Kindred Healthcare's (KND) CEO Ben Breier on Q4 2016 Results - Earnings Call Transcript

| About: Kindred Healthcare, (KND)

Kindred Healthcare, Inc (NYSE:KND)

Q4 2016 Results Earnings Conference Call

February 28, 2017, 09:00 AM ET


Eddie Jones - IR

Ben Breier - President, CEO

Stephen Farber - EVP, CFO


A.J. Rice - UBS

Josh Raskin - Barclays

Sheryl Skolnick - Mizuho Securities

Gary Lieberman - Wells Fargo

Frank Morgan - RBC Capital Markets

Kevin Fischbeck - Bank of America


Good day, everyone, and welcome to Kindred Healthcare's Fourth Quarter 2016 Conference Call. Today's call is being recorded.

And at this time for opening remarks and introductions, I would like to turn the call over to Eddie Jones. Please go ahead.

Eddie Jones

Thank you and good morning. Welcome to the Kindred Healthcare fourth 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 actual results could differ materially from those contained in the forward-looking information.

The Company refers you to its reports filed with the Securities and Exchange Commission, including the Company's annual report on Form 10-K, the Company's other reports filed periodically with the SEC, and its press release regarding the fourth quarter operating results, for a discussion of these forward-looking statements and other factors that could affect these forward-looking statements.

Many of these factors are beyond the control of the Company and its management. The Company cautions investors that any forward-looking statements made by the Company are not guarantees of future performance. The information being provided today is as of this date only, and the Company disclaims any obligation to update any such factors or to announce publicly the results of any revisions to any of the forward-looking statements to reflect future events or developments.

Certain references to 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,

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.

Ben Breier

Thanks, Eddie, and good morning, everyone.

I'd like to start my comments by thanking everyone who helped make 2016 such a successful year for Kindred. Last week Kindred is recognized for the 8th time by Fortune Magazine as one of the most admired companies in Healthcare Services in the world. On behalf of the Board of Directors and myself, I want to express our deep appreciation to all of our teammates and partners around the country who help make this fine recognition possible.

Last night we reported fourth quarter and full year 2016 operating results in line with our expectations. We reported revenue for the year of $7.2 billion, core EBITDAR of $950 million and core earnings per share of $0.76. We have very strong cash flow in the quarter and we're ahead of our expectations for the year with $299 million of core operating cash flow and $157 million of core free cash flow. Stephen will address our financials in detail in a few minutes along with our outlook for both 2017 and 2018.

During the quarter we made significant progress growing Kindred at Home which comprises our home health, hospice and community care businesses. We also advanced our inpatient rehabilitation businesses and made progress stabilizing our nursing center and RehabCare volumes.

Importantly we had solid volume and top line performance from our hospital division in its first full quarter under long-term acute care patient criteria which I'll discuss in more detail in a few moments.

Like many employers across the country for the past couple of quarters we've experienced significant pressure from higher labor costs particularly related to nursing in both our LTAC facilities business and Kindred at Home. We have a variety of mitigation strategies underway specific to each part of Kindred and expect to make meaningful progress reducing these costs in 2017.

In the fourth quarter we also advanced our plan to divest our skilled nursing facility business. As we discussed last quarter, our strategic decision to exit this business as an owner and operator is the final step of a process that really began more than 15 years ago when Kindred operated approximately 300 skilled nursing facilities across the country. We are very encouraged by the high level of interest at a variety of owners and operators of expressed in our portfolio thus far and we hope to complete this initiative by the end of 2017.

Similar to our strategic move into the home health hospice and community care businesses, our exit from the skilled nursing facility business will contribute to the ongoing transformation of Kindred's growth, cash flow and leverage profile. Today excluding our skilled nursing facility business on an adjusted basis, approximately three quarters of our earnings come from our primary growth engine Kindred at Home and our hospital-based rehabilitation businesses both of which enjoy exceptional growth profiles and robust cash flow characteristics.

We continue to consider skilled nursing to be a critical element of the care continuum we provide and as we described last quarter, we will continue to work closely with many high quality providers of skilled nursing facilities across the country to care for patients in need as part of our ongoing continue to care initiatives.

We recently announced a groundbreaking clinical collaboration initiative with Genesis HealthCare to improve quality, outcomes and care transitions across the post-acute continuum. Our future will be driven by collaborative efforts to deliver coordinated post-acute care with other providers enabled by technology and data driven care management capabilities. We believe that working with companies like Genesis is an important step in driving effective patient centered care solution and proactively addressing the changing healthcare marketplace.

We intend to create other such relationships with buyers of our skilled nursing facilities, RehabCare customers and other regional providers so that we can serve our patients and customers the full array of post-acute services they need.

Now let me address each of our business units starting with our hospital division. As we've discussed in the hospital division, over the last two years our hospitals - our leadership team has been diligently preparing for entry into LTAC criteria and the fourth quarter of 2016 was our first full quarter under the new reimbursement system.

We were particularly pleased with our volume and topline performance in the quarter despite the approximately $30 million revenue impact in the quarter from reduced Medicare rate for those patients that fell into the medically complex site-neutral designation. We were able to maintain essentially flat same-store revenues year-over-year in total. We also grew volumes by 2.5% on a same hospital year-over-year basis.

In addition to the strong volume performance our mix continue to improve as well. For the quarter, approximately 89% of Kindred's same-store hospital division revenues came from compliant patients up from approximately 87% in the month of September. The remaining 11% of revenues were from Medicare site-neutral patients.

