U.S. Physical Therapy, Inc. (USPH) Q2 2017 Earnings Report, Transcript and Summary

Good morning. My name is Stephanie, and I will be your conference operator today. At this time, I would like to welcome everyone to the U.S. Physical Therapy Q2 2017 Earnings Conference Call. [Operator Instructions] After the speakers' remarks there'll be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn the call over to Chris Reading, Chief Executive Officer. Please go ahead, sir.

Thank you. Good morning, and welcome everyone to U.S. Physical Therapy second quarter 2017 earnings call. With me on the call today include Larry McAfee, our Executive Vice President and Chief Financial Officer; Jon Bates, our Vice President and Controller; and Rick Binstein, our Vice President and General Counsel. Before we begin to discuss our results, we need to cover a brief disclosure. Jon, if you would, please.

Thanks, Chris. This presentation contains forward-looking statements, which involve certain risks and uncertainties. And these forward-looking statements are based on the company's current views and assumptions, and the company's actual results can vary materially from those anticipated. Please see the company's filings with the Securities and Exchange Commission for more information.

Okay. Thanks, Jon. So I'll start the call today by covering some of the financial information and operating results and then leading that into a discussion and a narrative about what we are doing and what is happening in the company, both for the quarter and as we go forward for the rest of the year. First, let's begin with our top line revenue growth, up 15.3% this quarter, which is ahead of where we've been of late. That increase came as a result of a 10% increase in our PT-based revenue, and included in that is a modest net rate improvement for the quarter-over-quarter period to $105.73 a visit. And the bulk of the rest of the revenue increase was due to our workforce performance solutions business, which we acquired March of this year. Let me just say also that the performance of that partnership has been terrific right out of the gate for us. We expect many good things to come from that transaction and that relationship. So for the quarter, revenue was very solid. Same-store revenue improved to 3.5% on a quarterly comparison while improving sequentially as well. Same-store volume, 2.6%, was also an improvement from earlier this year and against the particularly challenging quarterly comp from the year prior. April and May of this year set records for the highest visit per clinic per day volume we've ever seen, so generally speaking, I've been pleased with where our volumes have been trending and also very pleased with the performance of all of our recent deals, including, as I mentioned earlier, our workforce performance solutions partnership, where we are also working hard to add to that area of our expanded business. So volume's been pretty good. Development has been very good. We closed two very good deals in the quarter with terrific people, and we are seeing and landing good deals with very good people who are very capable and who, we believe, will help us grow for many years to come. So what's left? Well, in spite of the fact that this was technically a record operating results quarter, reporting $0.59 for the quarter against what was a previous highest quarter last year in Q2, we left some opportunity on the table in the form of carrying too much facility based expense, most of this in the form of salary and wage expense. Now before I outline what we are doing about that issue, I have to also point out some of the issues related to the pace and timing of our start up clinics, which are helping to depress our margin in the short run. Our pace of startups has increased, and we are on track for another very good year. And this, in combination with some lower margin deals which we've done recently on a combined basis, results in gross margins of those 2 groups around 11% to 12% range, which are decidedly lower than our core group of facilities. Now back to what we're doing about this issue and where we have opportunity. The issue is especially concentrated in two regions, but it's something that we are working on overall as well. And one of the regions under new leadership, we are making the necessary changes that I believe will result in growth and the right balance of staffing. The other region has made the necessary reductions and adjustments and needs now to find further traction for growth. While we always want to do and be our best, sometimes, we fall short, and we fell short this quarter balancing volume and expenses. We made a lot of adjustments, however. Most of that was late in the quarter to have any real impact -- too late in the quarter to have any real impact. But for the remainder of the year, those adjustments should have a beneficial effect. In retrospect, we may have thrown too much at the ops team at one time. We rolled out our new analytics tool to help pump up volume and referrals, which we felt was important to do, and we spent a lot of time on that. And while we are also working on the cost issue, I think in retrospect, we had too many balls in the air at one time for our team and our partners. I'm confident, though, that this will remain an important primary focus for the ops group as well as our partners. And now that we have some time with our new analytics tool to identify referral opportunities as well as tuck-in possibilities, I think that combination and focus will pay off for us as the year rolls forward. In order to help us fully regain and then maintain our footing in this important area, we've decided to add a corporate resource service and extra pair of hands and eyes on our facility cost situation. We hope to be able to fill this position quickly while we soon head into budget and planning for 2018. Safe to say this is and will be an ongoing priority and one where we are not satisfied with where we are or how we have done recently, so we will continue to make modifications and adjustments and resources focused on people until we return to the consistency and stability that we believe we can achieve in this area. Now I would like to ask Larry to cover the financials in greater detail before we open things up for questions. Thank you. Larry?

