Executives
Charles Edward Jones - Chairman and Principal
Paul J. Diaz - Chief Executive Officer, Director and Chairman of Strategic Development Committee
Richard A. Lechleiter - Chief Financial Officer and Executive Vice President
Benjamin A. Breier - President and Chief Operating Officer
Analysts
Kevin Campbell - Avondale Partners, LLC, Research Division
Gary Lieberman - Wells Fargo Securities, LLC, Research Division
Gary P. Taylor - Citigroup Inc, Research Division
Albert J. Rice - UBS Investment Bank, Research Division
Frank G. Morgan - RBC Capital Markets, LLC, Research Division
Robert M. Mains - Stifel, Nicolaus & Co., Inc., Research Division
Joanna Gajuk - BofA Merrill Lynch, Research Division
Kindred Healthcare (KND) Q3 2012 Earnings Call October 30, 2012 10:00 AM ET
Operator
Good day, everyone, and welcome to this Kindred Healthcare Third Quarter 2012 Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions, I'd like to turn the call over to Mr. Eddie Jones with Corporate Communications. Please go ahead, sir.
Charles Edward Jones
Good morning. Welcome to the Kindred Healthcare Third Quarter Conference Call. This is Eddie Jones from 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 third 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, 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; Rich Lechleiter, Executive Vice President and Chief Financial Officer; and Ben Breier, President and Chief Operating Officer. Mr. Diaz will begin the call.
Paul J. Diaz
Thank you, and good morning, everyone. Before we get started, I want to just take a moment to thank all of our teammates on the East Coast, thousands of which braved the night last night to make sure that all our patients were safe. We've had some minor damage in our facilities. We had at one point, 30 facilities under generator last night. But again, thanks to all of our people in the field, clinical and operations, we got through the night. We obviously hope you'll join us in praying for those lives that were lost last night and all the families, thousands of families that have been displaced. But within the Kindred family, we're okay and we'll hopefully dig out over the next 48 hours.
Last night, we announced our operating results for the third quarter and maintained the midpoint of our annual earnings guidance of $1.45 per share and guided to a fourth quarter midpoint of $0.43 per share. Excluding certain items, our diluted earnings per share for the third quarter totaled $0.21, in line with our expectations. Each of our operating divisions reported good results from both a clinical and financial perspective, and our clinical and operating teams continued to deliver on our mission and our promise to patients, residents, customers and shareholders.
These results reaffirm our confidence in our long-term strategic plan, our annual earnings guidance and our ability to look for new ways to create value for our patients, teammates and shareholders.
For commenting further on our results and our opportunities going forward, I'd like for Rich to recap our operating results, and then we'll provide some additional operating color. Rich?
Richard A. Lechleiter
Thanks, Paul. Good morning, everybody. Just a couple of highlights. The $0.21 is our core EPS for the quarter. That's in line with our expectations internally as we think about the full year.
A couple of items to note. One, the Hospital division was very strong. 2% same-store admission growth, 4% revenue growth and 10% EBITDAR growth for the quarter, a very good showing. Our RehabCare business, margins were 11%, down a little bit sequentially from Q2 but quite strong nonetheless. In our Home Care business, we now approach $200 million of revenue and the margin's in that business now at 10% compared to 7% a year ago.
On the cost front, some very good news. In our Hospital division, our total cost per patient day was up only 0.08% from a year ago, while in our nursing centers, our cost per patient, they were actually down 0.04% from Q3 last year, very good showing.
Our corporate overhead in nominal dollars was down $3 million from a year ago. And as a percent of revenue, corporate overhead now stands at 3% compared to 3.2% a year ago.
Our liquidity was quite robust in the quarter with operating cash flows at $141 million, a near record level, in the quarter bringing our year-to-date total to almost $200 million. You may note that our overall annual cash flow guidance is now up $20 million from what we discussed with you at the end of Q2. Our recent $200 million credit expansion now leaves us with $450 million of credit in which to execute our cluster market strategy and do additional acquisitions.
Finally, on the guidance front, we narrowed our guidance for the full year while maintaining the midpoint at $1.45 and implying $0.43 for the quarter. In addition, net of routine CapEx, our free cash flow is now expected at $85 million to $90 million for fiscal '12. Those funds have been used to acquire IntegraCare and some other previously leased real estate.
