Written 25 April 2008. Consult 'Investment Approach' tab for outline of what criteria gets a firm on the research list).

Quantitative score 70/100 on year-over-year accounting data. Qualitatively something similar. While US Physical Therapy (USPH) is in the health sector and a potential defensive, it has historically badly under performed peers in the Nasdaq Healthcare Index. In this it appears to have been a victim of its own financial conservatism. But several decisions since key management changes in 2004 suggest a cultural change. Indications are that the firm has embarked on a revised strategy that places more emphasis on using its strong cash productivity to acquire as well as grow in its usual organic way. In a fragmented market place there is scope for this method to flourish. The firm's website is here; and its latest 10K here.

US Physical Therapy with its 349 clinics is a distant number 3 in its marketplace behind Select Medical (1000+ clinics) and Physical Therapy Associates (825 clinics). It has a long share price under performance history versus peers which has seen its price/earnings rating drop steadily from the high 20s in 2003 to a shade above 20 today. This, perversely, has been the price paid for conservative management - USPH has not taken many risks despite its muscular financial profile.

There are conclusive indications that has begun to change in the last 2 years since the appointments of Messers Reading (CEO), McAffe (CFO) and McDowell (COO) in late 2004. Now settled in, they oversaw a wide ranging closure programme of marginal clinics in 2006 which shocked investors – the shares were marked down nearly 15% overnight floowing the announcement; they have made four acquisitions since 2005 the largest of which last year secured the privately held, 52 clinic STAR Physical Therapy (and, notably, which required a new $30m, expandable to $50m, revolving credit facility); and there has been over $550,000 of insider buying of its stock in March, likely a sign of renewed internal confidence given they were the first such transactions in over a year and a half.

Still, there are obstacles. Gross margins have been taking a methodical beating year over year since 2003; and the quarterly trend into Q4 2007 is especially uncomfortable because, most likely, of the STAR acquisition. The 10K on page 22 has a neat table summarising per visit revenue and cost breakdowns - both of which are going the wrong way.

This speaks to competition and regulation: health may be a defensive sector but it is also political. And in that context there is the concern that, with 207 differently branded clinics, the decentralised financial control style of USPH will not be able to make enduring improvements to its financial ratios despite its widespread use of profit share and ownership schemes with its clinic directors. It is an issue that will worsen in acquisition mode; and initiatives attacking what may now seem like financial minutiae will later look prescient investments.

The Big Picture, then, is that USPH has the balance sheet, free operating cash flow and desire to expand more aggressively than in the past. It clearly has the finances to close low margin sites in favour of acquiring higher – or potentially higher as would seem to be the case with STAR - margin ones. But some tough and detailed financial grind is required to make that game work: a successful change of company strategy depends, in this case, on an implementation of greater focus on internal financial method, measurement and culture.

Exhibit: US Physical Therapy tear sheet

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  1. Anonymous // 8/20/2008 03:10:00 AM

    As a "partner" for 10 years , I can assure you the management team of C reading and G McDowell have little experience leading a mid major company. As you stated in your article the "ownership schemes" are staring to catch up with them resulting in several clinic closing or underperforming. I would advise investing elsewhere.

  2. Anonymous // 8/20/2008 03:19:00 AM

    I thought I was the only former partner that was treated unfairly. USPh had a great business model when it started in the early 90's, however poor leadership and greed by a select few in the recent past has taken a once thriving concept and side railed it on the road to Healthsouth. Don't believe it! Look at the bio's of management. You guessed it, all ex HS management.

  3. Anonymous // 6/02/2011 04:43:00 AM

    My advice stay away from this company, they have gotten away from what made them who they are. They have forgotten there partners and seem to think that they are the gas that drives the engine. They have ruined there reputation in my market to the point where the only people they can hire to run ex-partner clinics are new/recent grads. Yes I am a former partner, I am making twice what I was with them, for doing basically the same thing I did before (and all the same work not more). Trust me you are not the only partner who was treated unfairly. You reap what you so. I am so much better off. I should thank them.

  4. Anonymous // 8/02/2011 04:57:00 PM

    This company is run by former Healthsouth folks, who have not been fair to there current partnerships. They do not honor their agreements with their partners requiring arbitration threats to get what is owned. I have heard from numerous former and current partners who are not happy with the direction this company is headed.

  5. Anonymous // 8/04/2011 11:06:00 PM

    This company's partnership model is a farce. They promise one thing and deliver another. I think as time goes on you will see a falling margin or they will have to change their business model markedly. You can't keep promising one thing and delivering another and not expect your new clinics to suffer. Just look at the numbers the aren't opening as many de novo clinics.

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