Thanks, Chris. Chris had some of the macro total revenue numbers, so I'll skip over that. As it relates to physical therapy operations, revenues increased $9.3 million to $97.7 million for the quarter due to an increase in patient visits of 10% plus an increase in the average net revenue per visit to $105.73. Revenue from the recently acquired workforce performance solutions business was $4.4 million. Our total clinic operating costs were $79.7 million or 76.5% of revenue. Rent, clinic supplies, contract labor and other as a percentage of costs were 19.2%. The provision for doubtful accounts was under 1% at 0.9%. Gross margin for the second quarter was $24.5 million or 23.5%. The margin from the PT operations was 24.4%, and the lower-margin workforce performance business came in at 15%, which was actually ahead of plan. Corporate office costs were 8.5% of revenue. Operating income for the recent quarter increased 4.3% to $15.7 million. Operating results rose 3.4% to $74 million. And as Chris mentioned, diluted earnings from operating results was $0.59. I'll now hit on some of the highlights for the first half of the year. Net revenue increased 13.8% to $201.8 million. Our PT operations revenue increased $17.8 million due to an increase in total patient visits of 10.1% coupled with an increase in the average net rate per visit to $105.39 from $105.25. Revenues from the workforce performance solutions business for the four months we've owned them was $5.9 million. Total clinic operating costs for the six months, 77.6% of revenue. Clinic salaries and related costs were 56.7%. Rent, clinic supplies, contract labor and other, 19.9%. And the provision for doubtful accounts for the first six months, also less than 1%, 0.9%. The gross margin for the first 6 months of the year was $45.3 million or 22.4%. The gross margin for the workforce performance solutions business, 14.8%. Corporate office costs, 8.6% of revenue. Operating income for the 2017 first 6 months rose 5.1% to $27.9 million. Operating results for the first half of the year rose 7.3% to $14 million or $1.11 per share. Same-store revenues for de novo and acquired clinics open for a year or more increased 2.8%. Same-store visits increased 2.4%, and net rate increased slightly. As for other financial measures for the first six months of 2017, the company's adjusted EBITDA grew by 5.2% to $29.3 million. Because of the recent acquisitions, the actual run rate is higher than that. Additionally, despite having spent approximately $45 million in the first half of the year for acquisitions, capital expenditures and dividends, our debt balance increased less than $24 million as our net free cash flow from operations has been strong. Our leverage remains a conservative 1.2 times EBITDA.

Thanks, Larry. That concludes our prepared comments. With that, operator, let's go ahead and open it up for questions.

[Operator Instructions] Our first question comes from the line of Brian Tanquilut with Jefferies.

So first question, I guess, for Larry. You haven't given guidance for the year, but how should we be thinking about your outlook for the second half [because we] think about the progression of earnings over the course of Q3, Q4?

We gave guidance. I don't have it in front of me, but we gave it. And we're still in that range.

Okay, still in that range. Got you.

I don't have it in front of me, but we've given our earnings guidance.

And Brian, what we'll do, as the year goes on, if we think we're going to be either outside that range materially, we'll do an update. But it's out there. I don't have it in front of me right now either. I'd throw it out, but I'm worried about missing by $0.01 one way or the other.