As you can see from these early results, in just the first full quarter of criteria our teams were able to offset much of the revenue impact caused by LTAC criteria which exceeded our expectations. In addition to the same-store admit growth and stable revenues, we are encouraged by our early success in reducing avoidable clinical delays such that our Medicare length of stay decline by 2.3% in the quarter most of which can be attributed to the average length of stay drop we saw in our site-neutral complex medical patients.

Reducing length of stay where clinically appropriate will continue to be an operational priority and is a significant opportunity to improve performance and overall bottom line results. In 2017, we expect our hospitals to make continued incremental progress with criteria mitigation, labor costs and margin despite the premium pay labor headwind we discussed earlier. And our early encouraging topline performance gives us confidence in our multipronged LTAC criteria mitigation strategy.

Let's turn now to Kindred at Home, the largest home health hospice and community care platform in the nation. Kindred at Home delivered another quarter of solid volume. For the fourth quarter, our Kindred at Home division delivered revenue growth of 4.3% over the same quarter last year. Home health same store revenues increased 4.7% on same-store episodic growth of 3.9%, while hospice delivered same-store revenue growth of 6.5% on same-store admissions growth of 4.4%.

Core EBITDAR margins for both home health and hospice contracted due primarily to nursing labor headwinds. These headwinds came from a combination of the macro labor conditions we spoken about and quite frankly some self-inflicted costs stemming from our continued integration of pay practices and electronic medical record systems. We expect to make meaningful progress on the controllable part of this labor equation in 2017.

The community care business continues to be a stable contributor with revenues for the fourth quarter growing at 11% over the same quarter last year. Margins in the segment continued to improve and we are very bullish on the opportunity for this business to grow aggressively and expand its role as both the key element of the care continuum and a key driver of growth for our enterprise.

Turning now to our rehab services division KRS. As a reminder, Kindred Rehab Services comprises our Kindred Hospital Rehab Service segment or KHRS and our RehabCare contract therapy service segment. Once again KHRS had an impressive quarter.

KHRS includes our 19 freestanding inpatient rehab hospitals, as well as the 102 acute rehab units we manage on a contract basis inside community hospitals. KHRS delivered revenues and core EBITDAR, there were each up more than 9% on a year-over-year basis in the quarter. This growth was the result of a combination of the maturation of recently opened IRF facilities and growth in same hospital discharges for our freestanding IRFs of 4.6% compared to the same quarter last year.

KHRS have a deep pipeline of new opportunities and the ability to develop additional IRFs and joint ventures with premier health systems across the nation. It remains one of the key growth drivers for Kindred.

2016 was clearly a challenging year for RehabCare. Despite essentially flat volume and rated on the same-store sequential basis, it's fourth quarter core EBITDAR was $5.6 million down from $9.2 million for the sequential quarter. The decline was due primarily to a reduction in therapist productivity in a large part related to year-end training and implementation associated with the RehabCare corporate integrity agreement we are now under. RehabCare continues to work to a number of challenges what we believe that run rates will normalize over the course of 2017 as the training activity starts to lesson out.

Moving now to our nursing center division. Performance in the quarter was generally in line with our expectation against the challenging industry backdrop and as we move forward with our plan to exit the skilled nursing facility business, we were very pleased with the steady leadership that our Division President, Mike Beal and his team were provided. He and his team of operators and clinicians continue to do a tremendous job staying focused on the patient care task at hand and not allowing themselves to get caught up in any distractions.

Revenues were essentially flat in the division with stable rate and volume. The decline in core EBITDAR against stable volume can be attributed to the same labor headwinds experienced by other Kindred businesses. We know many investors are watching closely our progress with our skilled nursing exit and as I said previously we've been very pleased with the amount of interest and activity in our combined portfolio. We continue to believe that the sale of the business scheduled to be complete by the year-end will be very attractive financially to the Kindred Enterprise.

We continue to expect the net after-tax proceeds to be between $100 million and $300 million of incremental cash flow to our Company. And as Stephen will speak to you shortly, in an effort to show investors what Kindred will look like post our SNF divestiture, we've taken the unusual prescriptive measure of guiding investors for 2018 to create clarity about our anticipated strategic operational and cash flow profile.

One last comment regarding our dividend policy before I turn it over to Stephen. As you saw on earnings release last night, the Board of Directors has made the decision to discontinue Kindred's quarterly cash dividend. Our board is determined that the trading levels of the Company stock, common stock for some time now has really not sufficiently reflected the value of the dividend and rather than directing $42 million per year to a dividend for which we are clearly not getting much credit for in the market, these funds will be redirected to repay debt and invest in growth.

The combination of our NCD sale and expected after-tax proceeds are normalized free cash flow generation and our change in dividend policy all should lead investors to clearly see how serious we are about deleveraging our enterprise.

And with that, I'll turn it over to Stephen. Stephen?

Stephen Farber

Thanks Ben, and good morning. So we got a lot to cover today, so I'm going to start by walking through the P&L with a focus on our 2017 and 2018 outlook that we announced yesterday.

First I want to point out to everyone's on the same page, that for our 2017 outlook we've assumed that our skilled nursing facility business is included in the outlook for the full year even though it will likely move to discontinued operations oversold prior to the end of the year. This way the 2017 numbers can be compared to 2015 results.

