EXPERT OPINION: A Conversation with Paul Diaz

October 19, 2011

In this "Expert Opinion" interview, Paul Diaz, CEO of Kindred Healthcare, discusses the importance of efficient short term care in skilled nursing, Medicaid rates, the CMS 11.1% Medicare rate cut, and more.

Paul Diaz, Kindred HealthcareWatch the video      Read the transcript

Paul Diaz is currently President and Chief Executive Officer of Kindred Healthcare, Inc., one of the largest providers of healthcare services in the United States.  Kindred is a New York Stock Exchange listed company with revenues of $6 billion and approximately 76,000 employees in 46 states.

 Kindred operates a diverse blend of health care service businesses including long-term acute care hospitals, skilled nursing facilities and contract rehabilitation sites in approximately 2,000 locations across the United States. For three years in a row, Kindred Healthcare was ranked one of the Most Admired healthcare companies by Fortune magazine.

 Mr. Diaz is an attorney and accountant who earned a bachelor’s degree in Finance and Accounting from American University's Kogod School of Business and a law degree from Georgetown University.

 Mr. Diaz currently serves on the Board of Directors of DaVita (NYSE:DVA), and the Board of Visitors of Georgetown University Law Center. He is also a member of the Business Roundtable and the Wall Street Journal CEO Council. He was formerly on the Board of PharMerica Corporation (NYSE:PMC), the Board of the Bloomberg School of Public Health at Johns Hopkins University, and the Board of Trustees and Executive Committee of the Suburban Hospital Healthcare Systems in Bethesda, Maryland.

 In the past four years, Modern Healthcare magazine named Mr. Diaz one of the 100 Most Influential People in Healthcare.  In 2008 and 2010, Modern Healthcare named him one of the top 25 Minority Executives in Healthcare.  In addition, in both 2008 and 2009 Hispanic magazine named Mr. Diaz one of the 25 Best Latinos in business.

 

Contact Information:
Susan E. Moss
Vice President Communications
Kindred Healthcare
680 S. 4th Street
Louisville, KY 40202
Phone: 502-596-7296

 

Watch the video of the interview: 


 


 

Read the interview transcript:

Steve Monroe:
I’m very happy to have an old friend of mine, Paul Diaz, CEO of Kindred Healthcare. Paul and I have known each other for quite a long time- definitely prior to Kindred, and he’s obviously one of the leaders of the skilled nursing industry, and really the healthcare industry in this country.

Paul Diaz:
That’s kind. Thank you.

Steve Monroe:
Well, you’ve done a great job and last summer with the announcement from CMS of the 11.1% Medicare average cut—I know for some people it’s obviously higher—that was a shocker for the skilled nursing industry. We were really caught off guard. While everyone was expecting a cut, no one saw this magnitude. Did the skilled nursing industry just really get caught up in the whole deficit cutting problem?

Paul Diaz:
I think there’s an element of that. But let’s be fair. We always knew that it was the intention of CMS that RUGs-IV be budget neutral. We all had a sense, at least from a rate perspective, that rates were trending above RUGs-III rates. So I think we all, and I think it was certainly in the public discussions, expected that CMS would do some recalibration of rates.

We were all surprised that the recalibration was done seemingly all at one time, and particularly concerned that our commentary and concerns about the other changes, for which there really has been no economic impact analysis done in the regulations, weren’t really taken into account. So I think that it was and continues to be the position of most of the skilled nursing providers that we should be working to get to budget neutrality over two or three years as one thinks about a ten year budget window, and if the therapy changes should be taken into account in that regard.

Steve Monroe:
And they were. The problem I thought that the industry really had was, with this cut—and it came very quickly—CMS seemed to ignore any impact that RUGs-IV from a year ago had on quality care, and what the changes would do to quality care. So how do you measure quality care at Kindred, especially in regard to—assuming we have [accountable care] organizations and how that will fit in?

Paul Diaz:
So let’s talk about it in the broader context of the first question. I think it is fair to say that there’s very little health policy discussions going on right now. Things about quality and outcomes, there’s no oxygen in the room because the entire dialogue right now is about politics and the politics of budgets and deficits. That’s the only thing that anybody is talking about, and has been talking about really since the beginning of the summer.

I think you were right to say that part of what happened with the 11% is between OMB and the deficit—and it happened the same weekend as the big deficit debacle—there probably was just no oxygen in the room to talk about what the impact on quality or access to services might be.