Okay. Yes, that's fine. And then Chris, as we think about M&A outlook, I mean, you've clearly done a pretty good job doing deals this year. I mean, is there anything that you're seeing that's driving incremental deal flow this year? And how should we be thinking -- I know you hate thinking about [the] pipeline, but how should we be thinking about your M&A outlook for the next 12 months given what's happening in the market?

Yes. The insight that I'll give you is that it's been an active time. We're seeing deals come to us through brokers. We're seeing relationships that have been cultivated over a period of years result in people getting to the point where they now feel like it's a good time. So we continue to be active. I'm very active. We've taken one of our top folks internally, who is a great person, been with us for a decade on the recruiting side, and she's now working with me, working to identify new opportunities and set up calls and facilitate more interaction. So my hope is we can continue on a good pace, be selective as we have been and [but] get good things done. I think it will -- I think the market will continue to be active for the foreseeable future, and I hope we can continue to be both desirable and competitive as we have been. So we'll work to make that happen.

I'm sorry. Go ahead, Larry.

I just found the guidance figure. It's $2.07 to $2.16.

Okay, I appreciate that. Last question for me, Larry. As I think about rate growth, you had pretty good rate growth this quarter. I mean, should we think of that as something that is sustainable at this point? Or I guess it's not [even] rate growth. [But] it's the net revenue per visit. But is that something that we should be modeling going forward?

Well, in our budget, we had it flat for the year. It's interesting that the rate went up because I think we discussed that some of the recent acquisitions had a significantly lower net rate than our average, which actually pulled us down a little. But I wouldn't necessarily increase it. I'd probably just keep it flat for modeling purposes.

I agree.

And there's some good news coming out at CMS and other places, so we're optimistic, but I wouldn't model it yet.

Thank you. Your next question comes from the line of Larry Solow with CJS Securities.

Just maybe quickly, could you just follow up on that little -- on that CMS teaser? And then I have a couple of questions.

Larry, you want me to take it? Or do you want to take it?

You speak good.

So CMS went through recently -- and it's been a rather prolonged process for physical therapy specifically, and there was some anxiety among our -- across and among the community and the trade association about the process. But they went through what's called a misvalued code process, which is something that they do every so many years. And it hasn't been done in a while for PT. And as a result of some work that our APTQI group did -- this is our trade association, if you would. We formed a group with the largest companies in our industry, created a 501(c)(3)and began to work on some very important industry things that, long term, would impact our company. And so this is something we got very involved in, along with some coding reform issues in prior periods. In any event, to their assessment, rather than adjusting codes downward, which was the fear that the APTA had that CMS would do, some of the more frequently used codes got modest, not significant but modest, upward adjustments and no downward adjustments. And so again, it's not a huge uptick, but I think it's definitely a win and it gives us what I hope is another steady period that shouldn't be dramatic in one direction or the other for this next coming year. That's what we're expecting right now.

So it avoids any near-term risk or is that where you are on pricing on that side of the business? So that is certainly a positive. Just on the same-store volume, closing in on -- or close to 3% this quarter, a little bit of an improvement from, I think, the last two quarters. Or maybe it was close to one of those other quarters. But is this sort of a comfortable place you think or a targeted growth outlook for you guys?

It's always hard to tell. I mean, we're not satisfied. We always try to deliver as much as we can and get as many people in the door as we can. But it feels better than where we've been, and it's something we're working to keep. Q2 last year was a tough comp. But I think with the tools that we have and the focus -- we have some seasonal ebb and flow, but we do that every year. Yes, I would say in this range is kind of where I hope, at least, we can stay.

And then just lastly. You mentioned some excess costs at your facilities, and I know this has been sort of a reoccurring issue, often driven by sort of the acquired clinics. And then you guys have done a great job at bringing costs down. It sounds like this time around, maybe it's a mixture of both? And do you have sort of any targets on time line or any other quantitative things you can share?