For our 2018 outlook we did the opposite and assume that the nursing facility business will be sold before the start of 2018. While we don't typically provide an outlook two years forward, the skilled nursing facility business is more than $1 billion business for Kindred and selling it will have a significant impact on our financials, our goal in providing 2018 outlook is to show essentially a clean and clear view of the go-forward enterprise. With the skilled nursing ability business sold and with LTAC criteria, various cost reduction and labor mitigation efforts baked in for our full year. We hope this approach is helpful.

So with that let’s get going. Starting at the top of the income statement we announced yesterday that revenue for 2015 was $7.2 billion. For 2017 we also expect roughly $7.2 billion of revenue at the midpoint with a range of $7.1 to $7.3 billion. There are three primary items that bridge revenue from 2016, 2017.

First, please recall that we sold 12 and closed three LTAC facilities in late 2016. These facilities contributed revenue of approximately $183 million last year. Second, 2016 included approximately 4.5 months of LTAC criteria so 2017 includes an additional 7.5 months to annualize the impact. And third, we expect meaningful revenue and volume growth in 2017 particularly in Kindred at Home and our IRF businesses. We expect this growth to be strong enough to offset the two items that I just discussed.

Moving now to EBITDAR, we announced yesterday core EBITDAR for 2016 of $950 million and that we expect core EBITDAR for 2017 of $930 million at the midpoint. Our press release last night and Ben's comment on this call identify the key items that bridged 2016 results to our outlook for 2017 including the increasing benefits we expect over the year from LTAC criteria mitigation, cost reduction plans particularly around labor, and the other initiatives to drive margin and growth.

Moving now to rent, for 2016 we reported core rent of $390 million. For 2017, we expect core rent of approximately $385 million at the midpoint. This reduction reflects a lower run rate in late 2016 after the closure and sale of LTAC facilities, offset by normal annual rent escalators in our portfolio lease obligations.

Moving now to depreciation and amortization. For 2016 core DNA was $159 million of which amortization was $24 million. For 2017 we expect core DNA of roughly $145 million at the midpoint of which amortization should be about $17 million. These levels compared to our expected routine capital expenditures in 2017 of approximately $80 million to $90 million and our estimated growth capital expenditures of approximately $50 million.

Moving out interest expense, for 2015 we reported $235 million. For 2017 we expect interest expense to be similar at approximately $240 million at the midpoint. Please note that both these figures include about $17 million of non-cash amortization of deferred financing fees.

Now for a couple of comments on tax rate. For 2016 we recorded a core book tax rate of 27% which was lower than normal due to growth and non-controlling interest. As NCI increases with greater JV activity, our tax rate is favorably impacted. We expect the core book tax rate for 2017 of around 30%.

This increase and expected rate is largely due to an accounting rule change effective January 1, 2017 that requires book tax differences associated with share-based payment to be adjusted through the P&L rather than directly to shareholders equity. As a reminder, this rate reflects the book tax liability as a percent of pretax income for NCI. We expect core NCI somewhere in the $50 million area for 2017 up from $55 million in 2016 with the growth in this number largely reflecting increased profit contribution from IRF JV. As we discussed previously, we expect our cash income taxes to be less than 10% of core book tax liability which I'll discuss more in a minute when we get the cash flow.

Moving now to share count, we expect a fully diluted share count for 2017 of roughly 88.5 million shares as weighted average for the year which compares to 87.5 million shares in 2016.

Moving now to earnings per share, we reported yesterday $0.76 of core diluted EPS for 2016 and we are expecting core diluted EPS of $0.55 at the midpoint for 2017. The primary drivers of this change are the same items we've already discussed. Labor cost pressure and the annualized impact of LTAC criteria, which we expect to increasingly offset over the course of 2017\.

Now before moving on to our 2018 outlook, I want to acknowledge that 2017 has a lot of moving parts including the unknown timing related to our skilled nursing facilitates business moving to discontinued operation. While we do not intend to provide quarterly guidance for 2017, we do expect the first quarter of 2017 to generate substantially similar results as the fourth quarter of 2016.

With improving results as the range of initiatives that we have extensively discussed gained traction over the course of the year. With this expected ramp and results over the course of 2017, we expect our starting point for 2018 to be meaningfully higher than our starting point for 2017.

With that, let's now turn to our outlook for 2018 that we announced yesterday. Please remember, all figures for 2018 assume the completed sale of our skilled nursing facility business before the beginning of 2018 and are indicative to help those working to model longer-term results for the Company.

As noted in our release last night, for 2018 our midpoint revenue estimate is $6.3 billion and our midpoint core EBITDAR estimate is $840 million. Our 2018 midpoint core rent estimate is $305 million and our midpoint core depreciation and amortization estimate is $120 million. This DNA level is meaningfully higher than our expected routine capital expenditures for 2018 approximately $70 million to 80 million.

Our 2018 midpoint NCI estimate is $45 million and our midpoint core diluted EPS estimate is $0.80. As we have mentioned before we expect the sale of the nursing facility business to be accretive to both earnings and cash flow and this is reflected in the affected increase in profitability indicated by our 2018 outlook.

With that let's now turn to cash flow. We are very pleased with our cash performance in 2016 with $299 million of core operating cash flow and $157 million of core free cash. These results demonstrate our greatly improved cash flow profile following our strategic repositioning and our investments in higher growth, less capital intensive businesses.