There’s no doubt that cost went up in the transition from RUGs-III to RUGs-IV; we don’t think that that was really taken into account. But I think the more important thing that we’re pretty proud of is that, as we look at our success over the last several years through RUG-III through this transition of RUGs-IV, we are doing exactly what the policy-makers asked us to do. We’ve lowered length-of-stay significantly, and that matters in terms of budget neutrality, too. Our return to home is over 50%; our clinical outcomes, our survey outcomes- we monitor the rehab outcomes through using a modified FIM score like the rehab hospitals do. And we published all those clinical results, all those outcome measures, including re-hospitalizations. That’s very topical in a quality report every year and it’s in our website.

In all our policy discussions, that’s where we always start. We start with, hey guys, the basic value proposition that you wanted from skilled nursing is not to have long term care but have efficient short term care and get people home whenever possible- most obviously with chronic care patients that we have a responsibility to—but in terms of reducing re-hospitalizations, getting people home, rehab outcomes, functional improvement, we’ve been very transparent about that. And again, you can find our quality report on our website.

Steve Monroe:
But they’re not listening.

Paul Diaz:
But they’re not listening.

Steve Monroe:
And at Kindred, you guys have been really working hard on your cluster effort, having LTACs, skilled nursing, home health and hospice and inpatient rehab in cluster markets. Are managed care companies noticing that, and are you able to measure within those clusters how well you do the business?

Paul Diaz:
Yes. I’ll steal a line from a friend of mine. We’re trying to really stay focused, even with all of the noise around these budget discussions and more rate cuts and all of that, on where the puck is going and trying to skate to the puck. And where we think the puck is going is to more managed care.

Now I think that whether one talks about Medicare advantage or the care of the dual eligibles and the significant pressure that Medicaid is under and will be under in 2014 under Healthcare Reform and the expansion of coverage, I think senior sector and skilled nursing has to be really thinking about developing programs and services that are geared to managing the dual eligibles. And so we do think there’s a tremendous amount of appetite today, and growing, in integrated care at a local level, and we see that in the context of discussions around accountable care organizations, bundling and the growth and the consolidation we’re likely to see in managed care.

Steve Monroe:
So that’s going to be ramping up in your mind, regardless of what happens in the overall healthcare world.

Paul Diaz:
There’s no question, and just going back to one other point: As a technical matter, one could see maybe CMS is overcorrecting here, probably overcorrecting on the therapy changes. But the real problem, Steve, is Medicaid. Medicaid rates are flat to down. Governors are keeping the provider tax revenue. So if Medicaid rates are growing at 1% and our costs are growing at 2%, on 65% of our days, the skilled nursing industry is in a big hole. That’s gotten lost a little bit because of the headlines around the 11%. Medicaid is a big part of the problem.

Steve Monroe:
Well, I think it’s also gotten lost because with Medicaid, everyone just assumes it’s a loser. And what you’re saying is if it’s a loser today, it’s a bigger loser tomorrow.

Paul Diaz:
I think it just gets tougher. I think it’s hard to imagine it getting better on Medicaid over the next five to ten years.

Steve Monroe:
But let’s talk about your LTAC business. I would argue that Kindred, as a post-acute provider, is probably in the best position to handle especially the 11% Medicare cut for skilled nursing because you have your LTAC business which didn’t get cut. But investors seem to be ignoring this, and I don’t understand it.

Paul Diaz:
We don’t understand it either. I think investors and health care services period right now—HCA, Kindred, the baby, the bathwater, the tub, the towels—everything has been thrown out the window. There’s not a portfolio manager in America that wants to talk healthcare right now because all healthcare—LTACs, inpatient rehab, hospitals, Pharma—everybody is on the list, or some list. And so capital is not going to go with this level of uncertainty. I think you have a dynamic now that no one is looking at the fundamentals. So they’re certainly not looking at the incredible success we’ve had with the Rehab Care deal, our rehab business which is really doing very well, our Long Term Acute Care hospitals, our rehab hospitals, and with a general diversification. And we are more diversified than others.

At the end of the day, though, we are going to still be very successful, and we have to compete in every single market with some really good local regional operators in other companies. So right now, we are better positioned just because of the diversification financially. But we had to sort of earn that.

Steve Monroe:
Right. And speaking of the Rehab acquisition, you closed that this past summer. How is that integration going? Is it as planned? Better than expected? How are those assets going to help you in terms of dealing with Medicare cuts?

