U.S. Physical Therapy, Inc. (USPH) Q3 2017 Earnings Report, Transcript and Summary

Good morning. My name is Brandy, and I will be your conference operator today. At this time, I would like to welcome everyone to the U.S. Physical Therapy Q3 2017 Earnings Conference Call. [Operator Instructions]. Thank you. I would now like to hand the call over to Mr. Chris Reading, Chief Executive Officer, to begin.

Thanks, Brandy. Good morning, and welcome, everyone, to U.S. Physical Therapy's Third Quarter 2017 Earnings Call. Today, I happen to be taking this call from Chicago, where I'm at the Annual Physical Therapy Private Practice Convention, which is always a great meeting for us to get things done, which ultimately results in the announcement like the one we had yesterday, where we announced the great new deal with a supergroup of 4 partners and a dedicated leadership team. With me in Chicago and on the call, Rick Binstein, our Vice President and General Counsel; back home in Houston, Larry McAfee, our Executive Vice President and Chief Financial Officer; Glenn McDowell, our Chief Operating Officer; Jon Bates, our Vice President and Controller. So again, welcome. Before we begin with some prepared comments, 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.

Thanks, Jon. So I'm going to start today and just let you know the majority of my comments are going to center around our plan for the business, how we have done, what we've done and are doing and where we are focused and headed from here. I may touch on a few financial highlights. However, for the most part, Larry will cover that in detail in a few minutes. So let's begin to unwrap the quarter a little bit. Volume at the clinic level, in spite of the 2 hurricanes, was really pretty good through the entire quarter. July didn't drop like it normally does. In fact, we had a better visit per clinic flow in July than we had in March, which normally isn't the case. Obviously, the storms impacted August and September, and that impact was significant in Texas, Florida and Georgia, where businesses closed and many evacuated. Most of the lingering effects were concentrated in Texas due to our severe flooding and in Florida, relating to the magnitude of the evacuation combined with the power disruption. In spite of all that, our visits held up overall and, obviously, would have been notably better without that storm-related disruption. During this period, whether our clinics were open or not, we paid everyone as we normally would have regardless of their ability to get to work, which many could not, for an extended period. So our numbers, I realize, this quarter are a little bit messy as a result. In spite of all that for the quarter, we had a really strong revenue -- we had really strong revenue growth of 16.6% coming from, in combination, a modest rate improvement, good physical therapy visit growth and very strong performance from our industrial injury prevention business, which, I will say, is doing very well, and that team is doing a terrific job so far. In the quarter, we continued to work on cost alignment, although admittedly, we have more work there. And the storm and resulting visit and payroll impact didn't help make things any clearer. What is now clear, however, to me is that our challenge around cost and getting and keeping it dialed in has much to do with the fact that upon a very close and thorough review of each of our regions' performance to date -- and I want to point out that all of our regional leaders in the operations team have been with us for a very long time, so it's not like that's a new group. At the end of the day, my conclusion is we've just stretched them a little too far and a little too thin, which has hampered us in getting the issue completely in hand. So we are making some changes in additions to our operations, leadership and structure, and the general theme around which will be to add a few more key people with a reduced territory and partnership load for each region. We feel like, in retrospect, we are overdue to make these changes. And while we continue to make progress, we need to further add to our team and our resource complement as we have grown significantly these past few years and should continue to do so, as evidenced by our strong revenue growth within the current quarter as well as prior quarters and our steady development pace. On that last point, we announced yesterday another great acquisition partnership with a great group of people in a state we like very much, where there's a good deal of embedded opportunity, both internally and externally, to develop additional sites beyond our 9 current locations. For the year, we've done 5 really nice deals, adding approximately 50 service locations, 39 owned and 10 managed, and also including our industrial prevention business, a partnership where we operate with on-site services in 17 states and with approximately 140 service sites. And as it has been our ability to attract high-quality, high-integrity and high-ability private practice owners continues to be very strong, we are -- continue to be excited also about who we are currently talking to and the quality of those folks in the current pipeline. So I know we're going to have more time at the end to talk about Q&A and to answer questions. So at this point, I'd like to ask Larry to go through the financials in greater detail. Larry?

