am pointing it out to primarily to reinforce that while we feel very good about the cash generating capacity of Kindred, it does vary quarter-to-quarter for business reasons, for calendar reasons and even more so as Kindred continues to evolve and change.
And with that let me turn it back to Ben.
Thanks Stephen. Before we open the call up for Q&A, let me just make a few comments on the build payment initiatives that are getting so attention in our space. As we’ve stated many time previously, we believe value based payment models that move patients into the most appropriate case setting coordinated over an episode of care are ultimately a win for our integrated market approach. Ultimately, we expect home health to be a decisive winner of volume under our fully rollout bundle product. That’s why we take such pride in being the largest and most diverse provider of home health services in the country.
As it relates to the volume impact on our IRF and SNF business from the existing CJR
Bundle, we estimate that only a small percentage of our Medicare discharges are at risk in IRFs and while it’s too early to quantify the potential impact on our sniff service line. It’s really important to reiterate my earlier point that because of the diversity of our business and specifically our robust home health services whatever impact is felt in our SNF and IRFs should know to the benefit of our home health business.
For the same reason, our preliminary analysis around the proposal to expand the CJR Bundle to include hip and femur fractures does not change our conclusion that the impact of this proposal should not be significant for our IRF and SNFs and should work to benefit our home health service line. Overall in the 67 demonstration markets for the proposal, less than 1% of our Kindred admissions are affected by the expansion of DRGs to include hip and femur fractures.
Let me also comment quickly on the new bundle proposal for certain cardiac DRGs. We typically don’t comment on proposed rules especially in the case of the cardiac bundle, where the specific markets will implementation in July 2017 have not yet been identified. That said our preliminary view, is if the impact on Kindred as a whole will be minimal and in the long run could be positive as we position ourselves as opposed to key provider of choice for managing patients across an episode of care.
Our preliminary analysis shows that overall, in all markets in which we operate less than 1% of our admissions across all service lines are affected by this cardiac proposal. And our analysis also shows that over 80% of the spending for these cardiac bundles occurs in the acute hospital setting. So the biggest opportunity to reduce spending over a 90 day episode of care is to partner with hospitals to reduce their inpatient spending by providing appropriate post-acute-care and limiting hospital readmissions.
We believe that the development and execution of our strategy is in anticipation of these very changes. While navigating these changes can pose some challenges in the near term. We believe Kindred is uniquely situated to benefit in longer term because of our diversification of service lines and our integrated care strategy.
With that operator, let’s open it up for questions.
Thank you. [Operator Instructions] We’ll take our first question from Gary Lieberman with Wells Fargo.
Good morning, thanks for taking my question. As you head into the patient criteria later this quarter, could you give us some color, what do you see is the greatest challenges and maybe some of the opportunities you see there as well?
Hey, Gary good morning. Well as I mention in my prepared remarks, we’ve been preparing all the way down to the individual hospital level for quite some time for this transition. We’ve put a lot of work in. We’ve done a lot of training. We have Gary and my view better analytic capabilities than we’ve ever had before to track and to manage and to influence performance in this division. And so as I said earlier we’re I think as ready as we can be for. No question a pretty significant change in what reimbursement will look like. I would just reiterate if I could for investors and for analysts on the call that we have taken a sort of three pronged approach to our strategy and I’ll just remind everybody again what that approach has been.
The first, as I mentioned earlier, a significant move in the context of a portfolio optimization strategy having gone from 116 LTACs now down once we close the Curahealth just a little bit over 80 LTACs has allowed for us to create in an environment a much more capable I think and efficient operating environment for our hospitals as weak sort of consolidated markets where we wanted to be. Because of that, we’ll be able to take more post intensive care patients, will be able to drive efficiencies and I think just managing our portfolio as we’ve reduced it by almost a third over the last couple of years is really an important part of our strategy.
Second, as I’ve talked about, we continue to work hard on going after these post intensive care compliant patients. We think and I’ve gone through the analytics with investors now multiple quarters in a row that there’s a lot of opportunity out there for us to get additional post intensive care patients. As market demographics continue to evolve, as we have more chronically sick patients with multiple comorbidities, even with all of the negative effect of bundles and conveners and lots of different things that are pushing against us, the population in this country continues to grow for the types of patients that are specialized LTACs stake. And we think that the denominator will continue to grow and that that will give us a chance to do that as well.
