Ed Lane: What are the principal health care areas in which Kindred Healthcare provides services?
Paul Diaz: Kindred Healthcare’s focus is obviously the elderly. Increasingly, we are seeing a growing subset of chronically ill patients who are in their late 50s or early 60s. In the state of Kentucky, the consequences of smoking and obesity have increased the growth rate of diabetes, heart disease and respiratory conditions. Kindred sees that cohort as the cause of an increased demand for long-term acute-care hospitals, short-term nursing centers and rehab centers.
EL: What are Kindred’s annual revenues?
PD: The last fiscal year (ending Dec. 31) Kindred reported $4.2 billion. 2007 revenues are after the spin-off of our institutional pharmacy business.
EL: On July 31, 2007, Kindred spun off Kindred Pharmacy Services. KPS combined with AmerisourceBergen Corp. to form a new entity – PharMerica Corporation. Why did Kindred decide to do this spin-off and what were the benefits to its shareholders?
PD: We think the merger was beneficial to our employees and patients, as well. David Yost, CEO of AmeriourceBergen, and I saw an opportunity to put our institutional pharmacy businesses together into what is now the second-largest U.S. institutional pharmacy business. Essentially, we simultaneously spun off each of those divisions and merged them in a very unique transaction from a tax structure standpoint and made it a new public company.
EL: PharMerica announced that its corporate headquarters would be located in Louisville. Could you discuss how this decision was made – the benefits of being located in Kentucky, the involvement of Greater Louisville Inc., the Kentucky Cabinet for Economic Development and Mayor Jerry Abramson’s office?
PD: Everyone came together on an aggressive economic package. Mayor Abramson, Joe Reagan of GLI and Gene Strong of the Kentucky Cabinet for Economic Development (who has since retired) were all incredibly proactive. Kentucky did a much better job than the state of Florida in the competition for PharMerica’s corporate headquarters. I wouldn’t say incentives were the primary driver of the decision. The economic stimulus package was a very important element and helped make the case, but there were other strategic reasons. We looked at the pros and cons of a Tampa headquarters. Louisville was a place to make a fresh start and is very centrally located. It’s also important to note that Tampa remains a very important office within the company with a customer service center located there.
EL: Who runs PharMerica?
PD: Greg Weishar is CEO of PharMerica. He was a great hire for us. Greg came to us from PharmaCare Management Services Inc., a subsidiary of CVS Corp. He is a wonderful executive and has done a great job of leading the integration of the two companies.
EL: Do you have any ongoing involvement in PharMerica?
PD: I serve on the board of directors until July ’08. David Yost and I felt that continuity was important for investors and employees and agreed to stay on the board for a year. Greg and Tom Mac Mahon, the chairman, have done a great job of recruiting new board members. It’s important for PharMerica to be independent, but there are still important relationships – Kindred is a very large customer and AmericsourceBergen is an important distributor for PharMerica.
EL: Do you know approximately how many employees the company has in Louisville?
PD: PharMerica now has about 150 employees with an expectation that employment will grow to 200-250 over the next year or two.
EL: How is the stock price doing now?
PD: Very well. Today, PharMerica is now trading at about $20.24; I saw that on the ticker this morning. Kindred hit $30 last week and is trading around $29. Today Kindred shareholders are holding securities (Kindred and PharMerica) with a combined worth of about $35 a share.
EL: How many of Kindred’s health care services are government regulated? How would you describe the current government-regulated reimbursement environment?
PD: Reimbursement in the health care industry is a challenge for Kindred, much in the same way that others are challenged by fuel and commodity prices. It is a struggle, both in terms of federal reimbursement policy (Medicare and a big Medicaid component), state Medicaid policy, and inconsistencies in terms of these policies. Kindred is similar to a heavily regulated public utility and, appropriately so, it needs to be very transparent and accountable to those government programs that represent the citizens of the U.S. and Kentucky.
There is great predictability for energy and other utilities in terms of pricing. Health care providers suffer from a great deal of schizophrenia in payment policy. This makes it hard to build a sustainable operating model and to attract investment capital. Kindred is spending an increasing amount of energy to gain better creditability and transparency around the values that we create in our hospitals and nursing homes. We are spending a lot of time advocating for a more stable and transparent government re-imbursement policy.
