UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

(Mark One)

☑	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2017

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-14057

KINDRED HEALTHCARE, INC.

(Exact name of registrant as specified in its charter)

Delaware		61-1323993
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)
680 South Fourth Street Louisville, Kentucky		40202-2412
(Address of principal executive offices)		(Zip Code)

(502) 596-7300

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class		Name of Each Exchange on which Registered
Common Stock, par value $0.25 per share		New York Stock Exchange

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☑ No ☐

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☑

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☑ No ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Annual Report on Form 10-K or any amendment of this Annual Report on Form 10-K. ☑

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☑ Accelerated filer ☐ Non-accelerated filer ☐ Smaller reporting company ☐ Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☑

The aggregate market value of the shares of the registrant held by non-affiliates of the registrant, based on the closing price of such stock on the New York Stock Exchange on June 30, 2017, was approximately $974,300,000. For purposes of the foregoing calculation only, all directors and executive officers of the registrant have been deemed affiliates.

As of January 31, 2018, there were 91,413,775 shares of the registrant’s common stock, $0.25 par value, outstanding.

TABLE OF CONTENTS

		Page
PART I
Item 1.	Business	5
Item 1A.	Risk Factors	37
Item 1B.	Unresolved Staff Comments	56
Item 2.	Properties	56
Item 3.	Legal Proceedings	56
Item 4.	Mine Safety Disclosures	57
PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	58
Item 6.	Selected Financial Data	60
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	62
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	90
Item 8.	Financial Statements and Supplementary Data	91
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	91
Item 9A.	Controls and Procedures	91
Item 9B.	Other Information	91
PART III
Item 10.	Directors, Executive Officers and Corporate Governance	92
Item 11.	Executive Compensation	93
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	93
Item 13.	Certain Relationships and Related Transactions, and Director Independence	93
Item 14.	Principal Accounting Fees and Services	93
PART IV
Item 15.	Exhibits and Financial Statement Schedules	94
Item 16.	Form 10-K Summary	94

All references in this Annual Report on Form 10-K to “Kindred,” “Company,” “we,” “us,” or “our” mean Kindred Healthcare, Inc. and, unless the context otherwise requires, our consolidated subsidiaries.

CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K and the documents we incorporate by reference herein include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements include, but are not limited to, all statements regarding our ability to complete the Merger (as defined below) and the expected timing of such Merger, as well as our ability to realize the anticipated benefits from the Merger, all statements regarding our expected future financial position, results of operations, cash flows, dividends, financing plans, business strategy, budgets, capital expenditures, competitive positions, growth opportunities, plans and objectives of management, government investigations, regulatory matters, and statements containing words such as “anticipate,” “approximate,” “believe,” “plan,” “estimate,” “expect,” “project,” “could,” “would,” “should,” “will,” “intend,” “hope,” “may,” “potential,” “upside,” “seek,” “continue,” and other similar expressions. Statements in this report concerning our business outlook or future economic performance, anticipated profitability, revenues, expenses, dividends or other financial items, and product or services-line growth, and expected outcome of government investigations and other regulatory matters, together with other statements that are not historical facts, are forward-looking statements that are estimates reflecting our best judgment based upon currently available information.

Such forward-looking statements are inherently uncertain, and stockholders and other potential investors must recognize that actual results may differ materially from our expectations as a result of a variety of factors, including, without limitation, those discussed below. Such forward-looking statements are based upon management’s current expectations and include known and unknown risks, uncertainties, and other factors, many of which we are unable to predict or control, that may cause our actual results, performance, or plans to differ materially from any future results, performance, or plans expressed or implied by such forward-looking statements. Risks and uncertainties related to the Merger include, but are not limited to, the occurrence of any event, change or other circumstance that could give rise to the termination of the Merger Agreement (as defined below); the failure of the parties to satisfy conditions to completion of the Merger, including the failure of our stockholders to approve the Merger or the failure of the parties to obtain required regulatory approvals; the risk that regulatory or other approvals are delayed or are subject to terms and conditions that are not anticipated; changes in our business or in our or our businesses’ operating prospects; changes in health care and other laws and regulations; the impact of the announcement of, or failure to complete, the Merger on our relationships with employees, customers, vendors and other business partners; and litigation related to the Merger. These statements involve risks, uncertainties, and other factors discussed below and detailed from time to time in our filings with the Securities and Exchange Commission (“SEC”).

In addition to the factors set forth above, other factors that may affect our plans, results, or stock price include, without limitation:

•

the impact of healthcare reform, which will initiate significant changes to the United States healthcare system, including potential material changes to the delivery of healthcare services and the reimbursement paid for such services by the government or other third party payors, including reforms resulting from the Patient Protection and Affordable Care Act and the Healthcare Education and Reconciliation Act (collectively, the “ACA”) or future deficit reduction measures adopted at the federal or state level. Healthcare reform is impacting each of our businesses in some manner. Potential future efforts in the U.S. Congress to repeal, amend, modify, or retract funding for various aspects of the ACA create additional uncertainty about the ultimate impact of the ACA on us and the healthcare industry. Due to the substantial regulatory changes that will need to be implemented by the Centers for Medicare and Medicaid Services (“CMS”) and others, and the numerous processes required to implement these reforms, we cannot predict which healthcare initiatives will be implemented at the federal or state level, the timing of any such reforms, or the effect such reforms or any other future legislation or regulation will have on our business, financial position, results of operations, and liquidity,

•

our ability to adjust to the new patient criteria for long-term acute care (“LTAC”) hospitals under the Pathway for SGR Reform Act of 2013 (the “SGR Reform Act”), which reduces the population of patients eligible for reimbursement under the Medicare prospective payment system for LTAC hospitals (“LTAC PPS”) and changes the basis upon which we are paid for other patients,

•

changes in the reimbursement rates or the methods or timing of payment from third party payors, including commercial payors and the Medicare and Medicaid programs, changes arising from and related to LTAC PPS, including potential changes in the Medicare payment rules, and changes in Medicare and Medicaid reimbursement for our home health and hospice operations, transitional care (“TC”) hospitals, and inpatient rehabilitation hospitals (“IRFs”),

•

our significant level of indebtedness, including our ability to meet our substantial debt service requirements, and its impact on our funding costs, operating flexibility, and ability to fund ongoing operations, development capital expenditures, or other strategic acquisitions with additional borrowings,

•

our ability to comply with the terms of our corporate integrity agreement with the United States Department of Health and Human Services (“HHS”) Office of Inspector General (“OIG”),

•

our ability to complete the Merger, and realize the anticipated benefits from the Merger,

•

the diversion of management and employee time, the use of resources and the incurrence of significant costs in seeking to complete the Merger,

•

the effects of additional legislative changes and government regulations, interpretation of regulations, and changes in the nature and enforcement of regulations governing the healthcare industry,

•

the ability of our hospitals and other healthcare services to adjust to medical necessity reviews,

•

our ability to successfully pursue our development activities, including through acquisitions, and successfully integrate new operations, including the realization of anticipated revenues, economies of scale, cost savings, and productivity gains associated with such operations, as and when planned, including the potential impact of unanticipated issues, expenses, and liabilities associated with those activities,

•

our obligations under various laws to self-report suspected violations of law to various government agencies (including any associated obligation to refund overpayments to government payors, fines, and other sanctions),

•

the failure of our facilities and other operations to meet applicable licensure and certification requirements,

•

the consolidation or cost containment efforts of managed care organizations, other third party payors, conveners, and referral sources,

•

our ability to control costs, particularly labor and employee benefit costs,

•

increased operating costs due to shortages in qualified nurses, therapists, and other healthcare personnel,

•

our ability to successfully reduce (by divestiture of operations or otherwise) our exposure to professional liability and other claims,

•

the costs of defending and insuring against alleged professional liability and other claims and investigations (including those related to pending investigations and whistleblower and wage and hour class action lawsuits against us) and our ability to predict the estimated costs and reserves related to such claims and investigations, including the impact of differences in actuarial assumptions and estimates compared to eventual outcomes,

•

our ability to comply with our rental and debt agreements, including payment of amounts owed thereunder and compliance with the covenants contained therein, including under our master lease agreement with Ventas, Inc. (“Ventas”),

•

our inability to maintain the security and functionality of our information systems, or to defend against or otherwise prevent a cybersecurity attack or breach,

•

the condition of the financial markets, including volatility and weakness in the equity, capital, and credit markets, which could limit the availability and terms of debt and equity financing sources to fund the requirements of our businesses, or which could negatively impact our investment portfolio,

•

national, regional, and industry-specific economic, financial, business, and political conditions, including their effect on the availability and cost of labor, credit, materials, and other services,

•

our ability to attract and retain key executives and other healthcare personnel,

•

our ability to successfully dispose of unprofitable facilities,

•

events or circumstances that could result in the impairment of an asset or other charges,

•

changes in United States generally accepted accounting principles (“GAAP”) or practices, and changes in tax accounting or tax laws (or authoritative interpretations relating to any of these matters), including a new lease accounting standard that will significantly increase balance sheet assets and liabilities on and after January 1, 2019, and

•

our ability to maintain an effective system of internal control over financial reporting.

Many of these factors are beyond our control. We caution investors that any forward-looking statements made by us are not guarantees of future performance. We disclaim 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.

PART I

Item 1. Business

GENERAL

We are a healthcare services company that through our subsidiaries operates a home health, hospice and community care business, TC hospitals, IRFs, and a contract rehabilitation services business across the United States. We are organized into three operating divisions: the Kindred at Home division, the hospital division, and the Kindred Rehabilitation Services division. At December 31, 2017, our (1) Kindred at Home division primarily provided home health, hospice, and community care services from 608 sites of service in 40 states, (2) hospital division operated 75 TC hospitals (certified as LTAC hospitals under the Medicare program) in 17 states, and (3) Kindred Rehabilitation Services division operated 19 IRFs and 99 hospital-based acute rehabilitation units (“ARUs”) (certified as IRFs), and provided rehabilitation services primarily in hospitals and long-term care settings in 45 states.

All financial and statistical information presented in this Annual Report on Form 10-K reflects the continuing operations of our businesses for all periods presented unless otherwise indicated.