Yes. Thanks, Chris. First, I want to talk about the third quarter this year as compared to the third quarter of '16. Net patient revenue from physical therapy operations increased $9.9 million to $96.3 million due to an increase in patient volume of 11.2% plus an increase in our average net rate to $105.26 from $105.06. Revenue from management contracts was $1.7 million as compared to $1.3 million a year ago. And the revenue from the recently acquired workforce performance solutions business was $4.4 million. Total operating costs were $81.8 million or 79.4% of revenue in the third quarter this year compared to 77.7% a year ago. Most of that increase was attributable to $8.6 million in operating costs related to new clinics opened or acquired in the past 12 months, plus $3.7 million related to the workforce performance solutions business. The gross margin for the third quarter of 2017 was $21.2 million or 20.6% of revenue as compared to $19.7 million or 22.3% of revenue for the 2016 quarter. The gross margin for the company's physical therapy clinics was 20.9% in the recent quarter as compared to 22.4% a year ago. Were it not for the impact from the hurricanes, the PT gross margin would have been approximately 60 basis points higher or 21.5% as compared to 22.4% a year ago. So if you look at the 3 quarters this year, we are closing the margin percentage gap compared to historical levels. That spread in the third quarter would have been 90 basis points as compared to 140 in the second quarter and 210 in the first quarter. The gross margin on management contracts was 16.8% in the recent quarter as compared to 15.6% a year ago. And the gross margin for the workforce performance business was 14.1%. Corporate office costs were 8.1% of revenue for the 2017 quarter compared to 8.6% for the 2016 period. Operating income in the recent quarter increased 6.9% to $12.9 million. Income taxes as a percentage of income before taxes less net income attributable to noncontrolling interest was higher this quarter at 37.8% as compared to 36.4% a year ago. Operating results for the 3 months ended September 30 rose slightly to $6,004,000. Diluted earnings per share from operating results were $0.48 for both periods, again, recognizing that we lost $0.03 this most recent quarter from the impact of the hurricanes. Same-store revenue increased 2.4%. Visits increased 1.2%, and the net rate increased by a little over 1%. I'll now touch on some of the highlights for the 9-month period. Revenues increased 14.7% to $304.8 million due to an increase in total patient visits of 10.5% plus higher revenue from management contracts due to an increase in the number of facilities managed by the company, plus, of course, the revenue from the workforce performance business acquired in March. Net patient revenue from physical therapy operations increased $27.7 million due to an increase in total patient visits of 10.5% and an increase in the average net revenue per visit to $105.35 from $105.19. Revenue from management contracts for the 9 months were $5.2 million versus $4.3 million a year ago. And then total revenue thus far from the workforce performance business is $10.3 million for the 7 months since we acquired them. Total operating costs were 78.2% of revenue in the first 9 months this year versus 76.2% a year ago. The increase, again, was attributable to operational costs related to new clinics opened or acquired in the past year, an additional $5.3 million related to the full month -- 9 months of activity in 2017 for clinics opened or acquired in the period last year and then $8.8 million related to the workforce performance business. The gross margin for the first 9 months of '17 is 21.8% versus 23.8%. The gross margin for the company's physical therapy clinics was 22.2% as compared to 23.9%. Again, that gap would be smaller if you factor in the effect of the hurricanes. The gross margin on management contracts was 13.1% as compared to 19.5%. We started out with a very low margin on some of our management contracts, but those steadily improved. The gross margin for the workforce performance business to date is 14.5%. Corporate office costs year-to-date, 8.4% versus 9.3% a year ago. And operating income for the 9 months ended September rose 5.7% to $40.8 million. Income taxes as a percentage of the income before taxes less income attributable to noncontrolling interest was 35.0% in the 2017 period versus 36.3% a year ago. Operating results for the 9 months rose 5.1% to $20 million. Diluted earnings per share from operating results were $1.59 for the 9-month period this year versus $1.52 a year ago. Same-store revenues increased 3.4%, thanks to our visits increased 2.6% as the net rate increased slightly. I'll touch on some other financial measures for the third quarter 2017. Company's adjusted EBITDA increased by 4.5% to $13.7 million. For the 9-month period, adjusted EBITDA grew by 5% to $43 million. I noted in my quote in the release that our net cash flow from operations has been excellent. Bank borrowings during the quarter were reduced by $13 million to $56 million at September 30 compared to $69 million at June 30. [Indiscernible] declared our regular quarterly dividend. That dividend of $0.20 per share will be paid on December 8 to shareholders of record as of November 17. We also, partly of because the hurricane, revised our earnings guidance. As disclosed, Harvey and Irma cost us probably more than 8,500 patient visits and over $0.03 per share. Primarily as a result of the impact from those storms, we currently expect the company's operating results for the year to be in the range of $25.4 million to $26.5 million or $2.02 to $2.10 in diluted earnings per share.

Thanks, Larry. That concludes our prepared comments. So operator, if we can, let's open it up for some Q&A.

[Operator Instructions]. Your first question comes from Larry Solow of CJS Securities.

Just a quick question on the guidance. The impact from the hurricane, I think you said, was like $0.03-ish. The adjustment is $0.05, $0.06. Is there some lingering impacts in Q4? Or is it more on a -- a rounding error? Or is it some of the costs -- the ability to bring down cost maybe a little bit slower than you thought?