For 2017 we expect modestly muted cash flow relative to 2016 but not meaningfully muted as we work through all the items we discussed and return Kindred to a higher level of profitability. For 2018 we expect our core cash flows to return the levels more consistent with 2016 roughly $300 million per year of core operating cash flow but about half of that amount in core free cash flow after deducting routine capital expenditures and cash outflows related to NCI. That said, we believe there is potential upside with this expectation as capital expenditures and NCI will be reduced meaningfully following our exit from our skilled nursing facility business.

In addition to our operating and free cash flows, we ended 2016 with approximately $464 million of federal net operating loss carryforwards. We also expect to generate additional NOLs resulting from our pending exit from our skilled nursing facility business. As a result, we expect our cash tax liabilities to be less than 10% of our core book tax liability for the next several years and for the these cash tax savings, to supplement our available cash.

Also as announced last night, the Kindred Board of Directors has discontinued the Company's quarterly cash dividend following the payment of the fourth quarter dividend in March. This dividend required approximately $42 million of cash per year. Also 2017 is the final year for dividends related to the mandatory redeemable preferred stock the Company issued in 2014. Philadelphia had an additional $12 million in cash per year starting in 2018.

In summary, we expect the combination of free cash flow, harvesting our NOL, the discontinuance of 54 million of annual dividend, the expected net proceeds from the sale of our skilled nursing facility business, and a range of efforts to drive margin and improved performance will create a significant increase in cash available to repay debt and drive growth.

And with that, let me turn it back to Ben.

Ben Breier

Thank you, Stephen.

Before I open up call to Q&A, let me just spend a moment talking about our priorities for 2017. Over the course of this year, we expect to make progress executing on our key initiatives including one increasing levels of LTAC criteria mitigation, two, successfully exiting the skilled nursing business and ensuring a smooth transition, Three, implementing cost realignment efforts across the enterprise, four, improving momentum against industry labor headwinds. And five, driving new joint venture and integrated market growth to drive our continued care strategy.

As we advance our priority initiatives in 2017, we will continue executing on our strategic vision to create innovative post-acute solutions and deliver effective care coordination across an entire patient episode within a value-based healthcare system. We believe our focus on creating interrelated solutions is the best way to deliver a positive patient experience and uniquely positions Kindred for long-term success.

We continue to make progress transforming Kindred into the post-acute benefits manager company that we believe we can be and we remain dedicated to setting the foundation for a stronger Kindred as we execute effective patient centered solutions and proactively adapt to the changing healthcare marketplace.

Thank you. And with that operator, you can open it up Q&A.

Question-and-Answer Session


[Operator Instructions] We'll go first to A.J. Rice, UBS.

A.J. Rice

Thanks, hello everybody. Maybe a just a couple of quick questions here. First drill down a little bit more on your comments around labor is - can you describe a little bit of what you see in as a wage pressure, does it tend to be more of RNs or the nurses aid, is it turnover, how is it manifesting itself and is there something you can deal with that, or that just the way the market is right now?

Ben Breier

Hi A.J. good morning. Look I mean labor is a bit of a complicated story because it's different for different business lines. In our hospital LTAC business, you know we've clearly seen a nurse shortage and particularly in some specific geographies across the country, some rural markets some areas and pockets in the Midwest and a couple of other areas.

And what you see if you look at that business is a couple of different factors. One average wage rates in the business really have not been driven much higher. We've been able to keep AWR at a pretty reasonable sort of cost of inflation kind of rate.

Secondly, turnover remains really steady in the business, we don’t - we are not seeing a ton of turnover for nurses and other staff members that we ultimately bring on to the payroll. Three, retention in the business seems to be pretty high. So both from a turnover retention perspective, we feel pretty good about that. It is really simply in some of these geographies that I talked about hard to find nurses to actually feel shifts. We've had hospitals over the course of Q4 where we actually had to have some sort of bed hold because we literally couldn't find nurses to put in another number of shifts.

And so A, that is muted even our excellent 2.5% admission growth, and B it caused us to have to go out A.J. and find lot of contract labor and premium pay support for the hospital division, so that's really on the hospital side.

The Kindred at Home story as I mentioned in my prepared remarks is really kind of more two-fold, I mean there are some exogenous related issues around some wage rate creep in that business but I would view Q4 as much more of a self-inflicted wound as I would and exogenous issue. We have gone through sort of the final stages in that business of consolidating our electronic medical records of consolidating pay practices and what I would really describe the fourth quarter in our Kindred at Home labor line being is really more of a productivity issue than an average wage rate issue, we had lots of our employees who were working off two systems doing some final stages of manual processing and I think A.J. that stuff will start to smooth itself out here in the first quarter into 2017.

So it's a little bit of a tale of two cities, there are real labor pressures on the nursing side and our hospital business and on that front, we are very active with trying to be prescriptive in lots of different ways to meet those ongoing issues. On the Kindred at Home side, we expect that to mitigate on our own as we kind of move to the final stages of that integration.

A.J. Rice

Okay, great. And maybe one other question, it makes sense decision on the dividend, I understand that and I know your refocus in capital with your decision to get out of the nursing home business. Can you just - is there a target that you’re trying to accomplish in paying down debt either leverage ratio and how do you look at that or should we expect that some of this cash is going to get deployed in de novos and acquisitions as well. Give us a little sense of what you are thinking in making that change and what the opportunities are?

Ben Breier

Yes sure A.J. It's really one of the top priorities of our organization as we think about where our equity trades and how investors view our company. The idea of continuing to focus on using our free cash flow to de-leverage this company either through paying down debt or by going out and finding more opportunities for growth or things that - our Board and I just - we'll let our management team, we are just laser focused on what we are trying to do.