Yes. So it's a mix. It's true that some of our acquired clinics, from a productivity standpoint have, a little lighter productivity and, in some cases, a little higher cost. But like anything else, that's also a portfolio. And we just -- for whatever reason, and I'm not going to make excuses, we need to do a better job staying on top of day-to-day costs, and this is kind of a day-to-day problem. Over 600 facilities, $30 a day equates to a few million dollars a year, more than a few, $4 million, $4.5 million. And so we've made some adjustments. They're not massive. And I don't want people to think we've had massive layoffs, but they're headcount adjustments, in some cases, hourly adjustments. And I expect that those are going to stick for the year, somewhere in the neighborhood for the remaining part of the year of about $1.8 million compared to where we've been. Now we're going to continue to do deals. We just did the South Carolina deal, which is a good-sized deal, which really wasn't in the Q2 numbers and will be in the numbers going forward. So we're going to have some moving parts here, but we're not real happy with how we have handled this of late. And everybody understands where we are and what we've got to do, and we've got to do it a little better than we've done lately.

Your next question comes from the line of Mitra Ramgopal with Sidoti.

First, a couple of questions on M&A. As you look in terms of the opportunities going forward and having recently done the workforce performance acquisition, are you more inclined to look more in that area or still try to keep the focus on the underlying clinic network?

No. I mean, we think that this workforce performance solutions business ties in really well with what we already know and do. We like it. We like the leadership team there. We like the platform. And so we're actively -- I'm actively in discussions with myself and the CEO of that partnership based in -- based out west. We're in active discussions with a number of different companies. So we're going to add to that group. So it's not really -- I wouldn't say it's a focus shift, so we're not taking our focus off PT and switching it to a different area. These are -- many of these people that run these companies, some are a little larger than others but most are similar size to the PT companies that we typically acquire, many of the leaders of these companies are PTs or athletic trainers. And so they're people that we also have run into over the period in the industry. And so it's not a big departure, and we're going to remain active on both sides. If you consider one side versus the other, we're going to be active in both.

But these clinical PT acquisitions are generally larger, and we have more opportunities there in terms of what we're looking at.

Yes, for sure. Larry is absolutely right. There are just more -- many more PT companies and clinics out there than there are these regional providers of work solutions.

Right, okay. And again, Larry, if you could remind us how much you have available in terms of the revolver that you could put to work post the most recent acquisition?

At June, 69 million.

All right. So we have 125 million facility, actually, we have an accordion feature we could expand it, at any point. We have 69 million outstanding at the end of the quarter, so we have plenty, we're not, in any way, capital-strapped.

Right, okay. And Chris, just more of a big picture question. Obviously, there's a lot of uncertainty over health care and insurance and what really happens on the ACA, et cetera, over the next few quarters. Are you seeing any maybe change in terms of the procedures, et cetera, the referrals you might be getting as consumers maybe try to adapt to the environment?

Yes. I can't say that I have. We're not aware of any. I mean, you guys see the numbers. You watch the same TV shows that we all watch. And so, yes, there's a lot of dialogue and a fair amount of uncertainty as to what's going to happen. And yet from a market perspective, we're not seeing in the numbers or we're not hearing any shifts in terms of consumer activity or referral-based activity just -- in this period versus any other recent period, pre-election, let's say. So that's not to say that a major change couldn't result in a different pattern, but it's not showing up.

Right, okay. And then finally, Larry, I don't know if you have maybe the payer mix handy.

Yes. Just one thing, a follow-on to what Chris was talking about in terms of the macro health situation. I will remind the listeners that we don't do much Medicaid. A lot of what's being debated now has to do with Medicaid. It's less than 2% of our business. And as for the rest of it, most of our business is your typical commercial payers. That was 50.2% in the second quarter. Workers' comp was 14.9%. Medicare and Medicaid combined were 26.9%. And then other was 8%. Again, with our focus on suburbs, a lot of our patients had insurance, even if they're in one of the affordable care plans now, had insurance before. And it doesn't look like anytime, near term, ObamaCare is going away, so our patient volume has been really pretty good.