Not a rounding error. You missed by $0.03 on the...

Yes, yes. I'm just trying to figure out sort of the differences there.

Certainly, in Harris County in Houston, you could see a little bit slower volume in October, though it's picking up. There were a couple other items. Our health care costs were higher than we expected during the quarter, so that -- it's probably going to continue to be higher through year-end, so that's baked in there. There was one operation where we had to write off about $0.01 worth of receivables. So those are the 3 items that constitutes the $0.05 to $0.06 adjustment. But I'd say that the impact from hurricanes was $0.03. I honestly think it's higher than that, but that's what we have quantified.

Yes, yes, yes. Okay. And that's sort of what I meant by the rounding error. I realize from $0.03 to $0.05 to $0.06, that's a little more than rounding. Okay. Now good, I appreciate that. And then just on the cost cutting, obviously, I know you guys addressed the issue, or you have off and on for the last several years the costs tend to rise, you guys have been great at getting in there and attacking it. Anything to read from this quarter? Obviously, the numbers are skewed by the lower sales, with the cost base remaining the same. In your discussion with adding a little bit of reorganization there, how should we view that? Is that going to -- would that sort of have a slight increase in cost in the short run and then, over the long run, that will bring cost down? Or any thoughts on that would be great.

Yes. So I did a really deep, thorough P&L dive going on like a couple of months ago and went through each region with a fine-tooth comb. And we have a great group of folks, so honestly, it's not their fault. I think we've -- that's a hard-working group. I think we've stretched them a little far. And we're just not able to get to and make the changes and stay on top of it like we should with the number of facilities and partnerships that each have added. So we've already promoted one person internally. We're rounding out her team. There'll be a little bit of cost in that. We're doing some other things that we haven't announced yet internally or externally, again, additional people and resources. So that will be on the corporate side. And our corporate cost is down. One of the reasons it's down right now is because we haven't been accruing much incentive comp. And so when you look at the opportunity that, really, we looked at left on the table, where we've had great revenue growth, and it's really not falling to the bottom line like it should, there'll be some costs. But I think it will be more than offset -- I expect it to be more than offset with the additional focus, which should result in additional profit contribution.

Got it. Okay. And just lastly on the same-store sales. The 1.2% volume, obviously, that's skewed because of the weather impact. How about just -- but on the rate increase, the 1% jump, was that just sort of the usual quarterly fluctuations? Or is there anything else in there to look into?

It moved around. I mean, it moves around quarter to quarter. I'm looking -- if we hadn't had the hurricane, the revenue would have grown 3.2% same-store on a 2.2% increase in visits. So obviously, it impacted just a little.

Right. And I think the rate -- this has been a very benign year for us. We expect the same next year. Some of it's due to the mix. Some of it, quite honestly, we lost some visits in Florida, where the rates are a little bit lower. I don't know that, that helped the rate be higher. We've done more deals in the Pacific Northwest, where the rates are considerably higher. So I think it's just a modest variation from our norm, but it's kind of what we expected this year.

Your next question comes from Mitra Ramgopal of Sidoti.

First, I was just wondering regarding the impact of the hurricanes. And I know you had temporary closures, but were there any locations that you permanently had to shut down?

No.

No, we're -- I think -- no, we were closed in some locations but none that we shut permanently, Glenn, correct, as a result of the hurricanes.

That's correct. We had no physical damage from the hurricane, just loss of volume. And otherwise, we're open and operating.

Okay. And regarding the acquisition yesterday, if you can just give us a little more color on that. Was that in a new market or existing market? And also, I know you added, in addition to the clinics, about 10 management contracts. And I'm just wondering what's your capacity in terms of being able to take on third-party contracts.

Yes. So yesterday, not 10 management contracts, I think 2 -- 9 locations, I think, plus 2 hospital-based management contracts. It's in what I would call an adjacent market. It's in a state we love and where we've had really good activity and good historic success. New market in that state, but it kind of fills in a gap area that we had. And this is a great group of people. Leadership's very connected, very in touch with what's going on in the profession, good relationships there. We were all out, Glenn, myself, Don Ryan, our VP of Operations, were all out there a few weeks ago for their management team meeting and had just a great time, great group of people. And so we're excited about that. There's a lot of internal and external opportunity, both embedded in things that we feel like we can grow into. And so we're -- we actually, we had wanted to get that deal closed about a month ago, and it took just a little bit longer, but we're excited about hitting the ground running here.

Right, right. No, that's great. And given you've had a couple of quarters now with the workforce performance solutions business, I was wondering if you see additional opportunities in that area?