And as we have laid out the pieces of our normalized free cash flow that we are going to generate of the excess proceeds that we will get from the nursing center sale, the 50 plus million of dividend, the 18 million of NCI that goes away, there will be a significant amount of free cash flow that we can deploy.

The answer to your question really is, we are driving towards a five times leverage ratio and we would like to get that over the next couple of years and that's kind of what we see in front of us, we hope over the next 8 to 10 to 12 quarters.

A.J. Rice

Okay, great. Thanks a lot.


We'll go next to Josh Raskin, Barclays.

Josh Raskin

Hi thanks, good morning guys. Just want to follow-up as we think about 2018 and we started looking at a more normalized Kindred business, how do you think about the growth rate of the entity and you gave some percentages as to what percentage of EBITDAR, I think it was three quarters is coming from, what call growth businesses.

So as you think about home health and hospice or the IRFs, what is that growth rate look like, what is that organic growth rate look like, I guess just looking at the 2018 numbers doesn’t feel like you have got any aggressive assumptions at all around where those business is growing?

Ben Breier

I think you're probably right Josh in terms of how you would define aggressive or I would define aggressive. I think that we have tried to be very conservative and meaningful in the way that we put the 2018 guidance out. We try to - look I don’t know I would think that investors and analysts would understand that when you're trying to put guidance two years out, you have to take a fairly conservative approach to how you're looking at it. We wanted to put some numbers out that we obviously felt good about being able to put our arms around and have the investor community and people who are buying our shares and are invested in our debt believe in and that's why we put the 840 EBITDAR number out with the $0.80 of earnings.

It shows clearly that the below the lines sort of cash flow generating part of our company is clearly improved in a post nursing center world but I think that you're right, it's probably got a pretty conservative placeholder on growth particularly in the Canadian home hospice and on the IRF side of the business. I think that generally speaking, on the topline of that business we could continue to expect that, you're going to see good mid-single-digit growth on both volumes and revenues in both home, health and hospice business.

On the hospice side you may even see high single-digit growth rates there and that you should expect that you know depending on how we're able to deal with our labor issues that a significant portion of that can drop through and if that's the case, than the $840 million number that we put out 2018 is I would agree with your assessment not a very horrific number.

But in terms of the placeholder, in terms of continuing to move our way to criteria, in terms of wanting to meet the commitments that we put out two years into the future, look we felt that was a pretty good number to kind of work our way around, it's a midpoint part of the range and we will continue to refine that estimate certainly Josh over the course of 2017.

Josh Raskin

Okay, that makes sense. On the sniff sale, were three months past our last discussion, I'm curious, you characterize the progresses as favorable. Are you thinking still more about one big buyer or at some point you start looking at smaller sales and Ventas made a comment around you now expecting this very late in 2017, is that the same way you'd categorize it as sort of 4Q late in the year event.

Ben Breier

Yes, well of first of all we're in total alignment with Ventas in terms of the timing and you know our expectations for when we expect to be able to send them the money that we owe them, the $700 million that we owe them for the portfolio sale. So on that front we're in total alignment.

Look on the first part of your question, I’ll get into a little bit of detail but Josh you understand not too much of detail as we’re kind of right in the middle of these negotiation and just say this, look we really have had quite a bit of activity, a remarkable amount of activity. I think it continues to show that there is real strength and interest particularly in owned real estate and owned assets, there are real cap rates to be paid, there are real people who want to operate these businesses and particularly a pretty high quality portfolio that I would argue that we have.

And so we are in the process of doing at this point having gone through two or three or four stages of the sale process is really trying to evaluate as I think investors would expect us. On the one hand certainty to close and on the other hand the price and the cash that we can generate, and if I could add a third hand I guess the simplicity of the deal in terms of do we go with one party or do we go with multiple parties.

And what I would say is look we have a number of parties, a number of parties who are interested in buying the whole portfolio. We also though have a number of parties who are interested in as little as one state and as much as two or three or four, five states.

And so there are number of paths that we can go down and we like having the optionality Josh of having those paths as we kind of settling on certainty of close and total cash proceed. And so I think that over the next couple of weeks, we really kind of getting down to the [indiscernible] decision which quite frankly I think at this point is more on us than on the buyer to really kind of decide who to we want our partners to be, what's path that we’re going to go down and the hope is that in the next couple of weeks and months ahead we could start to make some more public announcements on where we're at in that process.

Josh Raskin

Okay. And I guess just one last on that, if you're assuming that the deal closes by the end of the year what's announced versus closed time. How long did it take to get a transaction like that completed?

Ben Breier

If you just assume it's one big deal and you're doing it all at once, you know you're probably thinking four months probably regulatory wise there are some states that are tougher than others but I would say four months is probably as good a guess as any.

Josh Raskin

Okay. So you got plenty of time to get this announcement?

Ben Breier

I think so, I think so.

Josh Raskin

All right, thanks guys.


We'll go next to Sheryl Skolnick, Mizuho Securities.

Sheryl Skolnick

Thank you very much. Can we turn to the LTAC business please, I really want to try to understand your thoughts around the impact of criterion particular the second phase and how you're seeing that and sort of in a sequential kind of impact whether you think that is going to kick the fourth quarter more than beginning of the year et cetera.

So if you can give us a little bit of that because I’m having a little bit of trouble modeling it especially given that you've made changes in the portfolio for lately here. So from clarification on service starting run rate and then ending run rate might be helpful.