Merger Agreement. On December 19, 2017, we announced that our Board of Directors (the “Board”) had approved a definitive agreement under which we will be acquired by a consortium of three companies: TPG Capital (“TPG”), Welsh, Carson, Anderson & Stowe (“WCAS”) and Humana Inc. (“Humana”). Subject to the terms and conditions of an Agreement and Plan of Merger (the “Merger Agreement”) among the Company, Kentucky Hospital Holdings, LLC (“HospitalCo Parent”), Kentucky Homecare Holdings, Inc. (“Parent”) and Kentucky Homecare Merger Sub, Inc. (“Merger Sub”), Merger Sub will be merged with and into Kindred (the “Merger”), with Kindred continuing as the surviving company in the Merger (the “Surviving Entity”).

At the effective time of the Merger, each share of our common stock, par value $0.25 per share (“Common Stock”) issued and outstanding immediately prior to the effective time of the Merger (other than shares held by Parent, HospitalCo Parent, Merger Sub or Kindred and their respective wholly owned subsidiaries (which will be cancelled) and shares that are owned by stockholders who have properly exercised and perfected a demand for appraisal rights under Delaware law), will be cancelled and converted into the right to receive $9.00 in cash, without interest (the “Merger Consideration”).

The Merger Agreement contains customary representations, warranties and covenants for a transaction of this nature. The Merger Agreement also contains customary covenants, including, among others, covenants (i) providing for us and our respective subsidiaries to conduct business in all material respects in the ordinary course and not to take certain actions without Merger Sub’s consent and (ii) for each of the parties to use reasonable best efforts to cause the transactions contemplated by the Merger Agreement to be consummated. Additionally, the Merger Agreement provides for customary pre-closing covenants, including covenants not to solicit proposals relating to alternative transactions or, subject to certain exceptions, enter into discussions concerning or provide information in connection with alternative transactions, covenants to call and hold a meeting of our stockholders and a covenant to recommend that our stockholders adopt the Merger Agreement, subject to certain exceptions to permit our directors to satisfy their applicable fiduciary duties.

Consummation of the Merger is subject to various conditions, including, among others, adoption of the Merger Agreement by the requisite vote of our stockholders, the receipt of certain licensure and regulatory approvals, the expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvement Act of 1976, as amended (this condition was satisfied on February 20, 2018), the consummation of the purchase of the two remaining skilled nursing facilities from Ventas and payment of corresponding expense reimbursements to Ventas (this condition was satisfied on December 21, 2017), the satisfaction of the closing conditions to the Separation Agreement (as defined below) and certain related entity conversions, the absence of any material adverse effect on each of us, our home health, hospice and community care business, and our TC hospitals, IRFs and contract rehabilitation services business, and certain other customary closing conditions.

The Merger Agreement also contains certain termination rights for us and Merger Sub (including if the Merger is not consummated by August 17, 2018 (the “End Date”)) and provides that upon termination of the Merger Agreement under specified circumstances, including, among others, following a change in recommendation of our Board or our termination of the Merger Agreement to enter into a written definitive agreement for a “superior proposal,” we will be required to pay Merger Sub a termination fee of $29 million and reimburse the documented out-of-pocket expenses of Parent, HospitalCo Parent and certain of their affiliates in connection with the Merger Agreement (the “Parent Expenses”) up to $10 million.

If the Merger Agreement is submitted to a vote of our stockholders and approval of the Merger Agreement is not obtained, we will be required to reimburse Merger Sub for the amount of the Parent Expenses, up to $7.5 million.

Parent will be required to pay us a reverse termination fee of $61.5 million, and to reimburse certain of our expenses, including the reasonable and documented out-of-pocket expenses we incurred in connection with the implementation of the Separation Transactions (as defined in the Separation Agreement), up to $13.5 million, in the event the Merger Agreement is terminated (i) by us, subject to certain limitations set forth in the Merger Agreement, if (A) there has been a breach of a representation, warranty or covenant of Parent or Merger Sub that would cause the related closing condition to be incapable of being satisfied or cured by the End Date or, if curable, is not cured by Parent or Merger Sub by the earlier of 30 days after receipt of written notice of such breach and the End Date, (B) the conditions to Parent, HospitalCo Parent and Merger Sub’s obligations to consummate the closing have been satisfied (other than those conditions that by their terms are to be satisfied at or immediately prior to the closing, provided that such conditions are then capable of being satisfied at the closing), we have irrevocably confirmed to Parent in writing that we are prepared and able to consummate the closing, and Parent and Merger Sub fail to consummate the Merger by the later of the date the closing should have occurred and three business days following the date of the notice from us described above, or (ii) by us or Parent if the Merger has not occurred by the End Date and at the time of termination all of the conditions to Parent, HospitalCo Parent and Merger Sub’s obligations to consummate the closing have been satisfied (other than those conditions that by their terms are to be satisfied by actions taken at the closing, provided that such conditions are then capable of being satisfied at the closing) other than those relating to obtaining specified licensure and regulatory approvals and/or there being any injunction or other order by a governmental entity charged with jurisdiction over the granting of such approvals.

In connection with the Merger Agreement, Parent and HospitalCo Parent have obtained equity and debt financing commitments for the transactions contemplated by the Merger Agreement and the Separation Agreement, the aggregate proceeds of which will be sufficient to consummate the transactions contemplated by the Merger Agreement and the Separation Agreement on the closing date, including the payment of any amounts required to be paid by Parent pursuant to the Merger Agreement on the closing date, the repayment of our existing indebtedness, and the payment of all fees and expenses reasonably expected to be incurred in connection therewith. Pursuant to equity commitment letters executed and delivered concurrently with the Merger Agreement, subject to the terms and conditions set forth therein, Humana, TPG, WCAS and Port-aux-Choix Private Investments Inc. (“PSP”), have committed to, severally but not jointly, capitalize Parent, and TPG, WCAS and PSP have committed, severally but not jointly, to capitalize HospitalCo Parent, with the aggregate amount of the equity financing. In addition, each of Humana, TPG, WCAS and PSP have provided us limited guarantees, guaranteeing Parent’s obligation to pay the reverse termination fee and certain other reimbursement obligations of the Parent and Merger Sub pursuant to the Merger Agreement.

Separation Agreement. Concurrently with the execution and delivery of the Merger Agreement, on December 19, 2017, Kindred, Parent, HospitalCo Parent, and Kentucky Hospital Merger Sub, Inc., entered into a Separation Agreement (the “Separation Agreement”), pursuant to which, promptly following the effective time of the Merger, the Surviving Entity will be separated from our home health, hospice and community care services business and acquired by HospitalCo Parent.

The Separation Agreement relates to, among other things (i) certain restructuring transactions that are to take place with respect to us and our subsidiaries, (ii) procedures concerning the transfer of certain assets and employees used or employed in our respective businesses and (iii) the allocation of costs and expenses related to the separation of the Surviving Entity from the Homecare Business (as defined in the Separation Agreement). The Separation Agreement requires, among other things, us to take certain actions and expend certain efforts prior to the closing of the Merger in preparation for such separation transactions.

Ventas Lease Amendment. Concurrently with the execution and delivery of the Merger Agreement, on December 19, 2017, we and Ventas entered into Amendment No. 2 (the “Ventas Lease Amendment”) to the Second Amended and Restated Master Lease Agreement No. 5 (the “Master Lease Agreement”) pursuant to which, among other things, (i) Ventas agreed that the transactions contemplated by the Merger Agreement and the Separation Agreement comply with the Master Lease Agreement, subject to the satisfaction of the remaining requirements in the Master Lease Agreement related thereto, including payment to Ventas of a transaction fee equal to 10% of annual base rent under the Master Lease Agreement upon closing of the transactions, (ii) we agreed to pay to Ventas an additional $5 million fee within one business day of the signing of the Merger Agreement in exchange for Ventas’ approval of and agreement not to challenge the transaction structure (this condition was satisfied on December 20, 2017), (iii) we agreed to complete the purchase of the two remaining skilled nursing facilities under the Master Lease Agreement and our former Second Amended and Restated Master Lease No. 2 from Ventas, and pay corresponding expense reimbursements to Ventas, on or before December 31, 2017 (this condition was satisfied on December 21, 2017), and (iv) we agreed to make certain minimum expenditures for the leased facilities remaining under the Master Lease Agreement going forward.

Skilled nursing facility business exit. On June 30, 2017, we entered into a definitive agreement with BM Eagle Holdings, LLC, a joint venture led by affiliates of BlueMountain Capital Management, LLC (“BlueMountain”), under which we agreed to sell our skilled nursing facility business for $700 million in cash (the “SNF Divestiture”). The SNF Divestiture included 89 nursing centers with 11,308 licensed beds and seven assisted living facilities with 380 licensed beds in 18 states. During 2017, we completed the sale of 81 skilled nursing facilities and five assisted living facilities on various dates for total sales proceeds of approximately $664 million. The completion of the remainder of the sales is subject to customary conditions to closing, including the receipt of all licensure, regulatory and other approvals.

Thirty-six of these skilled nursing facilities were previously leased from Ventas (the “Ventas Properties”). We had an option to acquire the real estate of the Ventas Properties for aggregate consideration of $700 million, which we exercised as we closed on the sale of the Ventas Properties in connection with the SNF Divestiture during 2017. On each respective closing date, we paid Ventas the allocable portion of the $700 million purchase price for the Ventas Properties and Ventas conveyed the real estate for the applicable Ventas Property to BlueMountain or its designee. We paid Ventas approximately $647 million for 34 of the Ventas Properties in connection with closings that occurred during 2017. Additionally, as required under the Merger Agreement, we paid Ventas approximately $53 million to purchase the two remaining Ventas Properties that had yet to be sold in the SNF Divestiture at the end of 2017.

In accordance with authoritative guidance for assets held for sale and discontinued operations accounting, the skilled nursing facility business is reported as assets held for sale and was moved to discontinued operations for all periods presented.

Gentiva Merger. On October 9, 2014, we entered into an Agreement and Plan of Merger (the “Gentiva Merger Agreement”) with Gentiva Health Services, Inc. (“Gentiva”), providing for our acquisition of Gentiva. On February 2, 2015, we consummated the acquisition with one of our subsidiaries merging with and into Gentiva (the “Gentiva Merger”), with Gentiva continuing as the surviving company and our wholly owned subsidiary.