Finally, in 2013, while our earnings guidance is down from '12, I would note that our free cash flow level expected at $90 million is roughly the same as what we expect in 2012, positioning us to pursue additional acquisitions, repay debt and consider other strategic initiatives. Ben?
Benjamin A. Breier
Thanks, Rich. Good morning, everyone. And before I begin my prepared remarks, let me also echo Paul's comments this morning to echo -- to send my thoughts of appreciation and thanks to all of our teammates, our patients and residents up along the Eastern seaboard, many of whom had a very long night last night. We are continually reminded here at Kindred of the passion and compassion that our employees and teammates work with to take care of a very sick and elderly population. And again, their heroism was proven again last night, so thanks to all of them.
As we head into the fourth quarter and fiscal 2013, I want to add some color around our operating plans to achieve the earnings guidance that we've laid out for our investors. On a seasonal basis, the next 2 quarters are typically very strong and we see opportunities to continue to capitalize on our Continue the Care integrated care strategy, as well as the ongoing development of deeper relationships with our many referral sources across the country.
In both of our major divisions, we should see a sequential uptick from the third quarter in both daily admission rates and overall census. This should drive further growth in our RehabCare division on an organic basis, coupled with continued external customer contract growth that we have been seeing in this division all year long.
Finally, we are continuing to aggressively grow our Home Health and Hospice business, both on an organic basis and through strategic cluster market acquisitions. As you saw, our recently completed IntegraCare acquisition in Texas is showing early signs of success, and we're excited for the potential for additional growth in our Home Health and Hospice business over the next couple of quarters as we work to ensure a smooth transition into the Kindred integrated care network.
I'm sure you're all familiar with the significant reimbursement rate pressure that we face in fiscal 2013, particularly as it relates to the Medicare sequestration, across all of our businesses, as well as the budget neutrality adjustments in our Hospital business. On a combined basis, these cuts will negatively impact our revenues by as much as $100 million in 2013.
So in our view, growing volume, expanding our service base organically and continuing our cluster market development strategy, while very important, will not be enough to offset all of the rate pressures we'll face in 2013. And as a result, we began a process earlier in the year to consider other ways to improve our operating efficiencies, further refine our post-RehabCare acquisition processes and streamline some of our administrative functions across the organization. While this work is ongoing, our earnings guidance reflects further enterprise-wide cost reductions in 2013, almost all of which are away from the bedside, that will range from $20 million to $25 million. We'll have more to say on this topic when we release the fourth quarter results.
As Rich noted earlier, it's imperative that we continue to focus on managing our operations and our balance sheet to generate strong operating cash flows in excess of our routine capital spending to fund our strategic initiatives, cluster market acquisitions and repay debt. Paul?
Paul J. Diaz
Thanks, Ben. I'd like to make a few comments about our plans for the future and what our strategy is to succeed in a rapidly changing healthcare market, which is becoming more patient-centered, physician-driven and integrated from both a delivery and payment standpoint.
First, we will continue to focus on our core operations by executing on our plan to improve the quality of care and clinical outcomes for our patients and improved employee satisfaction and engagement. As Ben discussed, we also see opportunity to continue to grow admissions, reduce costs and deliver strong operating cash flows to support future growth. Our third quarter results and the reaffirments of our annual guidance provide a solid base line to grow the company, to pursue our cluster market and continue the care initiatives.
As we discussed in previous releases, our strategic plan is to build the capabilities to provide a full continuum of post-acute services in selected cluster markets throughout the country. We are more convinced than ever that this is the right strategy as an increasing number of hospitals, physician groups, employers, health systems and managed care pairs are coming together to form accountable care organizations and other integrated care networks to manage an episode of patient care from hospital to home. We are working with many of these systems in our cluster markets to help manage these care transitions and deliver higher-quality and more cost-effective care. To help advance our capabilities and knowledge in this area, we recently applied for and received approval from CMS to participate in their bundling demonstration project for a full post-acute episode.