Ben Breier

Sure Sheryl, I'll do my best and take more offline happy to do so. But let me just make sure that we're seeing from the same hymnal so to speak on when Phase 2 of criteria actually starts. It actually does not kick in until Q4 of 2018, not Q4 of 2017. So 2017 actually Q4 is our first quarter when we actually Sheryl get a decent comp, because it started this Q4 and so that's your first sort of year-over-year kind of decent top, apples to apples sort of it you will.

But let me try and I guess make a couple of broad comments on what we're seeing in the first full quarter of LTAC criteria and I'll see if I get to sort of triangulating around your question and then happy to go into more detail. We had said - let me go back up to 30,000 feet for a second, because it may be helpful.

We've said that that we were going to have a multiple pronged strategy to deal with LTAC criteria and the first thing we did as you well know and you just made a comment about, we made a meaningful step to divest and to optimize number of hospitals in 2016, I think the 12 that we sold the Cure Health, we shut down another three. We took almost 15% of the bed, almost a 1,000 beds out of the operation as we consolidated our LTAC business. And so that is important that work will continue as we go through 2017 and beyond.

Second, we said look, we are going to focus on trying to take more post intensive care patients more of the compliant if you will LTAC full DRG patients and if you saw as we reported the total percentage of revenue in the hospital division went from 87% in Q3 to 89% in Q4. We expect that that 89% will continue to move north over the course of the next seven quarters as we get to Q4 2018 before Phase 2 of criteria kicks in.

And at that point Sheryl we'll really be making the decision on whether or not we think we can manage effectively a site-neutral patient no longer in a blended rate. But as we said for now as long as we're continuing to drive more post intensive care patients as the 87%, 89% show, as long as we're continuing to add volume to the business which the 2.5% same-store mission growth shows, as long as we're able to drive Medicare rate effectively in our post intensive care population, and bring in more commercial and managed Medicaid and - Medicare advantage patient, with our capacity and our bed size we think that our approach is the right one and Q4 I think starts to prove that out.

Sheryl Skolnick

Okay. So I got that on the approach if we could just - kind of talk about what - so I’ll ask the question simply. So the 91 million of EBITDAR - core EBITDAR that the segment showed in the fourth quarter, is that a good run rate to start with for modeling purposes?

Ben Breier

Yes, I think it is. I think it's a pretty accurate number, I think you got to remember that it will go higher as you have better seasonality quarters and then it will go lower as you have others but in terms of the starting point, I think that's an absolutely appropriate place. I think look we left some dollars on the table clearly because of some of the premium labor issues we're dealing with and I would expect that you'll see some improvement in that number but I think at starting point Sheryl that's the right place to start.

Sheryl Skolnick

Breier because you had mentioned something earlier on that you expected somewhere in the neighborhood of $30 million in impact, right? So can you update that number because I thought last night we spoke about 60.

Ben Breier

Remember what we try to say was, when we were giving this guidance we were talking about the start of criteria which was going to have a $30 million impact in Q4 and then that was going to carry into 2017 with an incremental 25 million to 30 million if you will. The net combined number is sort of that $60 million drag Sheryl on an apples-to-apples basis for 2017.

So that's the difference between the $30 million in Q4 and the $60 million total for the year. And I would say on that front, look I mean we still feel pretty confident that those are the right numbers. We just think you know we're sort of getting at it a little bit different than what we thought. I mean I think the revenue outperformance in the business and the volume performance is clearly stronger than what we would've thought it would be heading into mitigation but the labor problems continue to remain fairly robust as well.

The net result of that is the dollars we talked about $30 million in Q4 and the $60 million drag into 2017, that's kind of what we said is kind of exactly where we still feel like we are.

Sheryl Skolnick

Okay. That’s very helpful. Thank you.


We'll take our next question from Gary Lieberman, Wells Fargo.

Gary Lieberman

Good morning. Thanks for taking the question. Just going back maybe to around the labor you mentioned labor issues on the therapy side of the business, could you talk a bit more about that?

Ben Breier

I think I'm not sure I did say that Gary, I think on the therapy side actually we've seen wage rates and capacity be pretty good. There's been a pretty good supply of therapists across the country, our turnover has remained pretty steady in our RehabCare business, I really think it's much more of an RN issue than is therapy issue for us.

Now seven or eight years ago we had a big therapy problem where you couldn’t find a therapist but today that actually seems like it's remain relatively in check. So I think what we’re really talking about is primarily an RN issue particularly in the hospital side of our business.

Gary Lieberman

Okay. And then so maybe just to follow-up there, you are certainly not the only facilities company to see pressure on labor. Could you - I guess talk a little bit more about how you think you're going to be able to make progress in a macro environment that's still going to probably be pretty tough in the labor front.

Ben Breier

Yes, look I think it has to be multiple pronged approach and it is not enough just to say, we’re going to try and recruit better and try and retain better. I mean we’re going to do all those things and we are - we've got a host of initiatives as you might imagine in regards to trying to make sure that once our team may comes here, joins Kindred that they want to stay in, they want to continue to be productive for many years to go. I mean there is no doubt reducing turnover to any degree. Certainly it helps you with your labor costs.

But I sort of agree with your premise Gary, I think labor in this unemployment environment with the aging population of nurses is going to be something that we’re going to continue to fight for the next couple of quarters. And so on that front, I've asked Kent Wallace, our Chief Operating Officer and many of others of our of our leadership around our Company, we have to continue to be very vigilant on the broader operating expense and an enterprise efficiency capabilities that we have around here. We have proven time and time again at Kindred that when we have to tighten our belts and when we have to find more areas to reduce costs and to optimize our sort of portfolio strategy, that we've been pretty good about going to do that.