At the effective time of the Gentiva Merger, each share of common stock, par value $0.10 per share, of Gentiva (“Gentiva Common Stock”) issued and outstanding immediately prior to the effective time of the Gentiva Merger (other than shares held by us, Gentiva, and any wholly owned subsidiaries (which were cancelled) and shares owned by stockholders who properly exercised and perfected a demand for appraisal rights under Delaware law), including each deferred share unit, were converted into the right to receive (i) $14.50 in cash (the “Gentiva Cash Consideration”), without interest, and (ii) 0.257 of a share of our Common Stock (the “Gentiva Stock Consideration” and, together with the Gentiva Cash Consideration, the “Gentiva Merger Consideration”).

Centerre Acquisition. On November 11, 2014, we entered into an agreement to acquire Centerre Healthcare Corporation (“Centerre”), a company dedicated to operating IRFs (the “Centerre Acquisition”). On January 1, 2015, we completed the Centerre Acquisition for a purchase price of approximately $195 million in cash. At the time of the Centerre Acquisition, Centerre operated 11 IRFs with 614 beds in partnership with some of the nation’s leading acute care hospital systems. Centerre had two additional hospitals with a total of 90 beds under construction that were opened in 2015, and a pipeline of additional potential hospitals in various stages of development.

Spin-off from Ventas. On May 1, 1998, Ventas completed the spin-off of its healthcare operations to its stockholders through the distribution of our former common stock. Ventas retained ownership of substantially all of its real property and leases a portion of such real property to us. In anticipation of the spin-off from Ventas we were incorporated on March 27, 1998 as a Delaware corporation.

Discontinued Operations

We have completed several strategic divestitures to improve our future operating results. For accounting purposes, the operating results of these businesses and the gains, losses or impairments associated with these transactions have been classified as discontinued operations in the accompanying consolidated statement of operations for all periods presented in accordance with the authoritative guidance in effect through December 31, 2014. Effective January 1, 2015, the authoritative guidance modified the requirements for reporting discontinued operations. A disposal is now required to be reported in discontinued operations only if the disposal represents a strategic shift that has (or will have) a major effect on our operations and financial results. In connection with the SNF Divestiture, the results of operations of the skilled nursing facility business, which previously were reported in the nursing center division, and the losses or impairments associated with the SNF Divestiture, have been classified as discontinued operations for all periods presented. In addition, direct overhead and the profits from applicable RehabCare contracts servicing our skilled nursing facility business that were not retained by new operators were moved to discontinued operations for all periods presented. We have reclassified certain retained businesses and expenses previously reported in the nursing center division to other business segments, including hospital-based sub-acute units and a skilled nursing facility to the hospital division and a small therapy business to the Kindred Hospital Rehabilitation Services operating segment for all periods presented. See notes 6 and 7 of the notes to consolidated financial statements.

HEALTHCARE OPERATIONS

We are organized into three operating divisions: the Kindred at Home division, the hospital division, and the Kindred Rehabilitation Services division.

The Kindred at Home division primarily provides home health, hospice, and community care services to patients in a variety of settings, including their homes, nursing centers, and other residential settings. The hospital division operates TC hospitals. The

Kindred Rehabilitation Services division operates IRFs and ARUs and provides rehabilitation services primarily in hospitals and long-term care settings.

Based upon the authoritative guidance for business segments, our operating divisions represent five reportable operating segments, including (1) home health services, (2) hospice services, (3) hospitals, (4) Kindred Hospital Rehabilitation Services, and (5) RehabCare. The home health services and hospice services operating segments are contained within the Kindred at Home division while the Kindred Hospital Rehabilitation Services and RehabCare operating segments are both contained within the Kindred Rehabilitation Services division.

KINDRED AT HOME DIVISION

Our Kindred at Home division primarily provides home health, hospice, and community care services for patients in a variety of settings, including their homes, nursing centers, and other residential settings. Kindred at Home provides services from 608 sites of service in 40 states, making us one of the largest and geographically diversified home health and hospice companies in the United States as of December 31, 2017.

Our home health operations offer medical care and other services for patients in their homes or other residential settings. Experienced nurses, therapists, and home health aides work with the patient and his or her family members to maximize the patient’s ability to handle a wide variety of daily activities and to educate the patient regarding medications and management of their medical conditions. Our services include nursing, physical, occupational and speech therapies, and medical social work.

Our hospice operations provide family-oriented care designed to meet the spiritual, emotional, and physical needs of terminally ill patients and their families. We provide hospice services in the home or other settings such as nursing centers, assisted living facilities, hospitals, and inpatient hospice units. Working in conjunction with a patient’s attending physician and/or the hospice medical director, our team of hospice professionals develops a plan of care designed to support the patient’s individual needs, which may include pain and symptom management, emotional and spiritual counseling, homemaking, and dietary services.

Our community care services include personal care (bathing and grooming), meal preparation, companionship, light housekeeping, shopping, respite care, and transportation.

In key markets, we also provide physician services focused on delivering primary and urgent care for patients in home-based settings such as assisted living facilities, independent living facilities, and patients’ homes, as well as care-transition managers to follow patients with specific diagnoses and/or risk factors through the entire care continuum.

Selected Kindred at Home Division Operating Data

The following table sets forth certain operating and financial data for the Kindred at Home division (dollars in thousands, except statistics):

	Year ended December 31,
	2017		2016		2015
Kindred at Home:
Home health:
Revenues (1)	$	1,822,357	$	1,762,622	$	1,578,500
Segment adjusted operating income (1)	$	276,218	$	279,531	$	256,173
Sites of service (at end of period)		375		390		373
Episodic revenues	$	1,314,175	$	1,313,974	$	1,194,536
Total admissions		358,908		349,689		331,135
Total episodic admissions		278,575		278,358		249,805
Medicare episodic admissions		234,580		242,104		218,850
Total episodes		451,442		451,585		406,313
Episodes per admission		1.62		1.62		1.63
Revenue per episode	$	2,911	$	2,910	$	2,940
Assets at end of period (1)	$	1,540,010	$	1,540,370	$	1,435,176
Routine capital expenditures (1)	$	4,323	$	6,401	$	4,201
Hospice:
Revenues	$	743,443	$	736,803	$	656,527
Segment adjusted operating income	$	129,273	$	116,326	$	109,120
Sites of service (at end of period)		178		183		175
Admissions		50,720		51,959		45,657
Average length of stay		96		95		97
Patient days		4,891,348		4,945,769		4,373,044
Average daily census		13,401		13,513		11,981
Revenue per patient day	$	152	$	149	$	150
Assets at end of period	$	913,230	$	929,774	$	922,710
Routine capital expenditures	$	2,379	$	2,342	$	1,215

(1)	Includes community care and home-based physician services.

The term “segment adjusted operating income” is defined as earnings before interest, income taxes, depreciation, amortization, and total rent reported for each of our operating segments, excluding litigation contingency expense, impairment charges, restructuring charges, transaction costs, and the allocation of support center overhead. A reconciliation of “segment adjusted operating income” to our consolidated results of operations is included in note 10 of the notes to consolidated financial statements. The term “episodes” refers to healthcare services provided to a patient over a base period of 60 days. “Average length of stay” is computed by dividing each facility’s patient days by the number of admissions in the respective period. “Patient days” refers to the total number of days of patient care provided for the periods indicated. “Average daily census” is computed by dividing each facility’s patient days by the number of calendar days in the respective period. Routine capital expenditures include expenditures at existing facilities that generally do not result in the expansion of services.

Sources of Kindred at Home Division Revenues

Kindred at Home division revenues are derived principally from the Medicare and Medicaid programs, private insurers, and private pay patients. Medicare reimburses both home health and hospice services under prospective payment systems, which are subject to numerous qualifications, standards, and adjustments. Medicaid reimburses home health and hospice service providers using a number of state-specific systems. We often negotiate contract rates of reimbursement with private insurers.

The following table sets forth the approximate percentages of home health (including community care and home-based physician services) revenues derived from the payor sources indicated:

Year ended December 31,	Medicare			Medicaid			Medicare Advantage			Commercial and other
2017		63.6	%		15.2	%		9.5	%		11.7	%
2016		66.5			15.7			8.5			9.3
2015		68.0			15.1			8.0			8.9

The following table sets forth the approximate percentages of hospice revenues derived from the payor sources indicated:

Year ended December 31,	Medicare			Medicaid			Commercial and other
2017		93.8	%		3.6	%		2.6	%
2016		93.7			3.4			2.9
2015		94.1			3.6			2.3

For the year ended December 31, 2017, revenues of the Kindred at Home division totaled approximately $2.6 billion or 42% of our total revenues (before eliminations). For more information regarding the reimbursement of our Kindred at Home division, see “—Governmental Regulation—Kindred at Home Division—Overview of Kindred at Home Division Reimbursement.”

Kindred at Home Division Management and Operations

At December 31, 2017, the Kindred at Home division was headed by a president, overseeing a chief operating, and clinical, financial, and administrative officers, and a senior vice president of sales. A president for each of the five geographic regions and a sixth president over the community care operations, report to the chief operating officer of the division. In addition, the Kindred at Home division has division-level sales, clinical services, finance, and operations executives.

We provide our Kindred at Home division with centralized administrative support in the areas of information systems, regulatory compliance, reimbursement guidance, licensing support as well as legal, finance, accounting, purchasing, marketing, and human resources management. The centralization of these services improves operating efficiencies, promotes standardization of processes, and enables our healthcare professionals to focus on delivering quality care to our patients.

Kindred at Home Division Competition

Our Kindred at Home division operates in a highly competitive and significantly fragmented industry. Our competitors include large providers of home health and hospice services, both for-profit and nonprofit and smaller independent local operators. There often are no significant barriers to entry in many of the markets in which our Kindred at Home division operates and new providers of home health and/or hospice services may enter into our current and future markets. Many of our competitors may have greater financial and other resources than we do.

Although there is limited, if any, price competition with respect to Medicare and Medicaid patients (since revenues received for services provided to these patients are based generally on fixed rates), there is substantial price competition for private payment patients. We believe our Kindred at Home division competes based upon its reputation for providing quality services, charging competitive prices, and being consistently responsive to the needs of our patients and their families and physicians.

HOSPITAL DIVISION

Our hospital division provides long-term acute care services to post-intensive care and medically complex patients through the operation of a national network of 75 TC hospitals with 5,553 licensed beds in 17 states as of December 31, 2017. We operate one of the largest networks of TC hospitals in the United States based upon revenues. Our TC hospitals are certified as LTAC hospitals under the Medicare program.