A very important part of positioning ourselves as a continuum of care provider with a patient-centered and cost focus is to continue to grow our Home Health and Hospice operations in our cluster markets. Following the success of our recent IntegraCare acquisition, we will continue to deploy our free cash flow to add quality home health and hospice operations in our cluster markets so we may better continue the care for our patients in their transition home and to a full recovery.
We are also continuing to look for opportunities to realign our portfolio to advance our cluster market and Continue the Care strategy. And in addition to the nonrenewal of the 54 Ventas skilled nursing care facilities is an example of this strategy. You can expect to see more portfolio rationalization in the future as we evaluate whether there are other non-cluster market assets that we may want to divest and redeploy the proceeds in our cluster markets.
Finally, we are committed to exploring new ways to create shareholder value and improve the capital structure of the company, including the deployment of free cash flows and the proceeds from asset sales to pay down debt, buy back real estate, finance acquisitions or return capital to shareholders.
That concludes our formal remarks. At this time, Rich and I will be glad to take your questions. And again, thanks to all our teammates who worked through the night and continue to dig out from Hurricane Sandy today.
Question-and-Answer Session
Operator
[Operator Instructions] We'll proceed to our first caller. That'll be Kevin Campbell, Avondale Partners.
Kevin Campbell - Avondale Partners, LLC, Research Division
I was hoping maybe you could start with some additional commentary on the RehabCare segment and some of the new reimbursement pressures. Maybe you can just sort of specify exactly what has changed, and just give us a little more detail around that.
Benjamin A. Breier
This is Ben. The primary issue at the end of the third quarter, which really went into effect October 1 with the new regs, is around our Part B reimbursement rates. Essentially, as you know, we always start the year with what is legislatively in the books as an $1,800 cap in terms of what a Part B beneficiary can receive. Typically, Congress extends that provision and raises that cap through a medical necessity provision to allow for us to see incremental patients above and beyond that cap. As part of the ongoing legislation in March to move the doc fix forward, et cetera, the regulators passed a second cap, if you will, a cap at $3,700, and that cap went into effect on October 1. But as I said, our patients and therapists started feeling the effect of dealing with the beneficiary in the month of September. And essentially, what they have created is not just this $3,700 cap, but they've created a significantly more difficult barrier to get a medical necessity granted from our intermediaries, from our max. It's both a bureaucratic and a very undefined process, if you will. And the net effect of that has been, Kevin, that it has affected access, if you will, to incremental therapy services for the Medicare beneficiaries that we think so badly need rehabilitation services to improve their functional outcomes and get better and get back home, which is what we're all trying to do. So the $3,700 cap has created bureaucracies, systems, lack of productivity. And as you can see, it had about a $1 million effect, if you will, on our operating results in the month of September.
Kevin Campbell - Avondale Partners, LLC, Research Division
And the -- can you give us a sense as to how it's been thus far in October? Has it been another $1 million sort of per month? Or has it gotten a little bit worse as it's been more fully implemented?
Benjamin A. Breier
It continues to be an issue that, from an administrative perspective, we are dealing with. There have been letters sent to the Part B beneficiaries themselves, to the individual patients and residents that I think have scared patients and residents away from getting the care that they need. We, as we always do in RehabCare, are pretty good about working through changes and systems implementations, and I think that you can expect to see the impact improve some in the fourth quarter, but it's certainly difficult.
Kevin Campbell - Avondale Partners, LLC, Research Division
Okay. And as guidance for fourth quarter and for -- the preliminary for next year, does it assume the same level of pressures? Or do you assume it gets better, you adjust to it, and so that mitigates throughout the year next year?
Benjamin A. Breier
Well, we're working through it. I think there's some that's in there and some that we're working through. Remember, the cap will start all over again on January 1, so there'll be a period heading into next year, depending on what happens legislatively and regulatory-wise, where the cap essentially is gone until it comes back into place. So there certainly will be an effect next year, and it is included in our guidance as we work through it.
Kevin Campbell - Avondale Partners, LLC, Research Division
Okay, great. And then on the cost savings, can you give us an idea as to when you expect those to be fully implemented, the $20 million, $25 million?