We do. We're talking to people, and I can't say much more than that, but that team has done a really good job. That growth and their ability to sell to existing clients, bring in new clients, big blue-chip companies, has been excellent. And it's taking a little time about what we expected, but we're in the process now of looking at all our existing Fit2WRK relationships and cross-selling and introducing our partner in the industrial prevention business to those relationships as well. So we're just on the front end of this, but there are other companies that we are looking at, have looked at, and we expect more activity in that space. Yes.

Okay. No, that's great. And Larry, if you can just update us following yesterday's acquisition in terms of your availability regarding a new revolver to do more transactions and, if you have handy, maybe the payer mix for the quarter.

What do we have? Half the facility updated? So we got plenty of dry powder. You can see how quickly we paid down debt in the third quarter because our net cash flow continues to remain very strong. In terms of the payer mix, the private and managed care, which is basically insurance business, was, I'm just giving you this for the quarter, was 51.6%. Workers' comp was 13.8%. Medicare and Medicaid combined was 26.9%, and obviously, most of that, almost all of it is Medicare. And then other was 7.6%.

The next question comes from the line of Brian Tanquilut of Jefferies.

I'm sorry if this was asked already. We got dropped off the call. But as we think about margin opportunities going forward, I know this quarter, you had a drag from the hurricane. But where do you still see the opportunities? I mean, I know there's still efficiency gains that you can squeeze out of the clinician. But how should we think about that going forward?

I'm a little hesitant to peg an exact number for a few reasons. One, we move around a little bit depending upon the quarter. And two, we still have more work to do to get our margins back to kind of where we think they should be and where they have been. So when I look at the revenue opportunity this quarter and, really, last quarter, above, let's call it, above 15% last quarter, just below this quarter, significantly above or at least modestly above 15%, we're not dropping in the PT side of the business, which is the majority of it. We're not dropping nearly what we should be and what we've historically dropped to the bottom line. So we've got to get this new structure in place. It's going to take a little bit of time, probably a couple more quarters. And not that -- it's not going to take quarters to get it done, but it's going to take quarters, I think, to have -- to see the effect. But we're working on it hard. We've made some progress, as Larry pointed out. I thought the quarterly progression is in the right direction. It's slower than we would have liked, but I think now we understand the issue, and we're working on it full speed.

Chris, to follow up on that, I mean, as we think about just broader wage pressure, right, I mean, you've got, obviously, therapists' salaries, and that's been an issue for a while. But how should I think about your ability to use more PTAs or extenders as a way to mitigate some of the cost pressures?

Yes. I guess because PTAs typically make a little bit less than therapists, we could move in that direction. I would tell you we've been a little bit reluctant to do that because of some of the inflexibility that -- not to say we don't have great PTAs, but it does enable us to handle the new patient volume. New patient volume's been strong. There are some limitations with federal payers, Tricare, particularly, and other reasons. And honestly, most of our patients want to see their therapist every day. So I think first things first, I think we need to wring out the opportunity that we have just by getting back on top of the business. It's true we have PTAs in many of our partnerships, but we haven't done a big wholesale mix. I honestly don't expect to.

Okay. And then just to that point on driving the top line, right, I mean, how do you -- where you sit, how do you balance what is macro-driven where it's almost hard to fight it versus more company-specific in terms of where that slowdown is coming from? And what do you do to fight a slowing macro environment if that was the case?

Yes. So what we've done in the past and what we've tried to do even this year, and this is not -- we're not certainly in a slowing macro environment right now, we're at a fully employed environment, where the fear index is as low as it's been in 17 or 18 years, and so it's a healthy environment. But we rolled out -- in spite of all that, we didn't rely on that. We rolled out a new analytics tool this year, which really has helped identify good sources of potential referrals in all the markets that we operate in across the country. And so we've added that tool as a complement to our partners and to our sales team. So we're constantly looking for that edge, whether we're in a headwind environment or a tailwind environment. I expect that, unless the ACA gets totally turned on its ear, which doesn't look likely right now, that we'll continue to be in a very healthy environment with strong insured population for a while yet, but we've been through headwind environments before. We did through the recession, and we were able to grow through that. It's always a little bit more challenging, but understanding that smaller companies, many of whom we compete with in these markets, have a much greater difficulty in an uphill environment than we do just because of our resources. And so there's opportunity there as well.

[Operator Instructions]. And there are no further questions at this time.

Okay. If there are no further questions, we're going to go ahead and wrap the call up. We thank you, certainly, for your time and attention. I'm going to be a little bit hard to reach. I've got meetings lined up all day today in Chicago. But I know Larry's back in the office, and he'll be happy to take your calls if you have any additional questions. Thanks again.

Thank you. That does conclude today's conference. You may now disconnect.