As a result of our commitment to the hospital business, we have developed a comprehensive program of care for post-intensive care and medically complex patients that allows us to deliver high-quality care in a cost-effective manner. A number of our hospitals also provide skilled nursing, sub-acute, and outpatient services. Outpatient services may include diagnostic services, outpatient wound care, rehabilitation therapy, CT scanning, one-day surgery, and laboratory tests.

In our TC hospitals, we treat post-intensive care and medically complex patients, including the critically ill, suffering from multiple organ system failures, most commonly of the cardiovascular, pulmonary, kidney, gastro-intestinal, and cutaneous (skin) systems. In particular, we have a core competency in treating patients with cardio-pulmonary disorders, skin and wound conditions, and life-threatening infections. Prior to being admitted to one of our TC hospitals, many of our patients have undergone a major surgical procedure or developed a neurological disorder following head and spinal cord injury, cerebrovascular incident, or metabolic instability. Our expertise lies in the ability to simultaneously deliver comprehensive and coordinated medical interventions directed at all affected organ systems, while maintaining a patient-centered, integrated care plan. Post-intensive care and medically complex patients are characteristically dependent on technology for continued life support, including mechanical ventilation, total parenteral nutrition, respiratory or cardiac monitors, and kidney dialysis machines.

Our TC hospital patients generally have conditions that require a high level of monitoring and specialized care, yet may not need all of the services of a traditional intensive care unit. These patients are not clinically appropriate for admission to other post-

acute settings because their severe medical conditions are periodically or chronically unstable. By providing a range of services required for the care of post-intensive care and medically complex patients, we believe that our TC hospitals provide our patients with high quality, cost-effective care.

Our TC hospitals employ a comprehensive program of care for their patients that draws upon the talents of interdisciplinary teams, including physician specialists. The teams evaluate patients upon admission to determine treatment programs. Our hospital division has developed specialized treatment programs focused on the needs of post-intensive care and medically complex patients. In addition to traditional medical services, our TC hospital patients receive individualized treatment plans, which may include rehabilitation, skin integrity management, and clinical pharmacology services. Where appropriate, the treatment programs may involve several disciplines, such as pulmonary medicine, infectious disease, and physical medicine.

Selected Hospital Division Operating Data

The following table sets forth certain operating and financial data for the hospital division (dollars in thousands, except statistics):

	Year ended December 31,
	2017		2016		2015
Revenues	$	2,106,375	$	2,434,311	$	2,483,376
Segment adjusted operating income	$	337,487	$	441,644	$	486,213
Hospitals in operation at end of period (1)		75		82		95
Licensed beds at end of period (1)		5,553		6,107		7,094
Admissions (1)		42,202		49,358		50,629
Patient days (1)		1,217,914		1,430,717		1,478,204
Average length of stay (1)		28.9		29.0		29.2
Revenues per admission (1)	$	48,395	$	48,281	$	48,209
Revenues per patient day (1)	$	1,677	$	1,666	$	1,651
Medicare case mix index (discharged patients only) (1)		1.178		1.169		1.162
Average daily census (1)		3,337		3,909		4,050
Occupancy % (1)		63.3		65.1		64.9
Assets at end of period	$	990,011	$	1,232,541	$	1,648,283
Routine capital expenditures	$	18,304	$	23,858	$	28,935

(1)Excludes sub-acute units and a skilled nursing facility.

The term “licensed beds” refers to the maximum number of beds permitted in a facility under its license regardless of whether the beds are actually available for patient care. “Medicare case mix index” is the sum of the individual patient diagnostic related group weights for the period divided by the sum of the discharges for the same period. “Occupancy %” is computed by dividing average daily census by the number of operational licensed beds, adjusted for the length of time each facility was in operation during each respective period. Routine capital expenditures include expenditures at existing facilities that generally do not result in the expansion of services.

Sources of Hospital Revenues

The hospital division receives payment for its services from third party payors, including government reimbursement programs such as Medicare and Medicaid, and nongovernment sources such as Medicare Advantage, Medicaid Managed, commercial insurance companies, health maintenance organizations, preferred provider organizations, and contracted providers. Patients covered by nongovernment payors generally are more profitable to the hospital division than those covered by the Medicare and Medicaid programs. The following table sets forth the approximate percentages of our hospital division revenues, admissions, and patient days derived from the payor sources indicated:

	Year ended December 31,
	2017		2016		2015
Revenue mix %:
Medicare		50.6		55.1		56.2
Medicaid		5.0		4.7		5.7
Medicare Advantage		12.5		11.6		11.4
Medicaid Managed		9.4		6.6		5.5
Commercial insurance and other		22.5		22.0		21.2

Admissions mix % (1):
Medicare		62.1		65.6		65.6
Medicaid		3.3		3.1		4.5
Medicare Advantage		11.9		10.9		10.7
Medicaid Managed		8.3		6.4		5.1
Commercial insurance and other		14.4		14.0		14.1

Patient days mix % (1):
Medicare		55.0		58.5		58.7
Medicaid		4.3		4.8		6.7
Medicare Advantage		13.2		12.2		11.8
Medicaid Managed		10.6		7.7		6.5
Commercial insurance and other		16.9		16.8		16.3

(1)

Excludes sub-acute units and a skilled nursing facility.

For the year ended December 31, 2017, revenues of the hospital division totaled approximately $2.1 billion or 34% of our total revenues (before eliminations). For more information regarding the reimbursement for our hospital services, see “—Governmental Regulation—Hospital Division—Overview of Hospital Division Reimbursement.”

Hospital Facilities

The following table lists by state the number of TC hospitals and licensed beds we operated as of December 31, 2017:

			Number of facilities
State	Licensed beds		Owned by us		Leased from Ventas (2)		Leased from other parties		Total
California		1,028		4		5		4		13
Colorado		133		-		1		2		3
Florida (1)		742		3		6		1		10
Georgia (1)		45		-		-		1		1
Illinois (1)		575		-		4		2		6
Indiana		206		-		1		3		4
Kentucky (1)		414		-		1		1		2
Missouri (1)		133		-		1		2		3
Nevada		254		1		1		1		3
New Jersey (1)		117		-		-		3		3
New Mexico		61		-		1		-		1
North Carolina (1)		124		-		1		-		1
Ohio		93		1		-		1		2
Pennsylvania		167		1		1		1		3
Tennessee (1)		49		-		1		-		1
Texas		1,332		2		5		10		17
Washington (1)		80		2		-		-		2
Totals		5,553		14		29		32		75

(1)	These states have certificate of need (“CON”) regulations. See “—Governmental Regulation—Federal, State and Local Regulations.”

(2)	See “—Ventas Master Lease Agreement.”

Quality Assessment and Improvement

The hospital division maintains a clinical outcomes and customer service program that includes a review of its patient population measured against utilization and quality standards, clinical outcomes data collection, and patient/family, employee, and physician satisfaction surveys. In addition, our hospitals have integrated quality assurance and improvement programs administered by a director of quality management, which encompass quality improvement, infection control, and risk management. The programs seek to ensure that patients are managed appropriately in our hospitals and that quality healthcare is provided in a cost-effective manner.

The hospital division has implemented a program whereby internal quality auditors review our TC hospitals for compliance with standards of The Joint Commission (“TJC”). The purposes of this internal review process are to: (1) ensure ongoing compliance with industry-recognized standards for hospitals, (2) assist management in analyzing each hospital’s operations, and (3) provide consulting and educational programs for each hospital to identify opportunities to improve patient care.

Hospital Division Management and Operations

Each of our TC hospitals has a fully credentialed, multi-specialty medical staff to meet the needs of post-intensive care and medically complex patients. Our TC hospitals offer a broad range of physician services including pulmonology, internal medicine, infectious diseases, neurology, nephrology, cardiology, radiology, and pathology. In addition, our TC hospitals have multi-disciplinary teams of healthcare professionals, including a professional nursing staff trained to care for long-term acute patients, respiratory, physical, occupational, and speech therapists, pharmacists, registered dietitians, and social workers, to address the needs of post-intensive care and medically complex patients.

Each TC hospital utilizes a pre-admission assessment system to evaluate clinical needs and other information in determining the appropriateness of each potential patient admission. After admission, the TC hospital’s interdisciplinary team reviews each patient’s case to determine a care plan. Typically, and where appropriate, the care plan involves the services of several disciplines, such as pulmonary medicine, infectious disease, and physical medicine.

A hospital chief executive officer or administrator supervises and is responsible for the day-to-day operations at each of our hospitals. Each hospital (or network of hospitals) also employs a chief financial or accounting officer who monitors the financial matters of such hospital or network. In addition, each hospital (or network of hospitals) employs a chief clinical officer to oversee the clinical operations and a director of quality management to oversee our quality assurance programs.

We provide centralized administrative services in the areas of information systems, clinical operations, regulatory compliance, reimbursement guidance, state licensing, and Medicare and Medicaid certification and maintenance support, as well as legal, finance, accounting, purchasing, human resources management, and facilities management support to each of our hospitals. We believe that this centralization improves efficiency, promotes the standardization of certain processes, and allows staff in our hospitals to focus more attention on providing quality patient care.

A division president, chief operating officer, and a chief financial officer manage the hospital division. The operations of the hospital division are divided into eight operational districts, each headed by a vice president, a divisional vice president or executive director who reports directly to the division’s chief operating officer. The division’s chief medical officer and senior vice president of clinical operations manage clinical issues and quality concerns of the hospital division. The sales and marketing efforts for the division are led by district sales leaders, who in turn report to our hospital division senior vice president of sales and business development.

Hospital Division Competition

In each geographic market that we serve, there are generally several competitors that provide similar services to those provided by our hospital division. In addition, several of the markets in which the hospital division operates have other LTAC hospitals and healthcare facilities that provide services comparable to those offered by our hospitals. Certain competing hospitals and healthcare facilities are operated by not-for-profit, non-taxpaying, or governmental agencies, which can finance capital expenditures on a tax-exempt basis and receive funds and charitable contributions that are unavailable to our hospital division.

