0:02 All right, today we're going to talk about a phrase that everyone who's ever worked inside a large healthcare organization has heard at least once. And maybe you Googled it to see what it meant. also usually a little bit of dread attached to it. And the phrase is, what's the EBITDA impact? Now, if you're a clinic director, a regional operator, or someone working inside a PE-backed healthcare organization, the size doesn't matter. You know exactly what that question means. It means the conversation has just shifted from clinical care to financial performance. Now, Larry's been watching this happen across healthcare for years, not just in PT, but in dental service organizations and other consolidated healthcare models.

0:43 And his argument is simple and pretty provocative and likely to make some people uncomfortable. EBITDA was supposed to be a reporting tool. And somewhere along the way, it became the mission. So today, let's unpack how that happened, what it's doing in physical therapy, and what a better scoreboard might actually look like. So Larry, let's start here. EBITDA, what is it? Because I'm sure clinicians out there probably heard their director say it, but if you were going to explain it to an eighth grader, how would you?

1:26 Yeah, thanks, Jimmy. EBIT was born, first of all, EBIT is a non-accountant accounting term because it's not a generally accepted accounting principle, but we'll get to that maybe. But it was born out of a legitimate need when private equity really started rolling up fragmented industries well before physical therapy got in the mix. We're talking like in the eighties and the nineties, cable companies, those kinds of things. you know, basically healthcare, then dental, then PT. PT was a lagger. They needed a common, you know, language. Think of it as a currency to compare different businesses, you know, a small practice, for example, in rural Texas and a twenty location group in New York have very, very different tax jurisdictions, different financing structures, different depreciation schedule.

2:13 If I buy a computer versus I have a fifteen-year-old chair, for example, What EBITDA does is it strips the noise out of that and lets you make as best you can an apples to apples comparison across that portfolio. So that's sort of the narrow context. It's genuinely useful. And our lenders requirement, our leverage covenants are demonstrated based on EBITDA multiples or the capital structure uses that language. You know, the shift happened when the metrics stopped being descriptive and became prescriptive or became what people chase. That's when I started noticing it. When everybody was using that language is when you start to notice it.

2:54 When clinic directors stopped being asked, how's the clinic performance doing? And they were starting to be asked, well, what's your EBITDA? You know, like that's the end thing to say. And that's the moment the tool became the mission. And that usually happens when compensation structures get tied to it. And once you pay people... you know, to produce against the metric, you've told them what the organization actually, you know, values. I think, you know, as a whole, EBITDA is a great common language, but if it's the only language that you speak, you're going to have a lot of misdiagnosis over a lot of problems. Yeah. In the article that you just wrote, you can find it on LinkedIn and on your sub stack. You talk about how adjusted EBITDA has almost become what you call this fiction contest, where companies start adding back more and more things to make the number look stronger.

3:44 So what kind of adjustments are we talking about? And why does that make the number even less reliable than you just mentioned? Yeah, so if you walk into any kind of management presentation, what they're going to try and show you is I think it's mostly referred to as a bridge. It's effectively a slide that starts with sort of the gap net income, not to get too much in the weeds here, but it walks you through step by step to the adjusted EBITDA. Then it has the add backs and they sound reasonable. and isolation, restructuring charges, M&A transaction, audit fees, you know, de novo losses during kind of an initial time period while they ramp up, management fees, COVID impacts, storm impacts, you know, snowstorm, owner comp that's considered above, you know, normal compensation.

4:36 And some of these obviously are entirely legitimate. The problem is that there's no standardized definition of adjusted EBITDA. It's a non-GAAP measure. Every sponsor defines it a little bit differently. Everybody takes liberties with that. Your covenants from the bank allow certain things and don't allow certain things very inconsistently. Even USPT, which is a company that I love and have been big fans of them and their founders and now their CEO, Chris, And it's one of the only publicly traded PT companies we have, and soon with select medical going private, the one, is they're legally required to disclose that this adjusted EBITDA number should not be considered in isolation from GAAP measures.

5:20 And they would never say that, and almost nobody in the room would pay any attention to it, but it's required because, as I said, GAAP generally accepted accounting doesn't recognize EBITDA. And then I love the other term, adjusted EBITDA. It's like a double entendre. So one of the more uncomfortable ideas in your piece, and I know you're not shy about making people uncomfortable, especially when you have the receipts, is that EBITDA doesn't just measure performance. It can actually change behavior. This is where I feel like it starts to get dangerous. What kinds of decisions start happening inside clinics when EBITDA is the main target and not clinical care or clinician health?

