Ladies and gentlemen, thank you for standing by, and welcome to the U.S. Physical Therapy's First Quarter 2017 Earnings Conference Call. [Operator Instructions] It is now my pleasure to turn the call over to Chris Reading, Chief Executive Officer, to begin. Please go ahead.

Thank you. Good morning, everyone, and welcome to U.S. Physical Therapy's first quarter earnings call for 2017. I'm actually calling in from one of our facilities in Richmond, Virginia, very close to where I started many years ago. With me on the phone and back in Houston, Rick Binstein, our Vice President and General Counsel; Glenn McDowell, Chief Operating Officer; Johnny Blanchard, our Assistant Controller. Larry, right now, is a little bit time zone-challenged. He is away with his family in Scotland and so he won't be on the call today. So let me begin. For the quarter ended March 31, 2017, U.S. Physical Therapy's net income attributable to common shareholders prior to interest expense - mandatorily redeemable noncontrolling interest - change in redemption value; net of tax, otherwise referred to as operating results, a [ mouthful ]; non-generally accepted accounting principle measure, was $6.4 million as compared to $5.8 million in the 2016 period. Diluted earnings per share from operating results were $0.51 in 2017 period compared to $0.47 in 2016 period. Analyst consensus estimate for the first quarter was $0.47. And before I continue, since I jumped the gun, I'm going to have Johnny read a brief disclosure, and then we'll continue. Johnny, if you would.

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

Thanks, Johnny, and sorry for jumping the gun there. For the quarter, U.S. Physical Therapy's net income attributable to its shareholders' GAAP measure was $4.8 million or $0.38 per diluted share as compared to $4.5 million or $0.36 per diluted share for the 2016 period. Net revenues increased $10.7 million or 12.3%, primarily due to a 10.1% increase in net patient revenue from physical therapy operations, higher revenues from management contracts, primarily due to an increase in the number of facilities managed by the company and 1 month of revenues from the workforce prevention business acquired in March 2017. Total patient visits increased by 10.3%, partially offset by an $0.18 decrease in average net patient revenue per visit: revenues from management contracts, 1.1 -- I'm sorry, $1.9 million as compared to $1.4 million for the 2016 period; revenues from the recently-acquired industrial prevention business, $1.5 million for the month of March 2017. Total clinic operating costs were 78.7% of net revenues compared to 76.4% of net revenues in the 2016 period: $8.9 million of the $10.4 million increase in operating cost related to new clinics opened or acquired in the past 12 months; $1.1 million related to a full quarter of activity in 2017 for clinics opened or acquired in the first quarter of 2016; and the addition of the industrial prevention business; the remaining cost, approximately $0.4 million, related to legacy clinics. Clinic salaries and related costs including those from new clinics were 57.2% of net revenue in the recent 2017 quarter versus 55% for the 2016 period. Rent, clinic supplies, contract labor and other costs as a percentage of net revenues were 20.6% for the recent quarter versus 20.1% for the 2016 period. The provision for doubtful accounts as a percent of net revenues was 0.9% for the…

[Operator Instructions] Our first question comes from the line of Larry Solow of CJS Securities.

Just a few quickies on the -- you mentioned that the same-store sales growth or the volumes, they had phenomenal numbers they realized Q1 of last year but -- so tough comp and a little bit of the weather I guess, clearly, impacted it too. But just looking out over the last few quarters, been a little bit slow, sort of in that 1%, 2% range, I think. In '14 or '15, you guys were probably closer to 4.5%, 5%, which might not have been sustainable. But as you look out, do you think sort of a 2% or 3% number is appropriate and good starting point? And I know you mentioned a couple of new programs, too, which could help that.

Yes, so right now I do. I mean, we want to get the full second quarter first in. We don't have June yet. But we had, again, better volume growth on the business per clinic per day basis. March was the best month in the first quarter. They're a little better than April. They're a little better than May. So I'm hoping it picks up a little bit. I don't know if it will be and I don't expect it certainly to be what it was last year in kind of the upper 4% to 5% range. But I'm hoping it's better than Q1, and that's what we're working to deliver.

Okay, great. And then on the cost side, it sounds like -- which has been the case the last few quarters. Just the -- most of it, the acquired clinics or weather driving the higher percentages? So it does look like you have some opportunities there. You mentioned that $2 million you took out. Was that sort of -- was that, I guess, the $2 million was mostly came out of acquired clinics? And was that -- did that benefit this quarter? Or was that sort of recently -- at the end of the quarter?