And last Gary, we’ve talked about this medically complex patient, for the next two years, we get a blended rate. And we’re running towards that, not away from that. We think that we can move occupancy higher. We think that as a provider in a market that when we talk to our referral sources and say what patients do we want to take, we can say anything that LTAC appropriate we want, gives us a leg up in the way that we talk to our customers and our referral sources, we’re already starting to see some of that. And we think we can manage lengths of stay now without the 25 day like the state burden on us with those patients to a level that we can be much more efficient and mitigate some of the cost that you’re seeing in the system today.
So you combine those three things with all the training and all the analytics and all the tools that we have available to us. And we’re ready, we’re as ready as we can possibly be to head into criteria and as I said, we’ll know more certainly after the next month after the last month and a half of this quarter into the fourth quarter of next year. And I think that, as we all sit here until February of next year and look back on Q4, we’ll be able to have a much better sense of kind of how this thing is gone.
Thanks, it’s helpful. And you made some comments about CJR, could you discuss what your conversations with the acute care providers have been and how you are you are partnering with them either in the - in the post-acute setting or the home setting on that?
We talk to health system, C suite folks and discharge planners and our partners all across the country, almost every day. We have very capable relationships not just in the joint ventures we have but in the joint operating committees, in the joint quality committees that we run. And we are we think very in tune with how they’re thinking about CJR and bundles. And number one, primarily they are looking to create a more narrow network if you will in terms of where they can send their patients to. They want to go to one maybe two trusted sources, where they can send their patients, where they can get transparent data, where they can limit hospital readmissions and maybe eventually start to share in some of the risk, whether it’s through pay for performance, shared risk savings or full risk on a capitated basis which I think the market will evolve into over the next couple of years.
But clearly what we’re seeing on market is hospital systems want to have narrow networks they want to be able to trust their partner and they want to know that when they send a patient into your network, they’re not going to get it back in the context of a 90 day readmission. That’s the most important thing. And that’s why it plays we think so strongly into our wheelhouse, because not only do we have the institutional settings, but can take a really complex patient, we have the home health and hospice settings throughout all of these integrated markets that we run, in a more detailed manner than most, where we can really be a partner of choice for lots of these systems.
So we’re having a lot of success talking about CJR, talking about these bundles. We’re watching it. It’s early I mean these this just started in April, so we’re still watching the effect of it. But as I said, everything we’ve done a Kindred to position our integrated delivery approach has been to deal and live and succeed in a bundled environment and we’re excited about what the future holds for our delivery system.
Great, thanks a lot.
Our next question comes from Chris Rigg with Susquehanna Financial Group.
Hi, this is Frank Lee on for Chris. Thanks for taking my question. Through this the swap transaction with select you quoted LTACs are already operating under new criteria. Has this changed the way you’re thinking about criteria for your facilities?
Yes, Frank. Actually it’s been one of the, I think real advantages of the swaps now. A reminder the five hospitals that we took in the swaps from select, we closed on June 1. So we only actually owned them for a month as it related to the effect in Q2 and we were getting everybody up on employee benefits and welcoming our new partners to our team and all the things that you might expect.
But there’s no question, Frank. We took a heavy look under the hood to determine, how they had been thinking about criteria having been in it, what their strategy was and how much success they were or were not having. And I think that the short story of it all is that the only thing that it really did was it reconfirmed for us. The idea that going after these medically complex patients seems to be in our view the right strategy at least for our company for now was confirmed by many of those CEO’s that came over that the idea of being able to talk to a referral source about yes, we’ll take all of your LTAC patients and we’ll figure out which one gets paid in a full DRG and which one gets paid at a blended site neutral rate.
On our shop, seems to be resonating, I think with referral sources. And so if we learned anything it’s that, we like the path that we’re going down in terms of taking these medically complex patients. And as I said, we’re going to do that certainly throughout the rest of this year and into next and if we decide that we want to turn left or turn right, we’ll do that in the next year. But I think it confirms our thinking about how we’re heading into criteria.
Okay, thanks. And then actually hospice and home health businesses are doing extremely well. At this point of view, efficiencies in those businesses or is there room to drive further margin improvement? Thanks a lot.