EL: How is KHI managing to improve operating efficiencies?
PD: A lot of our efforts center around our people – our greatest asset – and the driver of the most value is our employees, nurses, housekeepers and physicians. Kindred spends a lot of time and energy on recruiting and retaining its employees. We have identified a fairly simple business proposition. If we do a better job of training, recruiting and retaining employees and they feel recognized and rewarded for their contributions, they will understand the organization’s values are centered around its patients and their care.
Kindred has been able to drive and improve customer satisfaction scores and improve clinical outcomes. That in turn has made us more efficient and better able to manage supply costs. Our high quality creates comfort for physicians and hospitals that refer to Kindred. That grows our volumes and admissions. It’s a very simple business proposition that we talk a lot about – our people and quality drive our business success. A lot of our reward systems and culture focuses around that philosophy.
EL: In 2000, Kindred had a very large employee turnover (over 100 percent). How has the company reduced the rate of turnover?
PF: Turnover is one of the leading indicators we carefully monitor at the staff and local management levels. With over 600 service sites, how do you get a culture aligned and everyone rowing the boat in the same direction so we can create value for everybody? Retaining and recruiting the best local managers is really the bread and butter for Kindred. The hospital CEO or nursing home executive director are clinical partners. Recruiting the best people and keeping them in those jobs is probably the single best thing our managers can do to drive shareholder and patient values.
EL: Nationwide there is in huge demand for health care workers. Not only does Kindred have internal turnover but your competitors are also aggressively recruiting.
PD: Kindred has increased the number of its employees who have access to health, wellness and benefit plans. We know that employees who enroll in our 401k and participate in our health insurance and wellness programs don’t turn over. They are more loyal and engaged. They are better caregivers.
EL: In FY07, the company had an operating profit of $34.7 million but lost $77 million in the divestiture of operations. Could you explain the FY07 write-off?
PD: Every year since 2002, management has been in the process of cleaning up the company – divesting non-strategic assets and facilities. In the past Kindred was also challenged with significant malpractice insurance costs. There was a point in time when insurance issues made it virtually impossible to operate our nursing centers in Florida, Texas and Tennessee, and Kindred divested a number of assets in those markets. Our recent divesture was the consequence of a lot of things, going back to the bankruptcy and before. It’s been a long process.
There were very few hospitals and nursing centers in the 2007 reorganization. None of the facilities closed were strategic from a geographic standpoint. Some had physical plants that were very challenged, others did not fit into our clinical strategy or had high malpractice costs associated with them.
EL: Cornerstone Insurance Co., a limited purpose insurance subsidiary, insures Kindred for professional and general liability risks. How has this approach at self-insurance worked for Kindred?
PD: It’s been very successful. The primary driver of that success was not the insurance program. It hass really been three things: Our malpractice and workers compensation costs have been reduced principally because of quality initiatives. Kindred developed a very aggressive risk-management program including the use of nurse paralegals and others to work more closely with facilities in quickly identifying risk management errors and/or issues and proactively dealing with patients, families and physicians on those issues. Our liability claims department has done a really great job of managing the inventory of claims and working with our outside counsel. Back in 2002, we realized that the underlying issues were not insurance or re-insurance. The things driving the actuarial process were the frequency and severity of claims. We attacked those issues with a great deal of energy.
EL: How does Kindred get its patients?
PD: Almost 95 percent of referrals into Kindred’s nursing centers, rehab centers and long-term acute-care hospitals come from short-term acute-care hospitals. Those referrals might be generated by a physician, a case manager of a managed care organization, or a discharge planner at a short-term acute-care hospital.
EL: If Kindred makes future acquisitions, would it be a multilocation entity or would it acquire one hospital at a time?
PD: Our history has been to be fairly judicious in terms of acquisitions. This depends on the circumstances. The challenge to doing a larger acquisition is less strategic and more a question of price. We’re fairly conservative in terms of valuations. We would more probably invest in organic growth, new hospitals and smaller as opposed to larger acquisitions, but we’re looking at larger acquisitions all the time.
EL: What about new development?
PD: Kindred’s recent development includes the five or six hospitals that we’ve opened in the last 12 months. We have seven hospitals under development right now. The majority of our development program has been free-standing hospitals.
