Kindred Healthcare Announces Fourth Quarter Results

Kindred Healthcare, Inc. (the “Company”) (NYSE:KND) today announced its operating results for the fourth quarter and year ended December 31, 2006. All financial and statistical information included in this press release reflects the continuing operations of the Company’s businesses for all periods presented unless otherwise indicated.

Fourth Quarter Results

Continuing Operations

Consolidated revenues for the fourth quarter ended December 31, 2006 increased 14% to $1.1 billion from $971 million in the same period last year. Net income from continuing operations for the fourth quarter of 2006 totaled $21.5 million or $0.54 per diluted share compared to $25.5 million or $0.58 per diluted share in the fourth quarter last year.

Operating results for the fourth quarter of 2006 included certain items that, in the aggregate, increased net income by approximately $2.0 million or $0.05 per diluted share. These items included pretax income of $6.4 million related to a favorable actuarial adjustment of professional liability costs, pretax income of $2.3 million related to favorable settlements of prior year hospital Medicare cost reports, and pretax income of $1.5 million from insurance recoveries related to hurricane losses. These items also included a pretax charge of $4.2 million to adjust certain estimated institutional pharmacy Medicare Part D revenues recorded in the first nine months of 2006, a pretax charge of $3.1 million to adjust the accounts receivable of an acquired institutional pharmacy, and a pretax charge of $5.3 million for professional fees and other costs incurred in connection with the proposed spin-off of the Company’s institutional pharmacy business and the rent reset issue with Ventas, Inc. (“Ventas”) (NYSE:VTR). The Company also recorded favorable income tax adjustments in the fourth quarter of 2006 that increased net income by approximately $3.5 million.

Operating results for the fourth quarter of 2005 included certain items that, in the aggregate, increased net income by approximately $2.2 million or $0.05 per diluted share.

On January 1, 2006, the Company began to recognize compensation expense prospectively in its consolidated financial statements for non-vested stock options. The expensing of stock options reduced fourth quarter 2006 net income by approximately $1.6 million or $0.04 per diluted share.

Discontinued Operations

During 2005 and 2006, the Company entered into transactions related to the divestiture of unprofitable businesses. For accounting purposes, the historical operating results of these businesses and losses associated with these operations have been classified as discontinued operations in the Company’s consolidated statement of operations for all historical periods.

For the fourth quarter of 2006, the Company reported net income from discontinued operations totaling $0.6 million or $0.02 per diluted share compared to net income of $1.0 million or $0.03 per diluted share in the fourth quarter of 2005. Operating results for discontinued operations in the fourth quarter of 2006 included favorable pretax adjustments aggregating $2.0 million ($1.2 million net of income taxes or $0.03 per diluted share) and $5.6 million ($3.4 million net of income taxes or $0.08 per diluted share) for the same period of 2005 resulting from a change in estimate for professional liability reserves related primarily to the Company’s Florida and Texas nursing centers that were divested in prior years.

Other Fourth Quarter Information

The Company also announced that it has reached a settlement with the Internal Revenue Service (the “IRS”), pending final documentation, related to all disputed federal tax issues for fiscal 2000 and 2001. In connection with the settlement, the Company agreed to pay approximately $3 million to the IRS in 2007. In the fourth quarter of 2006, the Company reflected the impact of the settlement in its consolidated balance sheet by increasing certain net deferred tax assets by approximately $16 million, reducing currently payable income taxes by approximately $70 million and increasing stockholders’ equity by approximately $86 million. Because of fresh-start accounting rules related to the Company’s reorganization in 2001, the settlement of these pre-reorganization income tax matters had no impact on earnings in 2006.

Fiscal Year Results

Continuing Operations

Consolidated revenues for the year ended December 31, 2006 increased 11% to $4.3 billion from $3.9 billion in 2005. Net income from continuing operations totaled $71.2 million or $1.74 per diluted share in 2006 compared to $131.4 million or $2.90 per diluted share in 2005.

The impact of certain quarterly adjustments in 2006 had no net impact on full-year operating results. In addition to the items reported in the fourth quarter, these items included a gain from an institutional pharmacy joint venture transaction, an unfavorable settlement of a prior year tax issue, and a charge for revisions to prior estimates for accrued contract labor costs in the Company’s rehabilitation division.

Operating results for 2005 included certain items that, in the aggregate, increased net income by approximately $37.7 million or $0.83 per diluted share.

The expensing of stock options reduced fiscal 2006 net income by approximately $6.2 million or $0.15 per diluted share.

Discontinued Operations

In 2006, the Company reported net income from discontinued operations totaling $7.5 million or $0.18 per diluted share compared to net income of $14.9 million or $0.33 per diluted share in 2005. Favorable pretax adjustments related to changes in estimates for professional liability reserves totaled $19.3 million ($11.8 million net of income taxes or $0.29 per diluted share) for the year ended December 31, 2006 and $42.3 million ($26.0 million net of income taxes or $0.58 per diluted share) for the same period of 2005.