Competition for patients covered by nongovernment reimbursement sources is intense. The primary competitive factors in the LTAC hospital business include quality of services, charges for services, and responsiveness to the needs of patients, families, payors, and physicians. The competitive position of any LTAC hospital also is affected by the ability of its management to negotiate contracts with purchasers of, and to receive referrals from, group healthcare services, including managed care companies, preferred provider organizations, and health maintenance organizations. Such organizations attempt to obtain discounts from established charges, as well as to limit their overall expenditures by compressing average lengths of stay. The importance of obtaining contracts with preferred provider organizations, health maintenance organizations, and other organizations that finance healthcare varies from market to market, depending on the number and market strength of such organizations.

In addition, certain third parties, known as conveners, offer patient placement and care transition services to managed care companies, Medicare Advantage plans, bundled payment participants, accountable care organizations, and other healthcare providers as part of an effort to manage post acute-care provider (“PAC”) utilization and associated costs. Thus, conveners influence patient decision on which PAC setting to choose, as well as how long to remain in a particular PAC facility. Given their focus on perceived financial savings, conveners customarily suggest that patients avoid higher cost PAC settings altogether or move as soon as practicable to lower cost PAC settings. However, conveners are not healthcare providers and may suggest a PAC setting or duration of care that is not appropriate from a clinical perspective. Conveners may suggest that patients select alternate care settings to our TC hospitals, IRFs, or home health locations or otherwise suggest shorter lengths of stay in such settings. Efforts by conveners to avoid our care settings or suggest shorter lengths of stay in our care settings could have a material adverse effect on our business, financial position, results of operations, and liquidity.

KINDRED REHABILITATION SERVICES DIVISION

Our Kindred Rehabilitation Services division operates IRFs, manages ARUs, and provides rehabilitation services, including physical and occupational therapies and speech pathology services, to residents and patients of nursing centers, hospitals, outpatient clinics, home health agencies, and assisted living facilities. Within our Kindred Rehabilitation Services division, we are organized into two reportable operating segments: Kindred Hospital Rehabilitation Services and RehabCare. We are one of the largest providers of rehabilitation services in the United States based upon fiscal 2017 revenues of approximately $1.4 billion.

Kindred Hospital Rehabilitation Services Operations

Our Kindred Hospital Rehabilitation Services segment operates IRFs, manages ARUs, and provides program management and therapy services on an inpatient basis in LTAC hospitals, sub-acute (or skilled nursing) units, as well as on an outpatient basis to hospital-based and other satellite programs. As of December 31, 2017, our Kindred Hospital Rehabilitation Services segment operated 19 IRFs (which includes 17 joint ventures) and 99 ARUs and provided rehabilitation services in 104 LTAC hospitals, four sub-acute (or skilled nursing) units and 123 outpatient clinics.

Inpatient rehabilitation hospitals. Our IRFs provide services to patients who require intensive inpatient rehabilitative care. Our IRF patients typically have significant physical disability due to various medical and physical conditions, such as brain injuries, spinal cord injuries, stroke, hip fractures, certain orthopedic problems, and neuromuscular disease, which require medical and rehabilitative healthcare services in an inpatient setting. Our nurses and physical, occupational, and speech therapists work with physicians in a multi-disciplinary environment to get patients home and to work. Nursing and therapy staff provide patient care as directed by physician orders. Our IRFs use an interdisciplinary approach to treatment that leads to better care and superior outcomes. The medical,

nursing, therapy, and ancillary services provided by our IRFs comply with local, state, and federal regulations, as well as other accreditation standards. The majority of our IRFs are owned and operated through joint ventures with other health systems.

Hospital-based inpatient rehabilitation units. We are a leading provider of contract-based ARU management services. The ARUs we manage provide high acuity rehabilitation for patients recovering from strokes, medically complex and orthopedic conditions, traumatic brain injuries, and other neurological disease. We assist in the development of ARUs in acute care hospitals that have vacant space and/or unmet rehabilitation needs in their markets. We also work with acute care hospitals that currently operate ARUs to improve the delivery of clinical services to patients by implementing our scheduling, clinical protocol, and outcome systems, as well as time-management training for existing staff. In the case of acute care hospitals that do not operate ARUs, we review their historical and existing hospital population, as well as the demographics of the geographic region, to determine the optimal size of the proposed ARUs and the potential of the new facility under our management to attract patients and generate revenues sufficient to cover anticipated expenses. Our relationships with these hospitals are customarily in the form of contracts for management services, which typically have a term of three to five years.

An ARU within a hospital allows the hospital to offer rehabilitation services to patients who might otherwise be discharged to a setting outside the acute care hospital, thus improving the hospital’s ability to provide a full continuum of care and consistency in clinical services and outcomes. An ARU within a hospital typically consists of about 20 beds and is staffed with a program director, a rehabilitation physician that usually serves as the medical director, and clinical staff, which may include psychologists, physical and occupational therapists, speech/language pathologists, a social worker, a case manager, and other appropriate support personnel. Additionally, compliance, clinical education, and clinical programming are supported by our clinical compliance experts in an effort to ensure that clinical practices support the provision of quality rehabilitation services.

LTAC hospitals. We provide rehabilitation and program management services, including physical and occupational therapies and speech pathology services, to LTAC hospitals. We provide specialized care programs that support patients with complex medical needs, such as wound care, pain management, and cognitive deficits, in addition to programs for neurologic, orthopedic, cardiac, and pulmonary recovery. As of December 31, 2017, we operated therapy programs in 104 LTAC hospitals, of which approximately one-third are owned by third parties. We also provide LTAC hospitals with clinical education and programming supported by our clinical experts in an effort to ensure that clinical practices support the provision of effective and efficient quality rehabilitation services in addition to enhancing overall prevention programs in accordance with applicable standards of care.

Sub-acute units. As of December 31, 2017, we managed therapy programs in four sub-acute (or skilled nursing) units. These hospital-based units provide lower intensity rehabilitation for medically complex patients. Patients’ diagnoses cover a wide range of medical conditions, including stroke, post-surgical conditions, pulmonary disease, cancer, congestive heart failure, burns, and wounds. These sub-acute units enable patients to remain in a hospital setting where emergency medical needs can be met quickly as opposed to having to be transported from a nursing center. These types of units are typically located within the acute care hospital and are either separately licensed or under the hospital’s license as permitted by applicable laws. The hospital benefits by retaining patients who otherwise would be discharged to another setting and by utilizing idle space.

Outpatient therapy programs. We manage outpatient therapy programs that provide therapy services to patients with a variety of medical, orthopedic, and neurological conditions that may be related to work or sports injuries. As of December 31, 2017, we managed 123 hospital-based and satellite outpatient therapy programs. An outpatient therapy program complements the hospital’s occupational medicine initiatives and allows therapy to be continued for patients discharged from inpatient rehabilitation facilities and medical/surgical beds. An outpatient therapy program also attracts patients into the hospital and is operated either on the hospital’s campus or in satellite locations controlled by the hospital.

We believe our management of outpatient therapy programs enables the efficient delivery of therapy services through our scheduling, clinical protocol, and outcome systems, as well as through time-management training for our therapy personnel. We also provide our customers with guidance on compliance and quality assurance objectives.

RehabCare Operations

Our RehabCare segment provides therapy management services primarily to nursing centers, assisted living facilities, independent living communities, home health agencies, and hospice providers, allowing our customers to fulfill their continuing need for therapists on a full-time or part-time basis without the need to hire, train, and retain their own staff. As of December 31, 2017, our RehabCare segment provided rehabilitative services in 1,616 sites of service in 42 states.

RehabCare provides specialized rehabilitation programs designed to meet the individual needs of the residents and patients we serve. Our specialized care programs address complex medical needs, such as wound care, pain management, and cognitive retraining, in addition to programs for fractures, neurologic, orthopedic, cardiac, and pulmonary conditions. We also provide clinical education and programming that is developed and supported by our clinical experts. These programs are implemented in an effort to ensure that clinical practices support the provision of quality rehabilitation services in accordance with applicable standards of care.

RehabCare recruits and retains qualified professionals with the clinical expertise to provide quality patient care and measurable rehabilitation outcomes. RehabCare also provides quality-assurance training for all clinicians to maintain compliance with regulatory requirements.

Selected Kindred Rehabilitation Services Division Operating Data

The following table sets forth certain operating and financial data for the Kindred Rehabilitation Services division (dollars in thousands, except statistics):

	Year ended December 31,
	2017		2016		2015
Kindred Hospital Rehabilitation Services:
Revenues	$	703,915	$	679,800	$	614,321
Segment adjusted operating income	$	203,392	$	198,335	$	177,340
Assets at the end of period	$	828,310	$	815,804	$	803,831
Capital expenditures:
Routine	$	2,743	$	1,389	$	948
Development	$	547	$	20,773	$	4,701
Freestanding IRFs:
End of period data:
Number of IRFs		19		19		18
Number of licensed beds		995		995		919
Discharges (1)		19,307		18,409		15,991
Occupancy % (1)		70.4		69.1		70.2
Average length of stay (1)		12.7		12.8		13.2
Revenue per discharge (1)	$	20,134	$	19,531	$	19,104
Contract services:
Sites of service (at end of period):
ARUs		99		102		100
LTAC hospitals		104		119		119
Sub-acute units		4		5		7
Outpatient units		123		132		130
		330		358		356
Revenue per site	$	904,057	$	858,758	$	837,606
Revenue mix %:
Company-operated		25		28		30
Non-affiliated		75		72		70

(1)

Excludes non-consolidating IRF.

	Year ended December 31,
	2017		2016		2015
RehabCare:
Revenues	$	745,467	$	776,796	$	907,548
Segment adjusted operating income	$	6,884	$	32,586	$	35,876
Sites of service (at end of period)		1,616		1,718		1,798
Revenue per site	$	446,294	$	443,980	$	501,494
Assets at end of period	$	189,469	$	329,516	$	347,738
Routine capital expenditures	$	1,820	$	1,867	$	1,449

Sources of Kindred Rehabilitation Services Division Revenues

In the Kindred Hospital Rehabilitation Services segment, our IRFs derive a significant portion of their revenues from Medicare, Medicaid, and other payors that received discounts from their established billing rates. The Medicare and Medicaid regulations and various managed care contracts under which these discounts are calculated are complex and are subject to interpretation and adjustment. IRFs estimate the allowance for contractual discounts on a patient-specific basis given their interpretation of the applicable regulations or contract terms. These interpretations sometimes result in payments that differ from the IRFs’ estimates. Additionally, updated regulations and contract renegotiations occur frequently, necessitating regular review and assessment of the estimation process by management.