No, that was really at the end of the quarter. And it didn't all come from acquired clinics. I mean, the reality now, the acquired clinics stop particularly when we buy these companies. Even though they might be a little lower in margin, they're running the way that they're running and we buy them that way and look to grow volumes forward. We tend, on the cost side, to be a little bit slower to up-end what's been historically, for many of these partners, a good operating model, albeit maybe a little bit different than our norm. And so we tend not to tinker with those right out of the gate. We have enough facilities now that $20 or $30 a day, which is maybe an inefficient hour or part hour on the part of a clinician. It adds up over time. And so $2 million is a big number. But when you look at it on a per clinic basis, it's an increment of -- a small increment of time each day. And we're -- we haven't -- we have an opportunity to do better than we've done, and ops is very focused on it and we're all very focused on it. But we've got to keep it better dialed in than what we have, quite honestly.

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

It's Jason Plagman on for Brian. Just on the corporate cost, looks like they're pretty well controlled. How are you thinking about -- anything we should be modeling for the remainder of the year? Any step up? Or is the Q1 level of $8.5 million a pretty good number?

Yes, I don't know that that's exactly the right number. I think maybe -- and let me scroll up and I'll tell you what our percentage was in Q1. It was 8% -- let me find it here. It was 8-something. We didn't -- we had a little bit lighter comp accrual in this first quarter potentially than we had in the same quarter last year. So I think that number will probably advance. And in fact, I hope it does as we continue to deliver some results this year. On a percentage of revenue basis, I think it should stay in the, probably about -- I would say, the upper 8% range, maybe to low 9% range. I had it highlighted, and I'm trying to find it here.

Yes, it's 8.8% in Q1.

Yes, Okay.

But that's helpful. And then my second question. So can you just remind us what's kind of the glide path or -- of newly opened de novo clinics? How quickly do those ramp and get to -- in the shouting distance of established clinic revenue visits per day margin, things like that?

Yes, so the ramp up review on that would be profitable by the end of year 1. Some time by the end of -- between the end of year 2 and the end of year 3, depending on where those are, they end up being more like our mature base so in a more normal visits per clinic per day pattern. So it takes about 3 years for maturity or relative maturity profitable by the end of year 1.

And during that first year -- at 6 months, where -- kind of approximately where are you at? Or what's the ramp just in that first year? So we could -- for -- thinking about the drag from all of the clinics you've opened in the last 18 months?

Yes, so earnings or use to cash? Or from what perspective? What are we talking about?

Yes, just revenue growth and end margins, I guess.

Yes, so I would say on a revenue perspective, and I'd have to go back and look at our most recent period but -- so something in the 12 to 15 a day range by the end of year 1. So anywhere from, I'd say, at 6 months, 7 to 10 visits a day. At our average net rate, of course, that moves around depending upon where these are a little bit and ramping up to somewhere in the 12 to 15 a day range end of year 1, somewhere in the 18 to 20 range end of year 2 and then somewhere in the mid- to upper 20s end of year 3. And I would use our average net rate on that.

Yes. Sure, sure.

So definitely, at 6 months, there's a drag -- a bit of a drag in aggregate when you look at the first year just based on how they layer in. And then after that, they become profitable.

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

My question has to -- just to better understand the mandatorily redeemable noncontrolling interest, the change in redemption value. I'm looking at the balance sheet and I see you have an $80 million liability for that. And I read the notes, and my understanding is that at 3 to 5 years, after you do a deal with someone and if they're no longer there, then you actually do have to make the payout. So my question is on this $80 million liability. I know we exclude it in your reported operating earnings, the change in that value. But how much of that $80 million is actually going to be a cash payout at some point, over the next 3 to 5 years?

Yes. So on the mandatorily redeemable noncontrolling interest, first of all, it's important to understand our deal, which I'm going to describe here momentarily and then what happens in practical terms. And ultimately, that mandatorily redeemable noncontrolling interest gets paid out at some point in time. Now in all of our deals, we have a minimum holding period that's typically -- in deals we're doing right now, typically 4 or 5 years, and the deals we've done in the more recent period, 4, 5 years. The vast, vast majority of that time, we are not redeeming that interest at the end of that minimum hold period because our partners are not leaving. In fact, our partners are happy. They continue to own a decent chunk of the business and they continue forward with us. What typically happens over a period of years beyond that minimum period is at some point along the way, that partner raises its hand, still isn't ready to leave. And maybe they own 30% of the business, but they might be interested in selling 10%. And at that point in time, we redeem that 10%. And that's of course, a cash expense. It's the same multiple that we paid for what the trailing 12 months EBITDA was when we did the deal, same multiple at that point in time for the PTM EBITDA. And then ultimately, when they leave the business, and they're ride off into the Sunset Retirement or whatever they're going to do, which the vast majority of our partners haven't done, then ultimately, we redeem whatever the remaining interest that they have. But again, many redeem little bits along the way, which we're not obligated to do but which we do in practice. And so ultimately, that full number is a cash expense that the business will ultimately occur, and we'll pick up the earnings from that side of the equation when we do that as well. Does that answer your question?