Management Commentary

“Our consolidated fourth quarter results were strong, reaching the high end of our earnings guidance,” remarked Paul J. Diaz, President and Chief Executive Officer of the Company. “Our hospital results, which rebounded nicely from the third quarter, were driven primarily by the strength of our non-government business, higher overall admissions and improved operating efficiencies. Non-government hospital admissions grew 21% on a same-store basis from the fourth quarter a year ago. In our nursing centers, improved clinical outcomes and better customer service contributed to higher occupancy levels, better patient mix, lower professional liability costs and higher operating margins. We are pleased with the operational momentum we are gaining in our nursing center business and the opportunities for further improvements in 2007. Our Peoplefirst rehabilitation division continued to improve its operations, resulting in growth in revenues and operating income in the fourth quarter compared to last year.”

“While we are pleased with our consolidated fourth quarter operating results, our KPS pharmacy results in the fourth quarter were disappointing. Our soft operating results were primarily related to poor performance in our acquired pharmacy locations and transitional issues associated with the conversion to Medicare Part D. In the near term, we believe that we can improve the operating results of the acquired pharmacies by enhancing customer service levels and operating efficiencies. While we were quite successful in meeting the needs of our customers and most of the other challenges associated with Medicare Part D, we clearly had process issues with our Medicare co-payment revenues that were not adequately addressed until year end. Having addressed these issues, we can now work toward continued growth in KPS as we expand our customer base, better manage costs and improve our operations during 2007.”

Commenting on the Company’s full-year results, Mr. Diaz remarked, “Fiscal 2006 was a year in which we were challenged on multiple fronts. We began the year facing significant regulatory changes in each of our four operating divisions, the expiration of our warrants and a pending rent reset issue with Ventas. I am pleased with our successful operational transition through these reimbursement and operational challenges. We also successfully executed our share repurchase program and used all of the proceeds from the warrants to buy additional shares of our common stock. As a result, we reduced our diluted share count in 2006 by approximately 10% from a year ago and now have a more simplified equity structure. In addition, we successfully concluded the rent reset issue with Ventas in 2006, bringing clarity to our capital costs going forward.”

Commenting on the Company’s acquisition and development activities, Mr. Diaz noted, “During 2006, we acquired six hospitals (646 licensed beds), 11 nursing centers (1,579 licensed beds), four assisted living facilities (228 licensed beds) and three institutional pharmacies (4,593 customer beds). In addition, we opened two hospitals containing 98 licensed beds and opened five pharmacies in new markets through our organic development plan. In 2007, we will continue to seek further organic development and strategic acquisitions that enhance shareholder value and that reflect a more concentrated market-by-market strategy. We have already entered into a lease of eight additional nursing centers in northern California, and we expect to open four hospitals in 2007 that are currently under development.”

Mr. Diaz also commented on the Company’s planned spin-off of its KPS institutional pharmacy business, “We are making solid progress in combining our KPS business with the long-term care pharmacy business of AmerisourceBergen Corporation (NYSE:ABC) to form the new PharMerica, which will be the second largest operator in the industry. We are excited about the opportunities this transaction will bring to our customers, employees and shareholders and we expect that this transaction will be consummated in the second quarter of 2007.”

Mr. Diaz concluded his comments by saying, “Despite the external and operational challenges we faced in 2006, we turned in another very successful year not only from a financial perspective, but also in the important measures related to quality, clinical outcomes, human resource development and customer service. I am looking forward to 2007 as we continue to create more opportunities for our patients and their families, our employees and our shareholders.”

Fiscal 2007 Earnings Guidance – Continuing Operations

The Company announced its 2007 earnings guidance for continuing operations. The Company expects consolidated revenues for 2007 to approximate $4.6 billion. Operating income, or earnings before interest, income taxes, depreciation, amortization and rents, is expected to range from $587 million to $594 million. Rent expense is expected to approximate $356 million, while depreciation, amortization and net interest expense are expected to approximate $125 million. Net income from continuing operations for 2007 is expected to approximate $60 million to $64 million or $1.50 to $1.60 per diluted share (based upon diluted shares of 40 million).

The Company indicated that the guidance includes the operations of its KPS institutional pharmacy business for the full year but does not include any costs associated with the consummation of the proposed spin-off transaction. The Company’s 2007 earnings guidance also includes the estimated impact of the proposed rules issued by the Centers for Medicare and Medicaid Services on January 25, 2007 related to long-term acute care hospitals. The Company believes that these proposed rules, if adopted, could reduce Medicare reimbursement to its hospitals by approximately $20 million in the second half of 2007 (including the impact of a lower than expected market basket increase). The guidance does not include any other significant changes in reimbursement and does not take into account the effects of any material acquisitions or divestitures. While the Company does not provide quarterly earnings guidance, management believes that investors should consider the seasonality of the Company’s quarterly earnings, particularly the weakness in hospital admissions during the third quarter coupled with a negative proposed Medicare rule change that would take effect on July 1, 2007.