Regarding the rehabilitation and program management services we provide to residents, patients, and customers, the basis for payment varies depending upon the type of service provided. In the Kindred Hospital Rehabilitation Services segment, our (1) ARU customers generally pay us on the basis of a negotiated fee per discharge, a flat monthly management fee, or a combination of the two, (2) LTAC hospital customers generally pay based upon a negotiated per patient day rate, (3) sub-acute rehabilitation customers generally pay based upon a flat monthly fee or a negotiated fee per patient day, and (4) outpatient therapy clients typically pay us on the basis of a negotiated fee per unit of service. In the RehabCare segment, our customers generally pay us on the basis of a negotiated patient per diem rate or a negotiated fee schedule based upon the type of service rendered.

For the year ended December 31, 2017, revenues of the Kindred Rehabilitation Services division totaled approximately $1.4 billion or 24% of our total revenues (before eliminations). Approximately 6% of our Kindred Rehabilitation Services division revenues (before eliminations) in 2017 were generated from services provided to hospitals and care management functions that we operated.

As a provider of services to healthcare providers, trends and developments in healthcare reimbursement will impact our revenues and growth. Changes in the reimbursement provided by Medicare or Medicaid to our customers can impact the demand and pricing for our services. For more information regarding the reimbursement for our rehabilitation services, see “—Governmental Regulation—Kindred Rehabilitation Services Division—Overview of Kindred Rehabilitation Services Division Reimbursement.”

Geographic Coverage

The following table lists by state the number of sites of service of our Kindred Hospital Rehabilitation Services operating segment as of December 31, 2017:

			Contract services
State	IRFs		ARUs		LTAC hospitals		Sub-acute units		Outpatient units		Total
Alabama		-		2		-		-		-		2
Arizona		1		1		2		-		-		3
Arkansas		-		5		-		1		9		15
California		-		11		17		1		5		34
Colorado		-		-		3		-		1		4
Delaware		-		1		-		-		-		1
District of Columbia		-		-		2		-		-		2
Florida		-		-		10		-		5		15
Georgia		-		2		1		-		-		3
Illinois		-		7		6		-		19		32
Indiana		1		6		6		-		11		23
Iowa		-		3		-		-		2		5
Kansas		-		6		-		-		5		11
Kentucky		-		2		2		-		1		5
Louisiana		-		4		2		1		15		22
Massachusetts		-		1		3		-		2		6
Michigan		-		6		2		-		2		10
Minnesota		-		1		-		-		-		1
Mississippi		-		3		-		1		2		6
Missouri (1)		3		6		3		-		5		14
Montana		-		2		-		-		-		2
Nevada		-		-		3		-		-		3
New Jersey		-		-		2		-		9		11
New Mexico		-		-		1		-		-		1
North Carolina		-		-		1		-		4		5
North Dakota		-		1		2		-		-		3
Ohio		2		6		5		-		4		15
Oklahoma		1		4		2		-		1		7
Pennsylvania		2		4		5		-		3		12
Puerto Rico		-		1		-		-		-		1
Rhode Island		-		1		-		-		4		5
South Carolina		-		2		1		-		2		5
Tennessee (1)		1		2		1		-		-		3
Texas		6		7		19		-		10		36
Virginia		-		-		1		-		-		1
Washington		-		1		2		-		-		3
West Virginia		-		-		-		-		2		2
Wisconsin		2		-		-		-		-		-
Wyoming		-		1		-		-		-		1
Totals		19		99		104		4		123		330

(1)	These states have CON regulations for our IRFs. See “—Governmental Regulation—Federal, State and Local Regulations.”

The following table lists by state the number of sites of service of our RehabCare operating segment as of December 31, 2017:

State	Company- operated		Non-affiliated		Total
Alabama		1		2		3
Arizona		1		11		12
Arkansas		2		7		9
California		1		118		119
Colorado		5		38		43
Connecticut		-		5		5
District of Columbia		-		3		3
Florida		26		53		79
Georgia		-		4		4
Idaho		-		10		10
Illinois		3		251		254
Indiana		2		43		45
Iowa		-		14		14
Kansas		2		46		48
Kentucky		6		42		48
Louisiana		-		6		6
Maine		-		26		26
Maryland		4		48		52
Massachusetts		5		31		36
Michigan		-		21		21
Minnesota		-		49		49
Missouri		2		137		139
Montana		-		7		7
Nebraska		1		6		7
Nevada		2		1		3
New Hampshire		-		3		3
New Jersey		-		2		2
New Mexico		-		1		1
New York		-		14		14
North Carolina		9		67		76
North Dakota		-		2		2
Ohio		2		65		67
Oklahoma		-		15		15
Oregon		-		1		1
Pennsylvania		1		36		37
Rhode Island		-		2		2
South Carolina		-		4		4
Tennessee		9		39		48
Texas		27		162		189
Vermont		1		1		2
Virginia		1		19		20
Washington		-		9		9
West Virginia		-		2		2
Wisconsin		-		80		80
Totals		113		1,503		1,616

Sales and Marketing

The Kindred Rehabilitation Services division’s sales and marketing efforts are tailored to each of its operating segments. Kindred Hospital Rehabilitation Services focuses on the provision of therapy services and therapy program management for IRFs and hospitals, while RehabCare primarily focuses on the outsourcing needs of freestanding skilled nursing facilities. Both the Kindred Hospital Rehabilitation Services and RehabCare segments emphasize the broad range of rehabilitation programs, clinical expertise, and competitive pricing for the services that we provide. Kindred Hospital Rehabilitation Services’ new business efforts are led by a

vice president of business development and three directors of business development in geographically defined regions. RehabCare’s new business efforts are led by nine directors of business development in geographically defined regions.

Kindred Rehabilitation Services Division Management and Operations

At December 31, 2017, our Kindred Rehabilitation Services division was managed by a president, overseeing a chief operating, financial, medical, quality and other administrative officers. Our operations are further divided between the Kindred Hospital Rehabilitation Services and RehabCare operating segments.

The Kindred Hospital Rehabilitation Services segment is led by two vice presidents of operations who report to the division president, one in charge of IRF operations and the other in charge of ARU, LTAC hospital, sub-acute unit and outpatient therapy operations. With respect to our IRFs, a vice president of operations oversees the chief executive officers of our IRFs who are responsible for the day-to-day operations at each of our IRFs. Each IRF (or network of IRFs) also employs a controller to monitor financial matters, a chief clinical officer to oversee clinical operations, and a director of quality management to oversee quality assurance programs. With respect to our hospital-based contract rehabilitation services and program management, our operations are led by a vice president who manages five regional vice presidents.

The RehabCare segment is led by a chief operating officer, who reports to the division president. The chief operating officer has five division vice presidents reporting to her with six regional vice presidents reporting to the divisional vice presidents.

In both the Kindred Hospital Rehabilitation Services and RehabCare segments, area directors of operations report to the regional vice presidents. Each area director of operations is responsible for the overall management of 15 to 30 on-site program directors. Many of our rehabilitation customers have on-site program directors responsible for managing the therapy operations at such facility. There are two division vice presidents of clinical operations that manage clinical education for our therapists and implement quality care initiatives.

We provide our Kindred Rehabilitation Services division with centralized administrative services in the areas of information systems, clinical operations, regulatory compliance, reimbursement guidance, professional licensing support, as well as legal, finance, accounting, purchasing, recruiting, and human resources management support. The centralization of these services improves operating efficiencies, promotes the standardization of certain processes, and permits program staff to focus on the delivery of quality, medically necessary rehabilitation services.

Kindred Rehabilitation Services Division Competition

The IRF industry is highly fragmented, and there are generally several competitors in each geographic market that we serve that provide similar services to those provided by our IRFs. In addition, several of the markets in which our IRFs operate have other IRFs that provide comparable services. Other providers of acute-care services may attempt to become competitors in the future. Also, other acute-care hospital operators may choose to expand their IRF services in our markets. Certain competing IRFs are operated by nonprofit, non-taxpaying, or governmental agencies, which can finance capital expenditures on a tax-exempt basis and receive funds and charitable contributions that are unavailable to us. Similarly, nursing facilities may market themselves as offering certain rehabilitation services even though they may not be required to offer the same level of care.

Competition for IRF patients covered by nongovernment reimbursement sources is intense. The primary competitive factors in the IRF business include quality of care and services, treatment outcomes achieved, charges for services, and responsiveness to the needs of patients, families, payors, and physicians. Other companies have entered the IRF business with licensed IRFs that compete with our IRFs. The competitive position of any IRF is also affected by the ability of its management to negotiate contracts with purchasers of, and to receive referrals from, group healthcare services, including managed care companies, preferred provider organizations, and health maintenance organizations. The importance of obtaining contracts with preferred provider organizations, health maintenance organizations, and other organizations that finance healthcare varies from market to market, depending on the number and market strength of such organizations.

With respect to our program management and therapy services operations, there are national, regional, and local rehabilitation services providers that offer rehabilitation services comparable to ours. A number of our competitors may have greater financial and other resources than we do, may be more established in the markets in which we compete, and may be willing to provide services at lower prices. In addition, a number of nursing centers and hospitals may elect not to outsource rehabilitation services, thereby reducing our potential customer base. While there are several large rehabilitation providers, the market generally is highly fragmented and is primarily composed of smaller independent providers.

We believe our Kindred Rehabilitation Services division generally competes based upon its reputation for providing quality rehabilitation services, state of the art therapy programs, qualified and well-trained nurses and therapists, competitive pricing, outcome management, and technology systems.

GOVERNMENTAL REGULATION

Medicare and Medicaid

A substantial portion of our revenues are derived from patients covered by the Medicare and Medicaid programs. Medicare is a federal program that provides certain hospital and medical insurance benefits to persons age 65 and over and certain disabled persons. Medicaid is a medical assistance program administered by each state, funded with federal and state funds pursuant to which healthcare benefits are available to certain indigent or disabled patients. Within the Medicare and Medicaid statutory framework, there are substantial areas subject to administrative rulings, interpretations, and discretion that may affect payments made under those programs.