[Operator Instructions] Our next question comes from the line of Mike Petusky with Barrington Research.

I appreciate the candor on the labor cost issue. So I guess I want to understand that a little bit better. The $1.8 million, you said you essentially took out at the end of the second quarter. Am I understanding that right?

Yes. Jon -- I don't have it right in front of me. So with the changes that we've made when we look at what remains for the year, that's effectively the impact over the next six months.

Most of the cuts were made in May, June and July, and included in the second quarter were some of the -- obviously some of the some severance costs related to that. So you just didn't see the impact yet of the cuts.

Okay. So was it issues around kind of full-time therapists? Or is there a kind of a PRN aspect to this, too, where you're just using too many kind of part-time folks?

Well, I mean, we -- there were a number of full-time cuts. There were a number of part-time people who we cut their hours. There were some PRN and temp issues, which we addressed, but it was a combination.

Okay. And then also, I guess, part of this is integrating the M&A. And I guess my question around that is, is there more to do, I guess, on integrating M&A in terms of rightsizing that labor? And then is there more to do just in general around these issues you've already cited that you've tried to get after?

I think the more-to-do part is we need to do a better job on the minute-to-minute management. And when I say minute-to-minute, obviously that's a little bit of an exaggeration, but really happens day in, day out. You have to decide whether you've got the right mix for what your schedule looks like. And so at our partners -- with the partners, acquired or otherwise, got to stay on top of that. Now we don't -- when we acquire these companies, whether they're lower margin than us, and a number are, or higher margin, we're paying for them where they are. We don't go in and overturn what they've been doing. That just creates a big destabilizing force. Now over time, as we grow, and most of these deals are growing nicely, we don't have to reduce staff. And we might grow into what they have, and we might gradually become more efficient. And that's certainly the goal, particularly if there's some inefficiencies. But there's not a big upside-down process that happens after we do these transactions. These changes occur slowly. But we have opportunity. We have opportunity in a number of areas, and we're not going to realize all those all at once. But in this particular area, it's a focus, and we need to stay on top of it.

None of the cuts we made were in recent acquisitions. Now some of the cuts were in acquired clinics, but they were acquired practices that we've owned for years.

Okay. All right. I guess any insight into how the quarter has started in terms of volumes through the end of July or anything to say there?

I don't really have any stats to share with you. I mean, it's the normal seasonal pattern, where you see a slowdown in the summer.

Yes. I don't want to get too far ahead in the quarter, and there isn't anything ominous about that. It's just -- I just think where we are and what we have going on, we're best to just focus on what we have out there in the public market right now.

There's nothing negative to report. I don't want people to be scared, but I just don't have any data.

[Operator Instructions] Our next question comes from the line of [Richard Focul], a private investor.

I have a question just about the interplay between your balance sheet and income statements on the mandatorily redeemable noncontrolling interest liability, and I'm proud that I said that in one breath. If I just look on your balance sheet from first quarter to second quarter, the liability grew about $3.5 million. And as far as I can tell, there were no payments made during the quarter. But on your income statement, you showed an expense of $3.9 million, plus or minus. So I'm just looking for some color as to -- I would have expected those numbers to be the same, and yet the income statement has a larger charge than the balance sheet change. Can I just get a little background on that?

Yes. Rich, the Q is going to be filed shortly, and there's a section in there that reconciles it. We actually bought in some minority interest during the period. That's the reason the two numbers don't match up. I would wait and look at that. And then after you look at that, give me a call, and I'll walk through it with you.

At this time, there are no additional questions in queue.

Okay. Well, thank you, operator. Thank you, everyone, for tuning in today. We appreciate your questions and interest. And we're available if you have any follow-up questions after the call. Have a great day.