Mr. Diaz commented, “Our fourth quarter results have provided solid operational momentum as we enter 2007. While there will always be internal and external challenges in each of our operating divisions, we are excited about our opportunities for success in 2007 and beyond. As in the past, high satisfaction levels for our patients, customers, employees and physicians will continue to be the key drivers of our business success.”

Forward Looking Statements

This press release includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements regarding the Company’s expected future financial position, results of operations, cash flows, financing plans, business strategy, budgets, capital expenditures, competitive positions, growth opportunities, plans and objectives of management and statements containing the words such as “anticipate,”“approximate,” “believe,”“plan,” “estimate,”“expect,” “project,”“could,” “should,”“will,” “intend,”“may” and other similar expressions, are forward-looking statements.

Such forward-looking statements are inherently uncertain, and stockholders and other potential investors must recognize that actual results may differ materially from the Company’s 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 the Company is unable to predict or control, that may cause the Company’s actual results or performance to differ materially from any future results or performance expressed or implied by such forward-looking statements. These statements involve risks, uncertainties and other factors discussed below and detailed from time to time in the Company’s filings with the Securities and Exchange Commission.

In addition to the factors set forth above, other factors that may affect the Company’s plans or results include, without limitation, (a) the Company’s ability to operate pursuant to the terms of its debt obligations and its master leases with Ventas; (b) the Company’s ability to meet its rental and debt service obligations; (c) the Company’s and AmerisourceBergen’s ability to complete the proposed merger of their respective pharmacy operations, including the receipt of all required regulatory approvals and the satisfaction of other closing conditions to the proposed transaction; (d) adverse developments with respect to the Company’s results of operations or liquidity; (e) the Company’s ability to attract and retain key executives and other healthcare personnel; (f) increased operating costs due to shortages in qualified nurses, therapists and other healthcare personnel; (g) the effects of healthcare reform and government regulations, interpretation of regulations and changes in the nature and enforcement of regulations governing the healthcare industry; (h) changes in the reimbursement rates or methods of payment from third party payors, including the Medicare and Medicaid programs, changes arising from and related to the Medicare prospective payment system for long-term acute care hospitals, including potential changes to hospital Medicare payment rules, the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, and changes in Medicare and Medicaid reimbursements for the Company’s nursing centers; (i) national and regional economic conditions, including their effect on the availability and cost of labor, materials and other services; (j) the Company’s ability to control costs, particularly labor and employee benefit costs; (k) the Company’s ability to successfully pursue its development activities and successfully integrate new operations, including the realization of anticipated revenues, economies of scale, cost savings and productivity gains associated with such operations; (l) the increase in the costs of defending and insuring against alleged professional liability claims and the Company’s ability to predict the estimated costs related to such claims; (m) the Company’s ability to successfully reduce (by divestiture of operations or otherwise) its exposure to professional liability claims; (n) the Company’s ability to successfully dispose of unprofitable facilities; and (o) the Company’s ability to ensure and maintain an effective system of internal controls over financial reporting. Many of these factors are beyond the Company’s control. The Company cautions investors that any forward-looking statements made by the Company are not guarantees of future performance. The Company disclaims any obligation to update any such factors or to announce publicly the results of any revisions to any of the forward-looking statements to reflect future events or developments.

As noted above, the Company’s earnings guidance includes the financial measure referred to as operating income. The Company’s management uses operating income as a meaningful measure of operational performance in addition to other measures. The Company uses operating income to assess the relative performance of its operating divisions as well as the employees that operate these businesses. In addition, the Company believes this measurement is important because securities analysts and investors use this measurement to compare the Company’s performance to other companies in the healthcare industry. The Company believes that net income from continuing operations is the most comparable measure, in relation to generally accepted accounting principles, to operating income. Readers of the Company’s financial information should consider net income from continuing operations as an important measure of the Company’s financial performance because it provides the most complete measure of its performance. Operating income should be considered in addition to, not as a substitute for, or superior to, financial measures based upon generally accepted accounting principles as an indicator of operating performance. A reconciliation of the estimated operating income to net income from continuing operations provided in the Company’s earnings guidance is included in this press release.

About Kindred Healthcare

Kindred Healthcare, Inc. (NYSE:KND) is a Fortune 500 healthcare services company, based in Louisville, Kentucky, with annual revenues of $4.3 billion that provides services in approximately 600 locations in 38 states. Kindred through its subsidiaries operates long-term acute care hospitals, skilled nursing centers, institutional pharmacies and a contract rehabilitation services business, Peoplefirst Rehabilitation Services, across the United States. Kindred’s 55,000 employees are committed to providing high quality patient care and outstanding customer service to become the most trusted and respected provider of healthcare services in every community we serve. For more information, go to www.kindredhealthcare.com.