We have been, and could be in the future, materially adversely affected by the continuing efforts of governmental and private third party payors to contain healthcare costs. We cannot assure you that reimbursement payments under governmental and private third party payor programs, including Medicare supplemental insurance policies, will remain at levels comparable to present levels or will be sufficient to cover the costs allocable to patients eligible for reimbursement pursuant to these programs. Medicare reimbursement in LTAC hospitals, IRFs, home health, and hospice is subject to fixed payments under the Medicare prospective payment systems. In accordance with Medicare laws, CMS makes annual adjustments to Medicare payment rates in many prospective payment systems under what is commonly known as a “market basket update.” Each year, the Medicare Payment Advisory Commission (“MedPAC”), a commission chartered by Congress to advise it on Medicare payment issues, recommends payment policies to Congress for a variety of Medicare payment systems. Congress is not obligated to adopt MedPAC recommendations and based on previous years, there can be no assurance that Congress will adopt MedPAC’s recommendations in any given year. Generally, these rates are adjusted annually for inflation. However, those adjustments may not reflect actual increases of the cost of providing healthcare services. In addition, Medicaid reimbursement can be impacted negatively by state budgetary pressures, which may lead to reduced reimbursement or delays in receiving payments. Moreover, we cannot assure you that the facilities operated by us, or the provision of goods and services offered by us, will meet the requirements for participation in such programs.

The Patient Protection and Affordable Care Act and the Healthcare Education and Reconciliation Act

Various healthcare reform provisions became law upon enactment of the Patient Protection and Affordable Care Act and the Healthcare Education and Reconciliation Act (previously defined as the ACA). The reforms contained in the ACA have affected each of our businesses in some manner and are directed in large part at increased quality and cost reductions. Several of the reforms are very significant and could ultimately change the nature of our services, the methods of payment for our services, and the underlying regulatory environment. These reforms include possible modifications to the conditions of qualification for payment, bundling of payments to cover both acute and post-acute care, and the imposition of enrollment limitations on new providers.

The ACA also provides for: (1) reductions to the annual market basket payment updates for LTAC hospitals, IRFs, home health agencies, and hospice providers, which could result in lower reimbursement than in the preceding year; (2) additional annual “productivity adjustment” reductions to the annual market basket payment update as determined by CMS for LTAC hospitals and IRFs, home health agencies, and hospice providers; (3) a quality reporting system for hospitals (including LTAC hospitals and IRFs); and (4) reductions in Medicare payments to hospitals (including LTAC hospitals and IRFs) for failure to meet certain quality reporting standards or to comply with standards in new value-based purchasing demonstration project programs.

Further, the ACA mandates changes to home health and hospice benefits under Medicare. For home health, the ACA mandates creation of a value-based purchasing program, development of quality measures, a decrease in home health reimbursement that began in federal fiscal year 2014 and was phased-in over a four-year period, a reduction in the outlier cap, and reinstated a 3% add-on payment for home health services delivered to residents in rural areas on or after April 1, 2010 and before January 1, 2016.

In addition, the ACA requires the Secretary of HHS to test different models for delivery of care, some of which would involve home health services. It also requires the Secretary to establish a national pilot program for integrated care for patients with certain conditions, bundling payment for acute hospital care, physician services, outpatient hospital services (including emergency department services), and post-acute care services, which would include home health. The Secretary is also required to conduct a study to evaluate costs and quality of care among efficient home health agencies regarding access to care and treating Medicare beneficiaries with varying severity levels of illness and provide a report to Congress.

Potential efforts in the U.S. Congress to repeal, amend, modify, or retract funding for various aspects of the ACA create additional uncertainty about the ultimate impact of the ACA on us and the healthcare industry.

The healthcare reforms and changes resulting from the ACA (including any repeal, amendment, modification or retraction thereof), as well as other similar healthcare reforms, including any potential change in the nature of services we provide, the methods or amount of payment we receive for such services, and the underlying regulatory environment, could have a material adverse effect on our business, financial position, results of operations, and liquidity.

Congress, MedPAC, and CMS will continue to address reimbursement rates for a variety of healthcare settings. We cannot predict the adjustments to Medicare payment rates that Congress or CMS may make in the future. Any downward adjustment to rates for the types of services we provide could have a material adverse effect on our business, financial position, results of operations, and liquidity.

Congress continues to discuss additional deficit reduction measures, leading to a high degree of uncertainty regarding potential reforms to governmental healthcare programs, including Medicare and Medicaid. These discussions, along with other continuing efforts to reform governmental healthcare programs, could result in major changes in healthcare delivery and reimbursement systems on a national and state level, including changes directly impacting the government and private reimbursement systems for each of our businesses. Healthcare reform, future healthcare legislation, or other changes in the administration or interpretation of governmental healthcare programs, whether resulting from deficit reduction measures or otherwise, could have a material adverse effect on our business, financial position, results of operations, and liquidity.

We believe that our operating margins also will continue to be under pressure as the growth in operating expenses, particularly professional liability, labor, and employee benefits costs, exceeds any potential payment increases from third party payors. In addition, as a result of competitive pressures, our ability to maintain operating margins through price increases to private patients is limited.

See “—Risk Factors—Risks Relating to Reimbursement and Regulation of Our Business—Healthcare reform has initiated significant changes to the United States healthcare system” and “—Risk Factors—Risks Relating to Reimbursement and Regulation of Our Business—Changes in the reimbursement rates or methods or timing of payment from third party payors, including the Medicare and Medicaid programs, or the implementation of other measures to reduce reimbursement for our services and products could result in a substantial reduction in our revenues and operating margins.”

Bundled Payment Programs

The Comprehensive Care for Joint Replacement Bundled Payment Program. CMS announced the final Comprehensive Care for Joint Replacement bundled payment program on November 16, 2015 (the “CJR Program”). The CJR Program implements a mandatory payment model in which acute care hospitals in designated metropolitan statistical areas (“MSAs”) are responsible for total spending for all inpatient care provided in connection with a lower extremity joint replacement or reattachment procedure, as well as for all spending related to care provided within a 90-day episode of care following discharge from such hospital. All providers will continue to receive fee-for-service payments under existing payment systems and total episode payments will subsequently be reconciled against a target price. The CJR Program will test this payment model over five performance periods between April 1, 2016 and December 31, 2020 to see if Medicare expenditures can be reduced while at the same time improving care coordination and preserving or enhancing the quality of care provided to Medicare beneficiaries. In November 2017, CMS reduced by half the number of MSAs where mandatory participation is required, effective January 1, 2018.

Expansion to Cardiac and Other Orthopedic Services. On November 30, 2017, CMS announced the cancellation of the expansion of the mandatory bundled payment program to cardiac and other orthopedic services. This bundled payment expansion was a mandatory payment model in which acute care hospitals in designated MSAs were responsible for total spending for all inpatient care provided in connection with acute myocardial infarction, coronary artery bypass graft, and surgical hip/femur fracture treatment, as well as for all spending related to care provided within a 90-day episode of care following discharge from such hospital. All providers would have continued to receive fee-for-service payments under existing payment systems with total episode payments subsequently reconciled against a target price.

Bundled Payments for Care Improvement Advanced Initiative. On January 9, 2018, CMS announced a new voluntary episode payment model, the Bundled Payments for Care Improvement Advanced Initiative. The program, which runs from October 1, 2018 through December 31, 2023, will include 32 clinical episodes (29 inpatient, 3 outpatient) including major joint replacement and stroke with the intention to align payment incentives, reduce expenditures and improve quality over a 90-day episode of care. Unlike prior bundled payment demonstration programs, which allowed PAC providers to be episode initiators, this program is focused on acute care hospitals and physician group practices as episode initiators. All providers will continue to receive fee-for-service payments under existing payment systems and total episode payments will subsequently be reconciled against a target price.

The Medicare Access and CHIP Reauthorization Act of 2015

The Medicare Access and CHIP Reauthorization Act of 2015 (“MACRA”) was signed into law on April 16, 2015. Among other items, MACRA: (1) permanently replaced the sustainable growth rate (“SGR”) formula previously used to determine updates to Medicare physician reimbursement, replacing these updates with quality and value measurements and participation in alternate payment models; (2) extended the Medicare Part B outpatient therapy cap exception process until December 31, 2017; (3) extended the 3% add-on payment for home health services delivered to residents in rural areas until December 31, 2017; and (4) set payment updates for post-acute providers at 1% after other adjustments required by the ACA for 2018.

The Improving Medicare Post-Acute Care Transformation Act of 2014

The Improving Medicare Post-Acute Care Transformation Act of 2014 (the “IMPACT Act”), passed on October 6, 2014, requires standardized assessment data for quality improvement, payment, and discharge planning purposes across the spectrum of PACs, including LTAC hospitals, IRFs, and home health agencies.

The IMPACT Act will require PACs to begin reporting (1) standardized patient assessment data at admission and discharge by October 1, 2018 for LTAC hospitals and IRFs and by January 1, 2019 for home health agencies, (2) new quality measures, including functional status, skin integrity, medication reconciliation, incidence of major falls, and patient preference regarding treatment and discharge at various intervals between October 1, 2016 and January 1, 2019, and (3) resource use measures, including Medicare spending per beneficiary, discharge to community, and hospitalization rates of potentially preventable readmissions. The Secretary of HHS will provide confidential feedback to PACs one year after this data is provided and public reports two years thereafter. Failure to report such data when required would subject a facility to a two percent reduction in market basket prices then in effect. The Secretary of HHS also plans to promulgate regulations requiring PACs to take certain of these quality, resource use, and other measures into account in the discharge planning process.

The IMPACT Act further requires HHS and MedPAC to study alternative PAC payment models, including payment based upon individual patient characteristics and not care setting, with corresponding Congressional reports required based on such analysis. MedPAC must provide a final report to Congress by June 30, 2022. The Secretary of HHS must also submit a final report no later than two years after it has collected two years of data.

The IMPACT Act also included provisions impacting Medicare-certified hospices, including (1) increasing survey frequency for Medicare-certified hospices to once every 36 months, (2) imposing a medical review process for facilities with a high percentage of stays in excess of 180 days, and (3) updating the annual aggregate Medicare payment cap.

The Bipartisan Budget Act of 2018

The Bipartisan Budget Act of 2018 (the “BBA”), enacted on February 9, 2018, includes several provisions impacting Medicare reimbursement to home health, hospice, LTAC hospital and rehabilitation therapy services providers.