Paul Diaz:
We’ve talked a lot about this when we released Q2 earnings, and we provided guidance for 2011, closed the Rehab Care acquisition on June 1st a month early. And we also gave preliminary guidance for 2012 which was obviously intended to give people a floor of the valuation and we’re trading at five times, six times our 2012 guidance. So people don’t believe our guidance. We have a high degree of confidence in the guidance that we’ve given, and part of that is because the integration with Rehab Care has gone very well. The synergies are real. They are clearly going to be an offset to the rate cuts. We updated our synergy estimate to $55 in 2012 and $65 million for 2013.

And more importantly, the guys are just doing a great job. Ben, our COO, we’re executing the teams and the culture have come together. But it’s a bad situation. We put out the number. It’s approximately $115 million of negative impact for these rules for us. So it’s a big number.

Steve Monroe:
Well, talk about positive impact and negative impact, remember just before the RUGs-IV went into effect October 1, 2010, I did a little story on Kindred, looking at Kindred’s unencumbered assets and doing a valuation of that -that you own. And the valuation was something like less than 15% of your business. But just that small part was worth more than the entire market cap of the company. And with the Rehab Care acquisition—I haven’t done an updated analysis yet—but isn’t that story even more compelling today?

Paul Diaz:
There’s no question that the company is a lot more valuable today than it was a year ago.

Steve Monroe:
And no one’s going to break up the company and sell the assets, but again. Why are investors missing this? Is it just that they’re throwing everything in the same bucket?

Paul Diaz:
Yeah. I think everyone’s fear, in terms of the public market, is there as we saw yesterday, across the board in all companies. I think that our real estate is collateral for our term loans, and that helped finance the Rehab Care deal. It’s a very important part of why we didn’t want to do a dividend recap with our real estate.

And part of the reason the Rehab Care deal is so successful is we didn’t overpay and we were very disciplined about the financing. We got a really good financing deal. So today, we’ve got a lot of capacity under our revolver, almost $350 million of capacity under our revolver, the ability to expand up to about $500 million in terms of our term loan and our revolver. And so we’re trying to look ahead to ’13 and ’14 on how we’re going to continue to grow. And if you look at our guidance, our guidance suggests that we’ll do $275 million to $300 million of operating cash flow, which we’ve talked about publicly. The routine cap ex is about $125 million.

That gives us a tremendous amount of free cash flow to continue to pay down debt or continue to grow in our cluster markets. We recently announced $53 million home care deal out West in our cluster markets that we’re very excited about. We’re going to keep our heads down and continue to look for opportunistic ways to go.

Steve Monroe:
Talk about opportunistic ways, when you look at the Medicare cut, in a kind of perverse way, is that going to open up acquisition opportunities for you on the skilled nursing side?

Paul Diaz:
There’s nothing good about this rule.

Steve Monroe:
Other than people may sell at a lower price for you.

Paul Diaz:
We’ve been doing this for a long time. People tend to dig in more.

But there could be some opportunities. We have been very selective acquirers over the last ten years at Kindred, and we’ll continue to be that. But if we can find really good assets like we did last year in Dallas and Los Angeles, we love to tuck in high quality skilled nursing assets that we can then turn into transitional care centers. We can programmatically and, with some expansion capital and renovation capital, move to our sub-acute model. And hopefully there will be more opportunities like that.

Steve Monroe:
Good. Lastly, 2012 is the year of the election. Is there a fear that, given the heated arguments going on in Washington, that 2012 from a business, financial, everything, is going to be a dead year? No decisions being made because everyone is waiting to see what happens with the election?

Paul Diaz:
I think that’s already happened. I think sadly, at a time when we need leadership—and this isn’t a senior living issue, it’s an American issue—we’re sort of paralyzed. Some of it is the extreme views of some folks on certain issues where we really need to make decisions and move on. But I fear that we’re so polarized and that that’s going to continue through the presidential election. It’s hard to imagine that people’s positions are going to soften. But I hope I’m wrong.

Steve Monroe:
I hope so, too. But I’m not holding my breath for it.

Paul Diaz:
No. Thank you for the time. It’s great to catch up.

Steve Monroe:
Well, good luck. I hope it continues to go well with Rehab Care.

Paul Diaz:
We’ve got a great team. Everyone is working hard. We’re just going to keep putting one foot in front of the other.

Steve Monroe:
All right. Good luck.

Paul Diaz:
Thanks.

 

 

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