Benjamin A. Breier
Yes, let me speak more broadly about the $20 million to $25 million that we talked about, which we have focused on calling Project Apollo here. And as I said in my earlier remarks, the focus for us really has been around process improvement. We're trying to reduce redundancies and bureaucracies wherever we can across our organization. And so, we're trying to create a more shared service support model that will allow us to assist our field operations across the enterprise, not just on a division-specific basis. And so, we're looking for every way that we can to reduce cost, to improve efficiency, but also to continue to provide the kind of care that we know our patients and residents both demand and deserve out of us. So we're months into the project. We have a good idea about where the $20 million to $25 million are going to come from. We're in the process of working towards implementation. We expect that, with a high degree of confidence, we can achieve that level of savings in 2013.
Kevin Campbell - Avondale Partners, LLC, Research Division
And as we think about it from a modeling perspective, theoretically, if it's $20 million to $25 million in '13, and it only partially impacts '13, then theoretically, in '14, those savings should be higher. Is that a good way to think about it?
Paul J. Diaz
No, don't get ahead of us, Kevin. In the broader context of sequestration cuts and budget neutrality adjustments, it's just our ongoing commitment to maintain the quality of our patient services and bringing costs down to mitigate those cuts. We'll have more to talk about when we release Q4, but it's not constructive to start thinking about that rolling in any larger amount into '14 at this point.
Operator
We'll go next to Gary Lieberman, Wells Fargo.
Gary Lieberman - Wells Fargo Securities, LLC, Research Division
Last week, CMS announced the settlement with a provider group regarding the ability to provide therapy to patients in order to just maintain functionality, there wouldn't be any need for functional improvement. Have you guys had a chance to look at that and given any thought to how it might impact you?
Paul J. Diaz
Well, look, it's a very important development and what will need to be an improved dialogue around the value of rehab services in post-acute care, whether it's in a home care setting, a long-term acute care hospital, an inpatient rehab facility, or a skilled nursing facility. It is an important development because way too much of the policy conversation has been about caps and rationing utilization, concurrent therapy and group therapy rules that have nothing to do with how we deliver rehab services and the benefit to the beneficiaries of the provision of those rehab services. So when we look at the top causes for falls and re-hospitalizations attributable to falls and in-house acquired pressure sores and contractures and maintaining quality of life and functionality and the opportunity to reduce costs for the system, RehabCare is a big part of that opportunity and it's a very cost-effective service. So the fact that HHS and the coalition of patient groups that have brought attention to this, again in the context of what Ben was just articulating around Part B, I think is very important. But we have no direction today about how that settlement will occur, what instructions we'll get from HHS going forward around medical necessity, but we're just encouraged that we're having the right conversation about how to maintain wellness, quality of life and reduce costs for the system, and that rehab is a big part of that.
Gary Lieberman - Wells Fargo Securities, LLC, Research Division
So there's no impact included in your guidance for next year from the settlement?
Paul J. Diaz
It is way too early to try to monetize this, other than -- if you look at our clinical results and you look at how we are performing better than the industry on re-hospitalization rates in our skilled nursing facilities, which are down to 16%, 17% in terms of re-hospitalization rates, 8% to 11% in our long-term acute care hospitals, it is because of RehabCare and the intensity of rehab services that we've brought in all of our sites of service. So that's our value proposition, but how that relates to economic modeling revenue or expense going forward in the context of all the other outstanding policy issues, it's just too early to speculate. But I will tell you that the value proposition as it's -- as we're seeing in our re-hospitalizations is significant and profound and the right kind of conversation to be having.
Gary Lieberman - Wells Fargo Securities, LLC, Research Division
And just one final follow-up to that, based on your understanding of the settlement, when is the timing that it would be implemented? Would that be at some point next year? Or when do you think that happens?
Paul J. Diaz
We have no sense yet of how that's going to go through the appellate -- whichever the court of jurisdiction is in terms of what the final settlement looks like. And then HHS and CMS will have to promulgate regulations and, in their manuals, give us guidance and the intermediaries guidance about how we can think about medical necessity. But again, I think it's a profoundly important case across all of our continuum of care from home care to long-term acute care hospitals, and we're excited to focus on this value proposition with HHS over the next year or 2 as we work through this.
Operator
We'll go next to Gary Taylor, Citi.