Yeah, thank you. Well I think on the margin improvement side, first of all you have to look home health and hospice separately on the margin side. I think that on the home health side, look you are dealing at a very tough rate environment. I mean you’ve got - you are heading into next year the last year of Medicare rebasing for the home health business. You know on the hospice side, we’ve just gone through this very significant change to the U shaped curve. And I think Frank that all of those things with reimbursement, you know we are going to talk. I am sure about pre-claims review and some of the other legislation it’s come down the pipe. We - all those things have a tendency to mute what happens with margins.
Having said that I am just incredibly impressed with David Causby and [indiscernible] and the team at Kindred home and what they’ve been to accomplish our five regional presidents across the county. They just do a fantastic job running this business. They continue to develop specialty programs and the ability to deliver on a higher patient in a way that I think actually singularly represents what’s happening in the home health space better than most of our competitors out there.
And so to that end I’ve been surprised that even in some of the rate pressure environment that we’ve been in and we’ve been able to grow revenues as effectively as we have. And so we’ll keep an eye on that as it relates to margin. I wouldn’t expect to see significant margin improvement over the course of the next year because the reimbursement pressures that are on, but I don’t that we can continue to drive revenue at a pretty meaningful clip. And I think you’ll see us do that into next year in the future.
Thanks a lot.
Our next question comes from Sheryl Skolnick with Mizuho Securities.
Thank you very much. I have one clarification and then a question if I may. Stephen, you talked about the $30 million of book versus cash tax benefits that does not run through free cash flow. These tax issues give me a migraine, can you just simply explain to me why it is that we don’t see that in the cash flow statement?
Sure. Yeah, you know it does not run through the core cash flow numbers, it does run through the GAAP cash flow numbers but them is the whole much of other stuff that’s wrapped inside your GAAP bash flow numbers as well. So probably there is a reconciliations table on page 20 of the release. The easier way to think about it probably Sheryl is you can just add 30 on top of the 126 or on top of the 83 and kind of get through same place with less brain damage.
Thank you, that’s helpful. Okay. Because that is a distinct advantage that you have what’s the difference between book and cash taxes that does need to go into the estimate, right. And then if we could just think about what you said about the sequential pattern of earnings, I want to understand how you are thinking this one through? So clearly there is deep seasonality in your business and you are very correct at the end of last quarter to remind us of that and I think estimates were brought down for the third quarter appropriate maybe not you know to where the guidance range is, but significantly somewhere they were.
And then you start something that there is usually $0.12 of pickup just from seasonality. So first of all I am going back and I am looking at the core EPS numbers and certainly see this seasonality but it’s kind of hard because there is still some noise in changing in the business and that sort of thing in between. So let’s just say that it was kind of the $0.12 that’s normal that you pick up, so you are saying you know you go from $0.07 to roughly $0.19 at the midpoint, are you saying that you are just going to get that seasonal lift or that - and that you are not planning on any risk from the LTAC that’s just seasonality and kind of same census level but - excuse me - but no impact on a census from - but the criteria but just the impact of seasonality. How should we think about that because I also think I heard at one point say you were trying to be conservative about the performance of the LTAC in the fourth quarter and I want to make sure that’s really but you know that there may be some additional conservative beyond just that 7 goes to 19?
So Sheryl, let me try and take the parts - take the pieces apart if I could and what - I know is a little bit of complicated environment. So, A, we’re trying to helpful with going back and looking at the last four years or five years, I think it’s even better if you go back even further just to talk about the seasonality effect of what happens from Q3 to Q4, primarily driven by our LTAC business. And well you exactly right the composition of our businesses has changed significantly and I’m going to get to that in a second.
The point is that because the LTACs typically have this touch seasonal third quarter, you do typically see this return to normal in Q4 and you do have a lift. We’re asked by a lot of analysts over the last - since we reported last night and some investors how do you get from 7 to 20 and we were simply reminding folks it’s not that big of a lift when you look at what has happened historically.
Secondly to answer your question a little bit specific, as I said I pull the pieces apart. I want to talk about some of the pieces that we think are happening to get from the midpoint guidance in Q3 to the midpoint guidance in Q4. Number one, yes, there is that seasonality lift, you should expect to see some lift in our hospitals and others as we get into the winter months as we see sicker patients towards the end of the year, we typically see a bit of seasonality moving from Q3 to Q4 and that is within the number. The conservative nature of your question is that what we have guided investors on in the context of our guidance is that we have a $30 million impact, the impact of criteria build into our guidance over the last 4.5 months of the year, that’s the month and a half here in Q3 and that’s three months of that $30 million in Q4. So we think we’ve taken a very realistic look at yes, we’ll have seasonal growth in the LTAC but on the other side, there is clearly going to be an impact from LTAC criteria in an environment that we will start to be able to mitigate against some of the criteria effect as we move into the end of Q4, but that mitigation really kicks in for us in 2017 and beyond.