With respect to home health providers, the BBA (1) will base payment on a 30-day episode of care (beginning January 1, 2020), coupled with annual determinations by CMS to ensure budget neutrality (including taking into account provider behavior), (2) will eliminate retroactive payment adjustments based upon the level of therapy services required (beginning January 1, 2020), (3) extends the 3% add-on payment for home health services provided to residents in rural areas (beginning January 1, 2018), coupled with a reduction and phase out of such add-on payment over the following four fiscal years, and (4) will establish a market basket update of 1.5% for the federal fiscal year beginning January 1, 2020.

With respect to hospice providers, the BBA establishes a new payment policy related to early discharges to hospice care from hospitals. This policy will impose a financial penalty on hospitals for each early discharge to hospice care, beginning October 1, 2018.

With respect to LTAC hospital providers, the BBA extends the initial two-year phase-in period of the new LTAC patient criteria under the LTAC Legislation (as defined below) for an additional two-year period, and will impose a mandatory 4.6% reduction in payments for services provided to site-neutral patients over a nine-year period beginning October 1, 2018.

With respect to rehabilitation therapy services providers, the BBA (1) permanently repeals the Medicare Part B outpatient therapy cap (effective January 1, 2018), (2) continues the targeted medical review process, while reducing the applicable threshold triggering such review to $3,000 (effective January 1, 2018), and (3) reduces payment for services provided by a physical or occupational therapy assistant to 85% of the amount currently payable under Medicare for such services (effective January 1, 2022).

Federal, state, and local regulations

The extensive federal, state, and local regulations affecting the healthcare industry include, but are not limited to, regulations relating to licensure, billing, conduct of operations, ownership of facilities, addition of facilities, allowable costs, services and prices for services, facility staffing requirements, and the privacy and security of health-related information. In addition, various anti-fraud and abuse laws, including physician self-referral laws, anti-kickback laws, and laws regarding filing of false claims, codified under the Social Security Act and other statutes, prohibit certain business practices and relationships in connection with healthcare services for patients whose care will be paid by Medicare, Medicaid, or other governmental programs. Sanctions for violating these anti-fraud and abuse laws include criminal penalties, civil penalties, and possible exclusion from government programs such as Medicare and Medicaid.

In the ordinary course of our business, we are regularly subject to inquiries, investigations, and audits by federal and state agencies that oversee applicable healthcare program participation and payment regulations. Audits may include enhanced medical

necessity reviews pursuant to the Medicare, Medicaid, and the SCHIP Extension Act of 2007 and audits under the CMS Recovery Audit Contractor (“RAC”) program and other similar programs.

We believe that the regulatory environment surrounding most segments of the healthcare industry remains intense. Federal and state governments continue to impose intensive enforcement policies that result in a significant number of inspections, citations of regulatory deficiencies, and other regulatory penalties. This includes demands for refund of overpayments, terminations from the Medicare and Medicaid programs, bars on Medicare and Medicaid payments for new admissions, and civil monetary penalties. These enforcement policies, along with the costs incurred to respond to and defend reviews, audits, and investigations, could have a material adverse effect on our business, financial position, results of operations, and liquidity. We vigorously contest such penalties where appropriate; however, these cases can involve significant legal and other expenses and consume our resources.

Section 1877 of the Social Security Act, commonly known as the “Stark Law,” provides that a physician may not refer a Medicare or Medicaid patient for a “designated health service” to an entity with which the physician or an immediate family member has a financial relationship unless the financial arrangement meets an exception under the Stark Law or its regulations. Designated health services include inpatient and outpatient hospital services, physical, occupational, and speech therapy, durable medical equipment, prosthetics, orthotics and supplies, diagnostic imaging, enteral and parenteral feeding and supplies, home health services, and clinical laboratory services. Under the Stark Law, a “financial relationship” is defined as an ownership or investment interest or a compensation arrangement. If such a financial relationship exists and does not meet a Stark Law exception, the entity may not submit or claim payment under the Medicare or Medicaid programs or collect from the patient or other payor. Many of the compensation arrangement exceptions permit referrals if, among other things, the arrangement is set forth in a written agreement signed by the parties, the compensation to be paid is set in advance, is consistent with fair market value, and is not determined in a manner that takes into account the volume or value of any referrals or other business generated between the parties. Exceptions may have other requirements. Any funds collected for an item or service resulting from a referral that violates the Stark Law must be repaid to Medicare or Medicaid, any other third party payor, and the patient. In addition, a civil monetary penalty of up to approximately $25,000 for each service may be imposed for presenting or causing to be presented, a claim for a service rendered in violation of the Stark Law. Many states have enacted healthcare provider referral laws that go beyond physician self-referrals or apply to a greater range of services than just the health services designated under the Stark Law.

The Anti-Kickback Statute, Section 1128B of the Social Security Act (the “Anti-Kickback Statute”), prohibits the knowing and willful offer, payment, solicitation, or receipt of any remuneration, directly or indirectly, overtly or covertly, in cash or in kind, to induce the referral of an individual in return for recommending or arranging for the referral of an individual for any item or service payable under any federal healthcare program, including Medicare or Medicaid. The OIG has issued regulations that create “safe harbors” for certain conduct and business relationships that are deemed protected under the Anti-Kickback Statute. In order to receive safe harbor protection, all of the requirements of a safe harbor must be met. The fact that a given business arrangement does not fall within one of these safe harbors, however, does not render the arrangement per se illegal. Business arrangements of healthcare service providers that fail to satisfy the applicable safe harbor criteria, if investigated, will be evaluated based upon all facts and circumstances and risk increased scrutiny and possible sanctions by enforcement authorities. The Anti-Kickback Statute is a criminal statute, with penalties of up to $25,000, up to five years in prison, or both. The OIG can pursue a civil claim for violation of the Anti-Kickback Statute under the Civil Monetary Penalty Statute of up to approximately $75,000 per claim and up to three times the amount received from the government for the items or services. We believe that business practices of providers and financial relationships between providers have become subject to increased scrutiny as healthcare reform efforts continue on the federal and state levels. State Medicaid programs are required to enact an anti-kickback statute. Many states have adopted or are considering similar legislative proposals, some of which extend beyond the Medicaid program, to prohibit the payment or receipt of remuneration for the referral of patients regardless of the source of payment for the care.

The U.S. Department of Justice (the “DOJ”) may bring an action under the federal False Claims Act (the “FCA”) alleging that a healthcare provider has defrauded the government by submitting a claim for items or services not rendered as claimed, which may include coding errors, billing for services not provided, and submitting false or erroneous cost reports. The Fraud Enforcement and Recovery Act of 2009 expanded the scope of the FCA by, among other things, creating liability for knowingly and improperly avoiding repayment of an overpayment received from the government and broadening protections for whistleblowers. The ACA clarifies that if an item or service is provided in violation of the Anti-Kickback Statute, the claim submitted for those items or services is a false claim that may be prosecuted under the FCA as a false claim. Civil penalties under the FCA range from approximately $10,000 to $25,000 for each claim and up to three times of the amount claimed. Under the qui tam or “whistleblower” provisions of the FCA, a private individual with knowledge of fraud may bring a claim on behalf of the federal government and receive a percentage of the federal government’s recovery. Due to these whistleblower incentives, lawsuits have become more frequent.

In addition to the penalties described above, if we violate any of these laws, we may be excluded from participation in federal and/or state healthcare programs. These fraud and abuse laws and regulations are complex, and we do not always have the benefit of significant regulatory or judicial interpretation of these laws and regulations. While we do not believe we are in violation of these prohibitions, we cannot assure you that governmental officials charged with the responsibility for enforcing these prohibitions will not assert that we are violating the provisions of such laws and regulations.

The Balanced Budget Act of 1997 (the “Balanced Budget Act”) also includes a number of anti-fraud and abuse provisions. The Balanced Budget Act contains additional civil monetary penalties for violations of the Anti-Kickback Statute discussed above and imposes an affirmative duty on healthcare providers to ensure that they do not employ or contract with persons excluded from the Medicare program. The Balanced Budget Act also provides a minimum ten-year period for exclusion from participation in federal healthcare programs for persons or entities convicted of a prior healthcare offense.

Various states in which we operate hospitals and IRFs have established minimum staffing requirements or may establish minimum staffing requirements in the future. Our ability to satisfy such staffing requirements depends upon our ability to attract and retain qualified healthcare professionals, including nurses, certified nurse’s assistants, therapists, and other staff. Failure to comply with such minimum staffing requirements may result in the imposition of fines or other sanctions. If states do not appropriate sufficient additional funds to pay for any additional operating costs resulting from such minimum staffing requirements, our profitability may be materially adversely affected.

The International Classification of Diseases (“ICD”) is a classification system for diseases and signs, symptoms, abnormal findings, complaints, social circumstances, and external causes of injury or diseases promulgated by the World Health Organization. We, like all healthcare providers, payors, and vendors are required to report medical diagnoses under ICD-10 diagnosis codes. If claims are not reported properly under ICD-10, there can be a delay in the processing and payment of such claims or a denial of such claims, which can have a material adverse effect on our business, financial position, results of operations, and liquidity.

HIPAA Privacy and Security Laws and Regulations. The federal Health Insurance Portability and Accountability Act of 1996 (“HIPAA”), among other things, broadened the scope of existing fraud and abuse laws. It also mandated the adoption of administrative simplification regulations aimed at standardizing transaction formats and billing codes for documenting medical services, handling claims submissions, and protecting the privacy and security of individually identifiable health information. HIPAA regulations that standardize transactions and code sets require standard formatting for healthcare providers, like us, that submit claims electronically. We are now required to use ICD-10 code sets for diagnoses and procedures on electronic claims forms, necessitating greater specificity in our coding and documentation practices.

Many federal and state laws regulate how we handle certain patient health information and restrict the use and disclosure of that information, including medical and billing records. The HIPAA regulations apply to “protected health information,” defined generally as individually identifiable health information transmitted or maintained in any form or medium. The HIPAA privacy regulations provide individuals with the right to access, amend, and obtain an accounting of their own health information and restrict how and for what purposes we use and disclose that information. We are required to limit our disclosures to only the minimum amount information reasonably necessary to accomplish the intended purpose.

HIPAA’s security regulations require us to safeguard the confidentiality, integrity, and availability of electronic protected health information that we create, receive, maintain, or transmit. We must protect against reasonably anticipated threats or hazards to the security of such information and against the unauthorized use or disclosure of such information. HIPAA provides for the imposition of civil and criminal penalties if protected health information is improperly used or disclosed.

KINDRED HEALTHCARE, INC 10-K