Gary P. Taylor - Citigroup Inc, Research Division
I have 2 questions. The first -- kudos on managing the operating expense in both hospital and SNF salaries and also supply costs were down year-over-year. My question is on the one bucket, that other operating expense per patient day, which is still up 4% in the hospitals, 2% in nursing. Could you just kind of remind us the biggest parts of that bucket and what's being resilient, whether that's utilities or coverage costs or -- what's the piece of that, that still drives the year-over-year inflation?
Richard A. Lechleiter
Gary, Rich, good morning. The 2 things that come to mind that are most prominent around inflation are utility costs, outside of natural gas, and also our malpractice cost continues to go up in both of our major divisions. Those are the 2 items of note.
Gary P. Taylor - Citigroup Inc, Research Division
So on a go-forward basis, I mean, I would guess the trajectory is pretty similar where you think in '13, you'll do probably a much better job on per patient day costs, SWB and supplies, and this will remain the piece that grows at a faster clip?
Richard A. Lechleiter
Yes, I think on med mal we actually have some opportunities in '13 and '14, particularly around the Ventas dispositions that would occur in April. I think there's an opportunity to start bringing that rate of growth down net of those dispositions. We'll see.
Gary P. Taylor - Citigroup Inc, Research Division
Okay. My second question, I just wondered, can you guys, if you're willing to comment on this Debtwire story that was out a couple of weeks ago that suggested there were 20 owned assets you were looking to sell. If you had any comment on that. And when we looked at kind of the talk in that article was maybe $50 million of EBITDA being sold potentially for $250 million or $300 million. That looked like that deal might be breakeven to slightly dilutive on EPS when we ran it all the way down. Obviously it would give you some proceeds to pay down some more debt. But can you comment on that news story at all?
Paul J. Diaz
No, Gary, I mean, I don't think it's constructive to talk about that article specifically. But I will restate sort of our commitment to continue -- in the context of what we're seeing and the direction of healthcare in terms of the integration at a local level, we do believe, as we said in the prepared remarks, that our cluster market strategy, our Continue the Care strategy, developing our integrated care model is absolutely the way to go. And so, accelerating that by looking to reposition our portfolio, both owned and leased assets, in a more aggressive way is something we are taking a very hard look at. And as I said, you can expect to see portfolio rationalization, but frankly, as we've done for the last 10 years, to continue and we are looking for opportunities to do that over the next 2 years in a fairly aggressive way.
Operator
We'll go next to AJ Rice, UBS.
Albert J. Rice - UBS Investment Bank, Research Division
Maybe first, just I don't know if there's anything to say here. Obviously, a lot of focus on the election, but is there any update on discussions around LTAC criteria of bills or the year-end push toward doc fix and what that might look like and so forth?
Paul J. Diaz
Well, sure, AJ. Again, we are very pleased that the American Hospital Association and the Federation of American Hospitals continue to lead the dialogue with policymakers, along with our colleagues in the LTAC community, to advance criteria. The bill continues to be refined. We do hope to advance it in the context of the year-end doc fix discussions. We do think it will -- it's the right policy, will score budget savings and therefore, there is potentially an opportunity to advance the legislation either at year-end or early next year. So again, a great deal of work continues in that regard. And we've obviously refined -- the AHA has led the effort to refine the bill in the context of the final regs that were promulgated earlier this summer. So we're continuing to move that along.
Albert J. Rice - UBS Investment Bank, Research Division
Okay. Just thought I'd ask about what the acute care guys are reporting, obviously, weakness in their volumes generally and then also, pressure on the -- which they have been reported for several quarters now, on their -- this challenge of outpatient observation status versus inpatient stays. And I've seen some reporting in the trade press that, that is creating some issues with people not having the 3-day stay in the acute care side to be able to qualify for nursing home care or skilled nursing care. To what extent are you guys observing any of that? Is it -- do you believe it's impacting your business in any way? Maybe any commentary along those lines.
Benjamin A. Breier
AJ, this is Ben. We're observing it just as you are and just as we read the results of some of the short-term acutes here in the third quarter. I mean, there's no question that inpatient admissions are under pressure from some of the largest hospital systems. We've done a pretty good job with the sales force we've built about being able to sort of outpace those -- the reduction in inpatient admissions in the short-term acute side. If you look at particularly in our Hospital division, the 2% year-over-year same-store admission growth in this environment has been pretty strong. The observation days is something that we're watching very carefully as well, and there's no question, if you look at the operating results in our nursing centers in the third quarter, you saw the pressures on our volumes. And it's hard to attribute exactly what the specific percentage is to that 3-day stay observation day issue. But I think certainly there is some piece of that, that's having an effect.