And the last point that I would mention, in terms of the conservatives and if you will that’s in the number or why we feel good about the bridge going from Q3 to Q4 is because you have to remember, you have to look at Kindred home and you have to look at our IRF business and you have to look at some of the faster growing parts of what we doing, the continuation of the synergies that we’ve achieved from Gentiva and you have to say there are lot of really nice growth stories I this company as we move from Q3 to Q4 as well. You take the combination of seasonality, growth stories and out businesses, historical president over being able to move EPS by on average about $0.12 over the last four years, netted against a conservative view of criteria $30 million of effect is built into this guidance and that’s kind of all the moving pieces.
So I mean I think that’s about as clear as I be and why we feel like the numbers are absolutely kind of what we said they be. As a reminder, we sit here at the middle of this year at about $0.63 of earnings, we had guided investors to a midpoint of $0.90 for the year, we are reaffirming that guidance, we’re trying to because of all the moving parts be really specific to hold everybody hands through what we think Q3 and what we think Q4 is going to look like. And I think we’ve been very transparency about where Q1 was going to be, where Q2 was and that’s all we are trying to do for Q3 and Q4.
Yeah, I am not debating that at all quite be opposite. So let me ask the question in different way. So what actually happed in those LTAC to make core EPS go from $0.30 to $0.02, you have to empty out the LTAC and readmit, you are going to have - I mean that’s - maybe that’s a better way of getting to ask the question because I know you put the $30 million in hiding, but I want to understand, are we seeing the $38 million going from $38 - this 30 million going from the $0.30 to the $0.02 and building backup, is that and the reason it makes the difference is I want to understand what actually happening mechanically to be able to sort of match the timing and how then understanding how you build that?
So here’s what’s happening mechanically. And I am sure Sheryl I followed $0.30 to the $0.02, I don’t know -
And you just report $0.38 in adjusted core?
Yeah, so $0.38 goes, do you get some seasonality between the June quarter and the September quarter, so some of the - so it’s - if you go to $0.02 at the bottom of your range, $0.07 below starting point of your range. So actually the other question, so some of that seasonality, some of that is LTAC?
Okay, and -
So mechanically Sheryl what happens and this is - it’s interesting because we’ve talked about this a lot, it’s maybe disappointing in the context of like looking for big bells and whistles to go off in terms of what happened. It’s going to be very much methodically moving forward kind of in the same path that we’ve been on. What you are going to see is, is that we will continue because of our approach in our LTAC to take all patients that we believe are medically appropriate for an LTAC level of care. Any referral source that want to send us an LTAC that we think either meets compliance or can ultimately be a medically complex site-neutral patient, we’re going to take.
Once those patients come to our facilities, our facilities will identify once and for all whether they’re going to meet a full LTAC DRG on the one hand or whether they will fall into the medically complex site on the other hand and then depending as we always do and focused on quality and focus on what the patient needs with a medically complex patient you should assume, acuity will probably be a little bit less likes of stays will go down and you will start to see the mitigation take hold by the reduction in length of stay on those patients that wind up on the medically complex site of the house if you will.
In addition, we will continue to go after and work towards finding more post intensive care patients on the other side. The net effect is going to be that on our full LTAC DRG post intensive care patients moving forward, you should see rates go higher, you should see length of stay probably go a little bit higher on that side. And on the medically complex site, you’ll see rates be the lower and you’ll see lengths of stay be lower. All of which we hope will ultimately lead towards higher occupancy in the hospitals in total and will allow us, as we work towards this to mitigate into Q4 into Q1 of next year and beyond, that mechanically how all work.
Okay, that is very helpful. Thank you.
Thank you, Sheryl.
We’ll take our next question from Josh Raskin with Barclays.