6:05 Yeah, that's the question. start making decisions based on EBITDA. So EBITDA is a lag measure. And typically what we like to see in physical therapy are lead measures. As I say to all my managers, I'm a data guy as well, but you can't have a quantitative data without also giving me qualitative data. And you can't have a lag measure like EBITDA without a lead measure like call rate, acceptance rate. And we can talk about that. But what I see people happening is chasing the target. EBITDA results from doing other things right, rewarding your clinicians, being centric around the physical therapist and PT assistants, or in the dental world, our dental professionals, our dentists and our hygienists, And how do you enable them?

6:53 How do you gauge them? What is your retention rate? How are they, you know, how many owners do you have in the particular clinics? And so when you start chasing EBITDA, you're chasing a number. And so what I've seen unscrupulous CEOs do is, you know, I heard about one recently that got rid of their PTO policy. In other words, if you leave or you get fired, you take no PTO with you. Well, why is that? Because now you could take the PTO, adjust it back, and all of a sudden your EBITDA climbs, right? The good news is the sophisticated investors, the sophisticated buyers, they can now sift through this. And now what I hear is a new term. And it's a term I actually use. It's called clean EBITDA. Clean EBITDA is without all these bullshit and all these other kinds.

7:42 Obliquely, you know, by not paying it. of other things right. And as you saw from my article, there was a hat that Greg White, Dr. Greg White gave to me and say, you know, people over EBITDA. You get what you emphasize in business. You know, everybody says you get what you measure. You actually get what you emphasize. If you emphasize EBITDA, you're not going to get EBITDA. Every CEO that I know that chased EBITDA has failed. Everybody who's chased, and this is why PTs make great entrepreneurs and make great leaders of PT organizations, because they know in order to keep their clinicians, they got to approach things clinically. They got to approach what drives a clinician.

8:23 No physical therapist, no dentist, no doctor ever went into business to chase EBITDA. They did it to do meaningful, impactful work. They did it because they wanted to help people. And so that's what we have to remember. It's really the basics and common sense. And we have to make common sense, common practice. Now, you make a pretty strong argument that EBITDA treats clinicians as a cost line, when in reality, they're the business. They're the thing providing the service that is our profession. So how does that disconnect show up inside physical therapy organizations specifically? Yeah, no, that's the real question. You know, physical therapy companies, their assets wear shoes.

9:06 They go home at night. They go to bed at night. Right. And they're the ones that produce revenues. That is the first start of the equation. You know, I used to have this sign. I'd have all clinics put on their wall. It was a picture of our patients. And underneath, as it said, we eat because of you. The patients come in. We produce the revenue. It's a conduit. And then we produce enough profits to keep everybody employed, keep the lights on and everything else. And what you see start to happen is they start to have morning productivity meetings. They start to have morning meetings. optimization, units per visit, all of these metrics, they're not qualitative, they're quantitative, and they frankly drive physical therapists nuts.

9:50 Now, the art and science of all this is how do you balance it? I'm not by any means suggesting you shouldn't use sound rationale, dashboards, and appropriate metrics to drive your business or to measure your business. It's when the measurement becomes the driver of the business rather than the driver being the absolute embodiment of caring for your employees and caring for, in turn, your patients that drive the results. So I just see this all the time. They create these committees. They terminate founders and PTs that drive the business. And all it becomes is a dumbing down of the profession. They make PTs into widget makers, and they forget that PTs are the drivers of the business, not the standby byproducts of the business.

10:39 Well, you pulled out a story and an analogy that I'd never heard of, but it's pretty simple to follow, which is the Soviet nail factory story. Can you explain that idea? I love it because it's pretty obvious, it's pretty quick, and I feel like it applies really well to healthcare metrics. Yeah. So the Soviet nail factory is a really interesting one because I used it actually, I think in my last Substack post to illustrate the point about Goodhart's law. And it's the perfect illustration of it. The Soviet factory managers were basically given a production quota, make nails. So they made the quota work. When the target was the number of males, they produced thousands of tiny, useless nails.

11:20 We're producing hundreds of patients that aren't coming back because they were moved too quickly because they were used to measuring units per visit and how much turnover in patients could I have? So the factory produced a small number of enormous, completely useless nails. And that's what happens when that's the target, but the target was hit and they were rewarded for it. We reward PTs for hitting or their managers for hitting EBITDA when EBITDA doesn't really respect free cash flow. Most of the PT platforms I know now, particularly the larger ones, aren't producing enough cash to even pay the interest on their debt. I mean, these platforms are in trouble. And so what you have to do is you have to realize it's ruining your healthcare organization.

12:05 Set EBIT as the target and the rational operators will hit it. They'll do it by suppressing clinical compensation. They'll do it by really suppressing CapEx and other kinds of expenses that you need. Then they'll come up with all kinds of things to be under or non-recurring ad backs. They may even make sign-on bonuses, you know, and add back. They may even make certain benefits and add back. Now, enough years, you know, there really has been a materially large, you know, materially producing, you know, platform acquisitions in the last two years. And it's because of this, not just in PT, but in healthcare and even in dental. And so your sophisticated buyers and investors are sifting through this and they'll make their own adjustments.