Paul J. Diaz
AJ, I'll just add 2 points. There's a substantial opportunity as we work past some pretty arcane fee-for-service rules down the road, whether it's in the context of new integrated pair model bundling or just as CMS tries to make the fee-for-service system better, that observations stays focusing on re-hospitalization policies, not only at the acute care side, but with the 35% of these patients who are accessing post-acute care on discharge as well, that there's just a tremendous opportunity around re-hospitalizations, coordinating these observation stays, that the current fee-for-service rules are inhibiting. And I do think that, that is an opportunity for alternative site providers and, in particular, post-acute providers.
Albert J. Rice - UBS Investment Bank, Research Division
Okay. Maybe just a last question. When you look at the 2013 guidance, and I know that was -- sort of came out because you were working on your bank deal, maybe a little earlier than you originally anticipated. But you've talked about the $20 million to $25 million, you've talked about the sequestrations. Is there any other broad stroke assumptions that maybe you could highlight or cull out for us that are embedded in the expectations for next year in terms of the trend continuing or varying, any of the major trends?
Richard A. Lechleiter
I don't think so. We're continuing and we have been continuing to work through our budget process for months now. And I think the issues of the day ahead of us, notwithstanding the reimbursement pressures we all know about, are about the same kinds of issues we're dealing with today, namely wage rate growth; our workforce, concentrating on turnover; taking a balanced approach, as we always have, around quality of services and cost efficiencies. I think as you look across the spectrum, the issues remain the same for us. Obviously, we're excited to be able to continue to grow the business. Although this is not included in the guidance, the free cash flow that we expect to generate in '13 offers us a lot of excitement in terms of the cluster market development strategy, as well as expansion into home health and hospice services, so we continue to pursue that in a big way.
Operator
We'll go next to Frank Morgan, RBC Capital Markets.
Frank G. Morgan - RBC Capital Markets, LLC, Research Division
I guess as a follow-up to the question on the LTAC admission trends being good and softness on the nursing home side. Was there any particular payer class where you're seeing softer admissions on the nursing center side? I know we've had some other companies talk about Medicare Advantage getting more aggressive in trying to shorten the length of stays. That's a downward pressure. But any particular payer class that's making admissions go down on the Nursing Center side?
Benjamin A. Breier
Well, it's pretty -- it's broadly mixed, Frank. I mean, I think we have, as we've talked about now for a number of quarters, experienced that same length of stay pressure on the MA plans as what you just spoke about. I think we're seeing some certain states on the Medicaid side of the world, particularly those that are going to Medicaid managed, that are pushing patients out of our long-term care facilities and into homes faster than what we might otherwise have seen. I think there's some pressure there. So it's a combination of those 2 things, I would say.
Frank G. Morgan - RBC Capital Markets, LLC, Research Division
And any commentary on just kind of volume trends, say, within the LTAC business across the months of the quarter? A lot of the acute care guys said September was unusually soft. Did you see a similar trend there?
Richard A. Lechleiter
We did. September was soft, yes.
Frank G. Morgan - RBC Capital Markets, LLC, Research Division
Would you say it was the softest month in the quarter?
Richard A. Lechleiter
Yes.
Frank G. Morgan - RBC Capital Markets, LLC, Research Division
Okay. Just a housekeeping matter for Rich. Any prior period cost report settlements in the quarter, any med mal reserve releases in the quarter?
Richard A. Lechleiter
No, sir.
Frank G. Morgan - RBC Capital Markets, LLC, Research Division
Okay. And then, let's see, just one final on the contract therapy business. I mean, after kind of having, last year, obviously some declines in contracts, but you've had nice sequential growth for a couple of quarters here. Is there anything in particular that you can call out that's starting to drive the sequential growth in contracts? Is it because of reimbursement changes or any other factor or any commentary there?