Hi, thanks. Just want to talk about the LTAC sale, when you guys announced it, you talked about 215 in revenue and I think sort of breakeven EBITDA. And so I’m just trying to think was that sort of pre-criteria. I’m just trying to figure out if you guys sell these right before criteria hits, was there some assumption of actual negative EBITDA in the fourth quarter embedded in your original guidance and I’m just trying to think it’s easy to take out pro rata $215 million of revenues, but is it possible this is actually helpful from that core EBITDAR perspective?
Possible, Josh. I’d say I say slightly, but I wouldn’t say there won’t be any effect. I mean obviously, these hospitals first of all they’re running very well. They’ve done a great job of keeping their focus and on running their business just like we want them to do all the way through the tape of getting this deal done. We want to make sure that we’re being really good partners to our friends in Nautic and Curahealth who are buying these. And I think if they’re taking 12 hospitals are going be in great shape when they take them over. There is clearly going to be an effect of criteria on these hospitals. And that was not contemplated in our guidance. So there may be a little bit of upside there to your question. It was also contemplated quite frankly as the Nautic and Curahealth folks evaluated what they’re willing to spend on this and how we came to obviously a transaction point. So I think both of us are kind of walking into this with our eyes open. But yes, I think it could be slightly positive for us after we close the deal.
Okay. So that may be a slight 3Q to 4Q benefit as well, right?
Okay. And then the second one, you mentioned in the press release 2017, at least a billion of EBITDAR, maybe how should we think about just broad strokes pluses and minuses, is that sort of flattish top line as well and then I guess we can assume obviously you’ll have a hospital down, Kindred at Home up or Rehab up, et cetera, I don’t know what the assumption on nursing, but just maybe broad focus not dollars, but anything directionally on the segments would be helpful?
Well, I’m looking down at the table of my Chief Operating Officer, Kent is tell me that we have negotiate a budget yet, so please don’t make it budget for next year, quite yet. So look, I’ll just speak to it at a high level of if I could, Josh. I think that if look it shouldn’t surprise you many of the trends that we expect to continue to see in 2017. You should see outpaced growth in our home health business hopefully in the mid single-digit levels revenue wise, you should see outpaced growth in a hospice business at the same levels. I think that as our IRF pipeline continues to fill and as our IRFs business continues to grow, you’ll obviously continue to see outpaced growth there.
I think you will continue to see stabilization in our RehabCare segment inside of KRS. And I would expect it will do much better in that business segment next year than we did it this year. I think nursing centers are still a little bit of a question as we sort of watch as the year on fold, but I would think growth there will be pretty muted next year, clearly. And then you get back to the LTAC, Josh and that’s the obviously the effect of wildcard towards how do you get back to that billion dollars. And on that front look, I mean we’ve been pretty clear about what we think the mitigated effect of LTAC criteria is from 2016 to 2017.
And as a reminder, what we said in the last investor call was you’d have a $30 million impact this year and then you would have an incremental $25 million to $30 million impact next year. More of that will come in the first part of the year and then mitigation obviously will unfold and we’ll start to mitigate that in the back half of next year. So that will ultimately those puts and takes will get you to at least $1 billion number. We’ve done a great job in terms of continuing to as I talked earlier drive synergies of Gentiva. I think we’re getting close to the end on that we’re almost up to the $85 million level there.
We have always done a really nice job here Kindred on something that we call continuous improvement, which is where we’re always looking to take money out of the resources away from the bedside. And they’ll be a piece of that I think are planned next year. We’re still working on health benefits. And just there’s a lot of moving parts I think still. But generally those are the pieces that as we think about getting back to at least a billion next year that’s how we feel pretty good about getting to that point.
That’s helpful. All right. Thanks, Ben.
We’ll take our next question from A.J. Rice with UBS.
Hello, everybody. Couple of quick fill in the blank questions and then maybe one or two broader ones. So I don’t want to beat the LTAC criteria issue to depth, but you guys had said and you’ve been very consistent $30 million in the latter part of this year headwind you haven’t changed that. Is that just as you sort of allude to them before you’re really good at predicting and things come out as you thought or as you look in that $30 million today versus six to seven months ago when you first floated that do you feel maybe there’s upside potentially but you’re sort of sticking with it or is it really affirm that this is the right number?
Really we’re trying to play this pretty much straight down the fairway A.J. It’s really about what we thought it. It’s probably the best way to describe it I would say it’s kind of the midpoint of the scenario. There’s a better case and there’s a worst case and we think $30 million kind of the midpoint and that’s kind of just planted straight as we can that’s still our view.