Yes, it does. Let me -- just have to follow up. I'm looking on your cash flow statement and I see in the quarter, you paid $2.2 million in payments to settle the mandatorily redeemable noncontrolling interest. So I understand it's a small part of the $80 million. First, have you provided a schedule? And can you give us a sense of what you think the cash outflow is going to be to redeem those interests? And second, when you actually do pay the cash, the $2.2 million for example in this quarter, does that flow through your P&L at all?

No, it doesn't flow through the P&L ever when we pay the cash. It's not a P&L impact expense. What changes in the P&L based on this change in accounting treatment is it would -- that interest, which would now be ours, would no longer sit in that mandatorily redeemable component, which now flows through the interest line, and so that would change. And that's where we've provided the adjusted operating earnings line to help you guys get a better picture of where the company is. And so yes, from time to time, we buy bits and chunks. And at the end, we are on a contractual basis, required to buy whatever is left. But again, our partners stick with this for, generally speaking, for a long period of time.

Okay, so just -- and I understand that. And so maybe can just give us an idea, for example, of how much cash you expect to pay out this year or next year?

Yes, I don't know that I can. We don't have a schedule prepared. Understand that unless the partner has told us, "Hey, I'm going to retire in the next year," which I don't know off the top of my head, I don't know any that have told us that or any right now that we're expecting. These are conversations that happen over time. I don't know that we anticipate or expect to provide a schedule. When they notify us, it usually is ultimately in relatively near proximity. Sometimes we have a runway in terms of next 2 or 3 years. I want to think about this kind of thing, but it's not absolute until they pull the trigger. So I don't know what that number would be for this year.

Okay, okay. And then just back to the tax rate. If I remember correctly, your guidance you issued, I believe you talked about a 37% tax rate. And I noticed this quarter, the tax rate was a lot lower than that. Can you just tell us what's going on with the tax rate? And what we should expect for the year?

Yes, so in the first quarter, just based upon how the tax rate was influenced beginning in the fourth quarter, this new accounting standards guideline, which all companies adopted beginning this year. And the change in value on the restricted share grants from when they were granted to -- as they vest for us because the stock, generally speaking, has moved forward over time, over a period of years, over these -- the vesting of these grants, our grants vested over 4 years, typically. That appreciation value ends up giving us the tax credit. And so because of how they vest, we have a bigger credit historically, in the first quarter and then a more normal presentation for the rest of the year. So Johnny, I still think, correct me if I'm wrong, we expect somewhere in the 36% range, 36.5% maybe for the year. Correct me if that's not the right number. So it will go up in the coming quarters.

That is correct.

Okay. And just on -- Chris, you're backing out your taxing when you do your operating earnings, the mandatorily -- the change in the mandatory convertible interest at 39%, I believe. So you're backing that out when you're telling us to use a tax rate of 36% or 37%, meaning that on the rest of the income it would be a 33% or 34% or 35% whatever percent tax rate. Am I understanding correctly?

Your understanding is correct. What we do is we have to use our standard statutory tax rate to back that out because the credit related to the equity compensation that doesn't affect that component of our income.

Okay. Okay, so for your operator earnings, should we then be using a 35% rate? Or I guess, if you're saying it's going to be 36% for the year is a lot lower in the first quarter, should -- is it going to be high-30s, 40s for the next 3 quarters?

It will be high -- probably in the 37% to 38% range. We do have some credits coming through throughout the year.

I would model somewhere in the 37%, 38% range for the rest of the year. Again, around 36% for the year in total, I think is what we said.

It's really hard to predict with the -- it depends on the stock price.

Our next question comes from the line of Mitra Ramgopal of Sidoti.

A couple of questions. First, if you can just give me a little more color in terms of the acquisition of the industrial prevention business. Maybe give us a sense in terms how big that market is? How it's growing, et cetera? And do you need like a separate sales team to kind of grow that business?

Yes, so 2 good questions. So we're excited about that business. The market is very, very fragmented. There are a lot of small companies, mom-and-pop companies that do this type of thing that we do with our acquired partners business on a much smaller scale in a more local market. There's no big dominant player in this market. So right now, we're focused on additional acquisition-related opportunities to continue to grow that business. I don't know economically what the size of that business is. Because again, in this world, and the company we've acquired, they do a number of things. They do some on-site therapy. They definitely do a lot of on-site prevention work so pre-injury -- or pre-reported injury, injury prevention, ergonomic work, ergonomic solutions for the office, which includes some software and related solutions and a host of other things. And so it's a big market. We think it's a good-sized opportunity in time. It's doing well, very well, as expected -- as we expected it would do. We have a good team in terms of the sales force necessary. We're in the process. They were just in town, and we've had -- we have weekly calls, but we are in the process of taking what's been long established for us in Fit2WRK and the beneficial elements of that and blending that across and into some of the elements in our acquired business. And so when you look at what we used to do historically in Fit2WRK, this fits together like a really nice puzzle. There were a number of elements that we just didn't do a lot of on Fit2WRK that our acquired partner here in this business does very, very well across the country with some blue chip name companies that you guys would now, very -- would be very familiar with. And so we're going to, again, just like we've always done with our acquisitions, choose our partners carefully. There's an organic component to this growth, which is strong. So we'll integrate this with -- in time, it's not done yet, with our sales force so they get up to speed and create incentives in that area. But yes, there are definitely cross-selling opportunities and we'll be diligent and disciplined on the acquisition side, but we're looking for other opportunities there as well.