Richard A. Lechleiter
Well, yes, thanks for that question. We're very pleased with the robust growth that we've seen in RehabCare. And despite, or maybe because of some of the regulatory uncertainty, we continue to find a lot of the individual operators out there who really who are looking for our services and continue to talk to RehabCare about helping them manage their therapy provision. There's been so many ups and downs in that business in the way that we provide care that, as I said, a lot of the individual operators really need a company like RehabCare who can come in and help. And so, we've had 2 things really that have happened, particularly in the SRS part of our business, the skilled rehab service part of our business. One, we've signed a lot of new contracts this year. I think we're up to about 160 that we've signed year-to-date. But 2, our turnover has been at the lowest level, really, that any of us can remember in probably 5 or 6 or 7 years. We've had a lot of stickiness in these contracts, and it's created a net contract growth, which has been very good for that business. We've seen the same thing on the HRS side as well, Frank, in the hospital rehab services, where we've signed 18 new hospital rehab service contracts this year, year-to-date, which is an all-time record for them in terms of what they've done. So we're very bullish on our continued third-party contract growth in both aspects of that business.
Operator
We'll go next to Rob Mains, Stifel, Nicolaus.
Robert M. Mains - Stifel, Nicolaus & Co., Inc., Research Division
A couple more RehabCare questions. First of all, the change in therapy that you described affecting Part B, is that -- the $1 million drag, is that forgone revenues or increased costs or is it a combination?
Richard A. Lechleiter
It's a combination. It's a combination.
Robert M. Mains - Stifel, Nicolaus & Co., Inc., Research Division
So you got to -- effectively, you've got to jump through more hoops but some of the -- sometimes, you don't make it all the way through the hoops effectively.
Richard A. Lechleiter
That's right.
Robert M. Mains - Stifel, Nicolaus & Co., Inc., Research Division
Okay. And then also, HRS margins were down a little bit sequentially from Q2 to Q3. Anything going on there?
Richard A. Lechleiter
We had -- a little bit of that was related to some inpatient volumes with some of our host facilities. I would expect that to normalize as the year goes on.
Robert M. Mains - Stifel, Nicolaus & Co., Inc., Research Division
Okay. And Paul, when you talk about, and Rich, when you talk about the free cash flow generation this year going into next year and kind of the ways that you could use it, have you thought anything that you'd want to discuss with us in terms of how you would prioritize the potential uses of free cash?
Paul J. Diaz
Well, first of all, it is a very important point because I don't think, quite frankly, that we've done a good enough job of drawing attention to the free cash flow per share, what we are generating here, how that's been deployed over the years. The residual value of the real estate, for example, that's been accumulated on the balance sheet, and the growth now of a $200 million plus Home Health business and the RehabCare business, both of which have much better margin characteristics and organic growth characteristics going forward. So we have to look at that, Rob, through the lens of the policy environment and maintaining a margin of safety. But obviously, as we get more visibility on next year and the policy environment around sequestration or a larger deficit reduction conversation in Washington, from a more defensive posture of paying down debt to a more aggressive posture of expanding our Continue the Care strategy, home health, our cluster market development, we will look at those opportunities. And then lastly, as I've said in my prepared remarks, taking a very hard look at the different choices and options we have to create shareholder value, whether they be looking at share repurchases, dividends or other ways to bring -- create value for shareholders through that free cash flow generation.
Robert M. Mains - Stifel, Nicolaus & Co., Inc., Research Division
So do I take away from that, that first, you want to kind of get your feet or everybody's feet, or what, the ground beneath them stop shaking, whatever the right metaphor is, for the reimbursement environment. And then think about whether you'd deploy more kind of to the business or to shareholders?
Paul J. Diaz
Well, let's just look at the context. As Rich said, we will essentially generate, after the planned development, $90 million of free cash flow. This year, we had a great opportunity with IntegraCare in our cluster markets and some other smaller home health acquisitions to deploy that capital in a very meaningful accretive way, as we've talked about $0.09 of accretion next year with respect to Integra. The $1.30, we're -- that includes sequestration, that includes a budget neutrality adjustment. So in that context, we've taken the -- preparing for the worst and hoping for the best. And so assuming that we can do better than that, if the policy environment improves, then more of that free cash flow can be generated opportunistically through acquisitions or pursuing the shareholder friendly options that we might have.