Okay. And then we kicked around the pickup in the guidance from third to fourth quarter. I guess and even first half to back half. I guess there’s two things are and I’m not sure you comment on you got this 25% rule for LTACs that I know the industries has been lobbying for relief but as of right now I think nothing’s past. Is that a meaningful headwind for you, how you effective had in and then obviously there’s a home health update in the fourth quarter is that - I’m assuming that’s reflected in the guidance as well?
Well, first of all 25% rule. Let me start with is bad policy, doesn’t make any sense. You have LTAC criteria in place which is presumably created by Congress, signed off in law by the president which is pretty declarative about what an LTAC patient is or isn’t. The 25% rule seems to be an archaic, relic of the old legacy system that just quite frankly doesn’t make any sense. I always like to fall on what’s good policy and what’s bad policy. And my view is the 25% rule is that policy. That having said, we haven’t given up hope yet that talking to our friends in Washington when they come back and maybe after the election that there’s still a chance that we can hopefully try to get something done. I think at the right thing to do.
As it relates to our model and the effect of the 25% rule, a reminder that since 80 plus percent of our hospitals are freestanding hospitals in their own unique location. The 25% rule for us is not of no impact. But it is fairly de minimis I think in the context of the rest of the trends that we see and the various things that we’re dealing with. So we haven’t really qualified a specific dollar amount other than to say it is contemplated in our guidance and in our at least a billion for next year that we will be dealing with the 25% rule. But I still remain hopeful that legislatively we can work through what as I said again is that policy.
On the home health side, again I mean we’ve been dealing with rebasing. Now we have this pre-claim, review issue. And there’s no question that there is an impact to that. That is also already contemplated in the guidance that we give. And we’ll have to ultimately see I mean the Home Health rule is not finalized yet for next year. So when it is will ultimately give some more granularities on that. There’s no question. We’ll have some impact on our business as these reimbursement cuts have had in the past. But we’re pretty good about just kind of putting our head down and trying to work our way through them and I suspect we’ll do the same thing next year.
Okay, now when I look at the way the industries are fold, your decision to the emphasis and scale back and SNF business looks pretty smart at this point, but I know you’ve also said that especially in the markets where you have all the services, you want to have all the services, is there any point in your thinking where it may not be necessary to own SNF assets that you can get which you need by contracting with third parties. Give us any updated thoughts on where you are at in the SNF business and whether you would make any more strategic changes there?
Sure. Thanks A.J. Look we still have deep affection partners inside our business. We still believe it to be an extraordinary value proposition in the market place today. I remind investors all the time if you walk into one of our transitional care centers and seen the kinds of patients we take, what the rehab look like, the outcomes that we are producing, these are not your parents or grandparents nursing centers anymore, these are highly active, very capable facilities taking care of a complex patient at a pretty low price point. The problem is obviously today, you’ve got all these pressures with what they want to see happen with, what conveners want to do, what the consumer wants to do, people want to be home. And in some cases that’s the living facility and in some cases that’s home. And it’s having this pressure effect if you will in our nursing center businesses. But still think that it’s a very viable business and still very important.
As it relates the dispositions that we did over the last couple of years, look I appreciate your comment, you know Paul and I think worked hard over the last couple of years to try and figure out where we wanted this business to go. We worked hard with our partners at Ventas and Debbie to make sure that we were all collaboratively thinking about this in the right way. And I think that for all of us, we have made the right decisions for our companies in terms of the position we took to kind of the moving the direction away from nursing centers.
The interesting thing to your longer broader question about how we feel about nursing centers is that even today with our 90 plus nursing centers that we have across the country, we don’t have great geographic positioning in all of our integrated market, and so that leads me to the second part of your question which is we want to partner without the nursing providers in the markets where we don’t have full coverage. We think that as we evolve and become what we call a post-acute benefits manager. Our key relationships with hospitals as a trusted partner both in the context of caring for patients and in the context or coordinating care for patients’ means that more and more we are reach out to partners and create as I’ve been calling them these high performance virtual network. And that means we want to work with lots of other nursing center companies across the country they think about things the way we do, they think about their star ratings the way we do, they think about outcomes the way we do. And I think you’ll see more of those partnerships not less.
So it’s really kind of yes AJ to both of your questions and we’ll see how plays out over the course of the next couple of years.