So yes, we're going to be working hard on return over - on turn over, we're working hard on retention, we want to hire more people and get people in quicker, we want to stop quick people who leave us after 30 or 60 days.

But look there's no doubt we are incredibly focused around here about reducing broader OpEx both at the support center and at the building level sort of an non-clinical hands on patient way. And we'll talk more about that I'm sure after the next quarter but that we have a very focused initiative right here on trying to take more cost out to get it past than meet some of the labor pressures that I would expect will exist into 2017.

Gary Lieberman

Thanks. And maybe I just follow-up on the home health business. What you're seeing there, are you seeing any acceleration and consolidation with the continued pressure that the industry is feeling and maybe just proportionately on some of the smaller guys?

Ben Breier

Yes, I think not as much as I would have maybe thought a year ago, and I think it continues to be because price expectations and multiples I think for existing businesses continue to be very robust and I think most of us as buyers are trying to be pretty careful about what we think we can do with the business whether we can improve it not, and unless it really needs a specific geographic need.

I think buyers - larger buyers, some of the larger public companies like us have been have been pre-selective, if you go back and look at the capital we deploy Gary in 2016, we put a lot of capital work and we've put $75 million or $80 million to work in the home health space but primarily we bought licenses in [CON] [ph] markets where we thought we could grow our existing business, we bought as investors recall the state business from the state of South Carolina and the state of Arkansas businesses that were not running particularly well but that we thought we could do a lot with.

And I think we'll continue to look for opportunities in that regard in 2017. I would agree with your premise that the regulatory environment continues to become more and more complex. It makes sense to me that we that we will continue to see more consolidation but I haven't really seen it as fast as I said - what I might have thought in 2016 but we will see how 2017 plays out. We'll be responsive to opportunities as we typically are and well speak for us.

Gary Lieberman

Great, thanks a lot.


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

Frank Morgan

Good morning. Couple of random questions, I think you mentioned 89% of your revenue and your LTAC business was compliant. Do you have that same number on a census basis or on a volume-basis what percentage of your volume was compliant.

Stephen Farber

I don't, not in front of me Frank, we could probably get that for you offline. We were pretty focused on our revenue complaint numbers that's really kind of what drives everything around here so I'm sure we could find that for you offline.

Frank Morgan

Okay, I'll follow. And then I think in earlier call from last week there was mention of a potential change in or at least looking at a new home healthcare update to a group model or update of the case mix system. Just curious if you have any thoughts on that and then may be preparation for pre client review.

Ben Breier

Yes, sure I’ll tackle both of those Frank. First on the home health group, we are obviously watching that discussion very closely for those that are not are not familiar with it. The [Grouper] [ph] discussion in home health is the study that was commissioned by CMS really to look at redesigning the home health payment system much as CMS have looked at the nursing center reimbursement system and others over the last couple of years.

They claim that as they look at it, they're looking on it - they're looking at it in what would be a budget neutral way but essentially when you look at what came out of the study, the study would essentially suggest that the idea of changing sort of from a 60 day to a 30 day episode which you can imagine would be a major change in proposal to the industry.

There is also a proposal in it you know round less emphasis on the services around the provision of therapy obviously as big therapy providers for those of us to take a higher acute patient that’s some concern. So, look it’s out there, it's sort of a white paper I think is the way I would describe it and I think typically the way we respond to these kind of things Frank is that we're in active discussion. I turn up to a way in too much about my feelings on it.

I would just say this, I think that it's really just a proposal, it had a lot of work to go, I don't think there is much oxygen in the room to see anything happens this year from a legislative or from a regulatory perspective CMS on this front, our associations are active and involves and we're having a lots of good discussion to CMS about any of those proposed changes in the future. So I think on that front we’ll just keep letting that one play out.

On pre-claim review, that's one that obviously is much more near and due to our heart because as we all know on April 1, subject to some potential changes coming out of secretary prices office here before April 1 which we're still hopeful will get pre-claim review goes into effect in the state of Florida which is - as we all know one of our biggest stakes and biggest piece of the business.

Look I've said this to the previous CMS administrator and we said this publicly I think pre-claim review in its current state is a flawed policy. I think that in Illinois it clearly turned out to be a fairly tough regulation to follow. It added in my opinion a lot of unproductive time to people who in my view would be better served putting their hands on, on your loved ones and my loved one and taking care of patient needs versus filling out paperwork which is really I think what pre-claim review has.

The intermediaries are clearly having a hard time figuring out how to create real linkages between our electronic medical record systems and what they're doing in terms of bill pay and so there is a lot of concern over it but on the other hand if it's coming on April 1, we have to be prepared to deal with it. Our folks have been working extremely hard to be prepared to deal with it.

We think that there may be some implication around productivity in the state of Florida if it in fact comes to pass but we continue to be hopeful that the conversations we're having in DC are continuing to enlighten regulators and policymakers that this is bad policy and we're hopeful that a change still is possible in the offing before April 1 will see.

Frank Morgan

One final question and then I’ll hop. You mentioned the Genesis collaboration again in your press release yesterday, maybe just anymore color there and how you see that over the long haul. Thank you.