That's great. And then just follow up a little on that. Obviously, it's very small right now, but as the business expands, I mean, do you see breaking that out separately? And also, how do the margins compare relative to your legacy business?

Yes, when we've broken it out, if you look at the release, we've broken out some of the elements separately. It's not big enough to constitute its own complete reporting segment right now, but we thought it's helpful to break out some elements. Margins, I think, for the quarter were -- and again, for us for the quarter with them, since they just started in the 1st of March, we only have 1 month in the quarter. Gross margin is 14.5%. But it's a business that's growing at a nice pace and we think can definitely add over time. When and where we get to be big enough to break it out in a segment, I don't know yet.

Okay, no that's very helpful. And then quickly, I know you -- on the legacy acquisition business, are you seeing any impact at all regarding -- given the uncertainty of the health care reform, et cetera, in terms of increasing your acquisition opportunities or maybe changing the pricing, et cetera? Or no change that you can sort of tell right now?

Yes. Well, I mean, it's tough to tell what's going to happen with ACA. And obviously, something's going to happen. But -- so that hasn't changed our acquisition strategy. It's an active market right now. We've been very active. We promoted somebody internally who helps me now for the deal prospect, and that's been helpful. The analytics tool that we've developed with that outside group, that's been very helpful in identifying additional facilities that might meet our criteria. On the pricing side, I will tell you that I expected pricing as interest rates begin to cool or begin to increase ever so slightly, I expect pricing to begin to cool, but we haven't seen that yet. So pricing is still, as it has been the last year or 2, pretty much at the high end of where it's been in my career, which spans now 32 years. And so we're seeing deals go 7.5x to 8.5x that are deals of decent-sized EBITDA to a couple of million plus or minus. So it's a healthy pricing environment for sure still.

[Operator Instructions] Our next question comes from the line of Dana Hambly of Stephens.

This is Jake Johnson on for Dana. Sticking with it, the M&A, your -- you've been active the last couple of quarters. Has your appetite for M&A increased? Or you're just sort of looking in more places like the -- kind of like the industrial services deal you did?

Yes, it's certainly -- with the industrial services deal, we've broadened so we're not just doing standalone PT deals as evidenced by this deal we announced at the end of February. So -- but no, the appetite hasn't changed. The appetite's been there. It's definitely been there. But listen. I mean, we're in a marketplace where multiples are very, very healthy. And we're the typical owners of the businesses, at least in the size and strata that we're interested in, which are, for our industry subset, they've been around for a long time. They're healthy. They've grown to a handful to maybe 10 or 12 locations, $1.5 million plus to $3 million typically in EBITDA. They're like me. They're getting some gray hair, and they're starting to think about what -- when is the best time maybe to bring on a partner? They're not ready to retire yet. And they see opportunity just because of the challenges in health care to pick up themselves, pick up smaller acquired partnerships. But they'd rather do that maybe with a partner that has the capital and the experience to help them get some of those things done. So I think that's the driver right now. The appetite remains unchanged.

Got it, makes sense. And then just a quick technical question. On the accounting restatement, were there any expenses to call out in the first quarter related to that? Or should we expect any kind of expenses in the second quarter?

Yes, you should expect we're going to -- we'll break out expenses related to this restatement accounting-related expenses, consultants and other things. We'll begin to flow through the second quarter and that we will identify. Johnny, correct me if I'm wrong, but I don't think we had -- we didn't have much in the first quarter?

We did not, so it's a very small amount.

You'll see some of this in Q2, though.

At this time, I'm not showing any further questions.

Okay, listen. It's been a long call, and a lot of stuff obviously to wade through with some of this accounting change, not just the restatement but some of the tax-related new standards that have been adopted. So I really, really appreciate everybody's patience with all of us as we've gone through this process. As I said early on, we've remained very focused not only in getting through this process but in running the company and looking for additional opportunities. So we're happy to put this chapter behind us. We appreciate your hanging in there with us and we look forward to things -- good things to come. Thanks again. Bye now.

Thank you, ladies and gentlemen. This does conclude today's conference call, and you may now disconnect.