EL: How is the economy affecting Kindred’s business?
PD: Kindred is experiencing the same challenge that everyone else is seeing. Our workforce is predominately folks working at a living wage. Kindred stepped up its minimum wage early because it’s important to retention and recruiting goals to get folks more access to benefits. We offer three insurance programs so that our employees have coverage options. We take that social responsibly as a good business practice too. But when it’s costing a nurse $4 a gallon to drive to work, particularly in rural markets, that’s a big challenge. Increased costs of goods and the energy to air condition our hospitals and nursing homes are all challenging, particularly in the context of the squeeze in reimbursements.
We see inflation in wage rates, benefits and supplies. Think about all the plastics Kindred uses and the petro-costs that go into making medical supplies and devices. These costs are growing at 4 to 5 percent, so when federal or state governments give us a 2.8 or 3.0 percent market basket adjustment (increase), we get squeezed. Trying not to be the ones getting squeezed is challenging.
EL: How is clustering Kindred’s operations beneficial?
PD: There are really three opportunities in our market-cluster strategy. First, we think we can operate more efficiently. If you have – as we do in markets like Boston with eight hospitals and 40 nursing centers – a number of facilities that are geographically close, Kindred can buy landscaping services, do job fairs, be a more visible employer and have our hospitals do laboratory services for our nursing homes. Lots of things on the expense side – like training and education – can be more efficient in cluster markets. The long-term strategy is to grow more clusters.
Second, Kindred can invest more in R&D around our programs and clinical education.
Thirdly, on the revenue side in a cluster market, Kindred can be more successful in marketing its services to physicians, managed care payers and hospital systems.
EL: How would you evaluate the work and effectiveness of GLI?
PD: We have found GLI incredibly supportive in the context of the PharMerica transaction and generally sensitive to the business community and trying to support the business community’s interests at the state level. It is a challenging environment to try to attract companies. There’s a lot of competition for that. But I think the GLI team is doing that in the context of the challenges and economic issues that could continue for another year or year-and-a-half.
EL: How do you see economic issues in the coming year?
PD: It doesn’t seem to me that supply-demand is driving oil prices. It seems other factors – speculators and geo-political risks – are affecting prices. Supply-demand doesn’t move prices $10 a barrel over 10 days. That doesn’t make a lot of sense to me – from a 100,000-foot perspective. That being said, the combination of oil prices, home foreclosures and higher food costs are all converging on consumers and our workforce. It’s going to make for a tough year.
EL: UK and UofL are major Kentucky educational entities in medical training, medical research and health care services. Do these state universities provide benefits to Kindred in its day-to-day business activities?
PD: There is a lot of good work going on in both university systems. We have had good conversations from time to time – particularly with the University of Louisville – on things that we might be able to do. One of the areas is more nurse management education, hopefully in partnership with one of these nursing schools. It’s an early conceptual idea. Kindred is looking at expanding its training facilities in Louisville, and we don’t have all the skills in-house. It’s beneficial to have a partnership in training nurse managers, which is different from clinical training skills for nurses. There are HR and supervisory skills, how you teach someone in clinication, and how to do clinical assessments. These are different skills than you learn in nursing school and the kind of training Kindred wants to do more of.
EL: What suggestions could you make regarding making Kentucky more attractive to new and expanding businesses?
PD: One of the things Kindred struggles with is direct airline flights. Mayor Abramson was great in really trying to get direct flights to Boston, and now they’ve been cancelled. Again, the airlines are going through a tremendous amount of challenge. Kindred has invested in the technology to allow us to do more video conferencing, and we’ll probably continue to expand that. We would prefer to have people in Louisville whenever possible and do face-to-face training and education here. But it is hard when people have to spend a day and a half traveling just get here.
EL: Do you have a closing comment?
PD: Kindred is very appreciative of all the support that its received over the years from the city and the state. We have embraced the challenge at both the federal and state levels to continue to demonstrate the value we are creating for employees, patients and their families, and our shareholders. We do see a great deal of opportunity over the next five years to create a lot of value for all of these constituents, and we appreciate the support of political leaders and others to allow Kindred to do that.
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