Ben Breier

Yes, thank you Frank. We'll share, look we are very pleased with that announcement. I think it's a really important strategic moment for our company, and I reflect investors back when we made the announcement to exit the skill nursing facility in total, a lot of investors and even some analyst from the sell side have been quick to ask into right. Well does that mean your integrated care continue to care strategy is not what you think it is anymore. And what we said was, was no, not at all.

Look we just have never had the appropriate and necessary amount of skilled nursing coverage in the 20 or 25 largest MSAs that we wanted to provide skilled nursing center care in our continue to care markets. And we were faced with a clear assessment of, do we double down on the nursing center business, or do we exit entirely and focus on partnership.

And our partnership with Genesis suggest that. We think they are one of the finest operators of skilled nursing facility business in the country. They are going to be very helpful to us with this clinical collaboration in many markets we serve. As I mentioned in my prepared remarks, we have lot of RehabCare customers who we think we will bring into the network, and there’s a lot of other good regional and national providers that we are on active discussions with as well.

We have said for a long time that we believe we can run these integrated care, continue to care markets without actually having to own the nursing center operation and assets and this clinical collaboration with Genesis is really that first example. Remember, Genesis also no longer has any home health or hospice business and we hope that we can become a provider for them there.

And we think that as size continue to be drawn, and people keep looking for more collaborative opportunities that this is going to be kind of an industry leading measurement towards how we sort of collaborate with each other. So we are very pleased with it.

Frank Morgan

Thank you.


And we'll take our final question from Kevin Fischbeck of Bank of America.

Kevin Fischbeck

Thanks. I guess just wanted to go into - you made a comment about labor cost and that you’re expecting to make some progress on some - I guess maybe some part of the issue was national labor pressure. Some part of it was under your control and you expect to make progress on that. Is there any way to size how much of the labor pressure you feel like is under your control and what to think about progress through the year on that?

Ben Breier

Look I think that most of the controllable labor issues and cost size that we have was in the Kindred at Home division, and not all of it was controllable. I mean, there is clearly some wage pressure happening in the home health space. But I think a large portion of it was, I would put the quarter - if you think about kind of the pressure on a year-over-year basis, I would argue probably somewhere in the $7 million to $10 million range of labor pressures related to productivity that I expect we will make progress on moving forward in Q1 and beyond, maybe not as much in Q1, but certainly in Q2 and beyond. As this system issue sort of clear themselves out, and we get back to - and the [pay practice] [ph] issues that we have been dealing with, and we get back to a more normalized run rate.

So I think you can use that number as a fairly good starting point in the Kindred at Home business so that you can see their ability as they continue to maintain their topline, they are going to get back to where robust bottom line growth rate as they get some of those labor issues under control.

I think Kevin on the hospital side, it’s a little bit more tricky. I think that those sort of longer term nursing center shortage issues are going to sustain themselves for a period of time. And so on that front, we are really working hard on that business to continue to really try and be as efficient as we can with our above the building resources that we have and Pete Kalmey who runs that business and his team are doing a terrific job, trying to take other costs out because I think, as I've said, I think quite frankly we'll continue to see those labor pressures in that business probably for the next couple of quarters. Does that help?

Kevin Fischbeck

Yes, that does. And I guess you mentioned that you're going to end the year on a stronger run rate entering 2018 then you ended 2016 entering 2017. Is it LTAC mitigation strategy in this labor issue? I guess maybe that's an nursing business, is there anything else that you'd say supports that ramp through the year?

Ben Breier

Well, I think primarily the LTAC issue, Kevin. I mean, you really, in Q4 of 2017, as I said in my earlier comments I think to a question Sheryl asked, you really have your first quarter where you're going to have a market basket increase for the first time in a long time, and where you’re going to have a normalized comp on a year-over-year basis.

And with all the work Kevin that we're doing around finding replacement patients, post intensive care patients in our LTAC business, what we think we have already accomplished in Q4, as you get back into that seasonably stronger Q4 with a good apples-to-apples comp, with a market basket and with - hopefully your home health business now on track in terms of its own labor rates with the IRF business continuing to grow at the pace that it's growing at.

I think you can kind of add it all up. It's just sort of lines itself up that you’re going to see pretty good momentum in Q4 of this year.

Kevin Fischbeck

Okay. And then last question, for 2018 what is the guidance assume as you mentioned you have 4, 4.5 months of the criteria in 2018. What is the guidance assume as far as pressure from that?

Stephen Farber

Well there is the potential for impact in Q4 of 2018. We have - I'm not going to get into the specifics Kevin about because we’re not going to guide that specifically. I will tell you we have included some effect on the second phase of criteria in Q4 of 2018 and so there is some degradation in that business in Q4, if that's what you’re asking about.

But as I said look we're pretty hopeful that as we move to the next seven quarters, we get to a point in Q4 of 2018 where we can make a real rational decision on whether or not it makes sense to keep taking those site-neutral patients. And so my answer is there is some - there's some diminishment of expectations in Q4 there next year but we think it's coming off a much smaller base. You know instead of coming off in a 11% site-neutral base, it's probably going to come off a 3% to 4% or 5% site-neutral base. So you know the drop-off is much, much less and that sort of how we built that into the guidance.

Kevin Fischbeck

Okay, thanks.


I’d like to turn it back to Ben Breier for closing remarks.

Ben Breier

Okay. We appreciate all of the activity and interest in the Company. We know it's been a busy quarter and a busy year but thank you everyone for your interest and we'll look forward to talking to you next quarter. Thank you all.


That concludes today's conference. We thank you for your participation. You may now disconnect.

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