Okay, great, thanks a lot.
Thank you. We got time operator for one more.
We’ll take our last question from Kevin Fischbeck with Bank of America.
Okay, great, thanks for taking the question. As far as the LTAC business I guess you talk a lot about in the Q3 and Q4, you said little about year-over-year I guess last year you had some pressure in the outside business. So I guess without criteria we probably normally expect year-over-year improvement in the margins there and then obviously all set by criteria. How do you think those two things kind of given out so we expect margins to be flat, up, down in LTAC year-over-year?
You know I think that when you look at - it’s a complicated question, Kevin when you start to about what our Q3 in our LTAC business is going to look like compared to Q3 last year. On the one hand, I agree with you, we had a very poor Q3 in our hospital business last year coming off of what was a very good Q1 and Q2. I don’t want to take everybody back to the horror shows of the summer of last year where we had all this displacement with the acute care hospitals and everything that was happening in the market place. It was a tough summer last year, as I recall for everybody in the healthcare acute services side and our hospitals obviously felt some of that.
But I think that as you think about this year Kevin, you know not does criteria start on September 1st but as Stephen mentioned in his prepared remarks, we have the first problem in half of August where all those patients that are in-house are going to effected by that as well. And Kevin there is really not much mitigation I think in the first 45 days that we do. We are going to take patients, the rates are going to be applied, you can do the math on what the rate degradation is going to be for those and move into medically complex. And I think that’s going to pressure margins in the quarter, that’s why we’ve guided the way we guided and that’s why probably you will see some pressure on margins in Q3 this year versus Q3 last year even though it’s coming off of an lots of rate comp.
Okay and that’s kind of review I heard that how much made, they were sending - sorry, they are experiencing criteria the smaller hospitals have an easy to move to criteria than larger hospitals have been. Is that consistent with what your expectations are or is that just a difference in your velocity and why you think it’s best to take all comers with your portfolio versus theirs?
It’s probably a little bit of both. I mean it probably is on the margin easier to take a 30 bed hospital and reconfigure and do what you want to do that is to take an 80 bed hospital and do what you want to do just because of size and complexity. Hard to argue that. But I think we have different approaches because the makeup of our building is different. I mean I think that our ability to manage a medically complex patient and to grow occupancies in our hospitals, because we’ve got a lot of fixed cost and we want to continue to cover that by putting more head and beds makes the right sense for us. And I am not sure that it’s any more complicated or less complicated, it’s just a different approach. And as I said our folks are well prepared and ready for the challenge.
Okay, then last question on labor cost, can you just talk a little bit of what you are seeing there and whether that all if impacts your thought process for 2017 guidance, do you expect labor cost to continue to be perhaps deteriorate or stay at your levels, how you think about that?
You know that’s a good question as it relates to ‘17. I think we are watching the labor pressure on fold, they are real. As I’ve talked about publically when you into the mid-4% unemployment levels and you’ve got a bust healthcare environment where everybody seems to want the same nurse or the same CAN. Particularly in these institution environments, there is absolutely an inflationary perspective to what’s going on. We probably had more contract labor in this quarter than we’ve in our hospitals and really Kindred in the long time, we’re usually very, very diligent about that. But we’ve had to go that past just to fill staff.
I think Kevin probably my view is we’re sort of at kind of a run rate on where we think labor is. I am not sure we’re going to see acceleration, it’s pretty tough and summer seems to be always the toughest part of the year, labor lies for us, also people go on vacations, people start to retire, people think about different things. So I don’t think we contemplated much of a change from our run rates into our ‘17 guidance. Let’s see how the rest of the plays out. I mean if labor continues like higher, we’ll obviously address it. But for right I think we feel pretty comfortable with the run rate on labor and where our forecast is for ‘17 being okay.
That concludes today’s question-and-answer session. Mr. Breier, at this time I’ll turn the conference back to you for any additional or closing remarks.
Okay. Well thank you everybody for very detailed and robust conversation, obviously a lot of moving parts in our business. Again we are very pleased with our Q2 performance, our cash flow, very pleased to reaffirm guidance for the rest of the year. We are ready to head into the challenge of LTAC criteria and we appreciate everybody’s questions and support and interest in the company and we will talk to all next quarter. Thank you very much.
This concludes today’s conference. Thank you for your participation.
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