Robert M. Mains - Stifel, Nicolaus & Co., Inc., Research Division
Okay, fair enough. And my last question, when you talk about trends for discharges and admissions in the skilled nursing business, can I kind of surmise from what you're saying, Paul, that the opportunity for growth might be greater in managed care-like products, not necessarily Medicare Advantage but some of the other initiatives, rather than the traditional fee-for-service program right now?
Paul J. Diaz
Well, look, I think it's a very dynamic situation, as Ben talked about. And whether it's in the context of the duals or just the movement to managed care, what we see is continued opportunity in 21st century skilled nursing, our transitional care centers, our hospital subacute base units. So by way of example, our Bridgewater facility in Indianapolis yesterday had 100 ADC of Medicare and managed care patients, 100. So we hope to build 3 to 5 of those facilities in our cluster markets over the next 2 years; another 1 in Indianapolis, 1 in Las Vegas and potentially 1 in Phoenix and some of our other cluster markets. So we do see a demand for that subacute level of service continuing to expand as people move through the continuum and we move to a more episodic payment environment.
Operator
[Operator Instructions] We'll go next to Kevin Fischbeck, Bank of America Merrill Lynch.
Joanna Gajuk - BofA Merrill Lynch, Research Division
Actually, this is Joanna Gajuk today for Kevin Fischbeck. I just want to go back to your discussion about streamlining your portfolio and the fact that you divested another LTAC. So are there any new temp [ph] plans to divest more LTACs? And also, are there plans to sell nursing home assets as well?
Paul J. Diaz
I'm sorry, you broke up a little bit. But I don't think I have any more commentary other than we're continuing to look at all of our assets that are not in our cluster markets to accelerate our strategy and prune and adjust the portfolio to where we think the puck is heading. So I don't really have any more commentary and again, I apologize, I didn't really quite make out the question.
Joanna Gajuk - BofA Merrill Lynch, Research Division
Yes, I was just wondering, your sort of preference in terms of divesting LTACs versus divesting the nursing homes.
Paul J. Diaz
I don't think other than within the context of our strategy, that's very geographically focused and focused on building out a continuum of services. Within those 2 lenses, I think is how you should think about how we think about prioritizing both free cash flow deployment and potential asset sales.
Joanna Gajuk - BofA Merrill Lynch, Research Division
Great. And then I might have missed it, but in terms of those changes you discussed on the rehab side, the Medicare Part b, new, I guess, clients there, is there anything you can do in terms of offsetting this? Or it's -- or you assume that it's -- the $1 million [indiscernible] will continue?
Richard A. Lechleiter
Well, like we do in RehabCare, every time we face a regulatory challenge, which has been quite frequent over the last couple of years, we'll get better at the process, we'll improve our own efficiency and we'll work through trying to get better at how we're delivering care. I would expect that you'll see continued improvement in that process, and we'll have to see how long it takes to get there.
Joanna Gajuk - BofA Merrill Lynch, Research Division
So you basically assume some improvement in your 2013 guidance?
Paul J. Diaz
I think we've answered the question. Do you have anything else?
Joanna Gajuk - BofA Merrill Lynch, Research Division
Yes. The last question I have is on the Illinois budget there for fiscal '13. There were some cuts specifically for LTACs it seems, which the State estimated would be about $30 million of savings for the State. So can you comment how it would impact particularly your hospital there?
Richard A. Lechleiter
We're aware of it. It's in our guidance already. We've started to deal with that here already in the back half of this year, and I don't think we have anything further to comment on in that regard.
Operator
We have no further questions in the queue at this time. I'll turn the conference back over to Mr. Diaz to offer any additional or closing remarks.
Paul J. Diaz
Right. I think you probably all heard enough from me this morning. A pretty solid quarter in the context of lots of volume pressures from our acute care partners and others. And again, thanks for all your support and recognition of the steady costs management and advancing of the strategy.
Again, thanks to our teammates that have -- again who have weathered the storm last night and are digging out today. And for all of you that are participating on the call today, thanks for making your time. And we'll look forward to talking with you over the next several months in the conferences and otherwise. Thanks again.
Operator
That concludes today's conference. Thank you for your participation.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!