12:47 They won't take your word for it. That's what quality of earnings and all these checks and audits are all about. So yes, the giant useless nails in healthcare, and I would put EBITDA at the top of that list. Yeah. I mean, the people who you're looking to invest are now savvy enough to see how you're gaming the system. Hopefully this leads to less people gaming the system because it's sort of not fooling anybody. So, all right, well, then we got to hold your feet to the fire then here, Larry. Here's the last question. If EBITDA shouldn't be the North Star, the next obvious question is, well, great, what should be? What would be a healthier, what would a healthier dashboard actually look like specifically for a physical therapy organization?

13:28 Yeah, so let me set some context. The business of physical therapy is not that complicated. We can make it complicated, and we do by having much too large of a dashboard, in my opinion. We have way too many BI tools. We have way too much data, but not enough caring. We have way too much numbers, but not enough compassion. We have way, way, way too many streams of emails on productivity without fundamentally listening and understanding the heartbeat of, in our case, physical therapists. but what i've proposed is what i really refer to as a four pillar you know framework because there are some differences that you can take into account amongst these four pillars and again two two premises don't give me a you know an objective data without a qualitative one and the second one is You know, don't give me a lag measure without a lead measure.

14:20 And so you have to have a, you know, a flavor of all of those. But if I was defining the four pillars, and since we're talking about financial, I wouldn't put that number one, but let's talk about it first. I would lead with unlevered free cash flow. So it's EBITDA minus CapEx minus working capital, you know, now it's again, gets in the weeds, but what it really tells you is what cash you really have that is, you know, over and above, you know, your spending. You know, that's the number that tells you where the business really can sustain itself. Even it tells you what it looks like before the bills come due is how I refer to that. So that's kind of the financial side I would use on lever-free cash flow. On the operational side, there's a lot, but I like same growth, store, you know, increased organic.

15:04 Everybody talks about wanting to buy things. Well, show me a company that can grow organically first and then let them buy things, right? That's the lead measure is can you grow a clinic organically? before you can buy something and then you maybe earn the right to buy things. Yeah. Now a new patient volume. I like that because it goes to throughput. You know, are you growing the number of new patients? What are the number of new patients per PT that they see in a day? As you well know, I like PlanetCare completion rate. It's it's a tough one, but it's a good one. I liked, you know, the number of patients that kept their visits, you know, that didn't that didn't you know, I think it's a proxy for quality almost.

15:45 And, you know, these are sort of the leading indicators that predict the future of EBITDA than what EBITDA stands for. Then I think a third category is clinical. So again, financial, operational, and then I like to refer to it as clinical. And this is a real outcomes, you know, scorecard. You can use whatever third part validated, you know, measure you want, photo, promise, functional improvements, all these kind of, there's a bunch of them. You know, if the C-suite can't tell whether your patients are actually getting better, EBITDA number serves without a purpose, right? And so you have to live with that. You have to have that clinical one. In fact, I'd move clinical to the first of the four pillars. And then, you know, then I would call the fourth pillar people.

16:25 You know, in fact, I would have people first, probably, clinical second, operational third, and financial, you know, fourth on my four pillars. And other people, it's retention rate. It's those engagement scores. um i i like to call them inspiration corey we used to measure patient set or you know employee satisfaction and i went to employee engagement now i actually think it's employee inspiration which keeps them inspired or how do they keep inspiring i like you know stay interviews how many of you completed in a given year these are people who are actually staying you finding out why these aren't exit interviews, which is very HR-ish. These are people, you know, getting to know why people stay, what's working, what's not working, what we need to start doing, stop doing, and keep on doing, you know, that kind of stuff.

17:12 And all those things give you a chance to fix something before it becomes a problem. So that's the dashboard that I'm fond of, and certainly in the organizations I've been blessed to run, and I'm currently working in a leadership role, and those are the things I look at first. Yeah, I like how you flipped that, where the thing we're talking about EBITDA, or even the financial metric, that comes fourth out of four. It's got to be there, but fourth out of four. I do like this conversation too, because it's not anti-capital or anti-growth. It's really about just understanding what we're measuring, what we produce. I always like to say, what game are we actually in? Are we understanding what game we're actually in? And then what measurements are pushing the organizations to do that better?

17:55 correctly or do that well, and then you get to sort of define what well looks like. Absolutely. It's all about culture and people. You know, culture is not the enemy of EBITDA. Culture is the engine of EBITDA. Absolutely.