U.S. Physical Therapy, Inc. Annual Report 2000

FY2000 Annual Report · U.S. Physical Therapy, Inc.
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On the ball

US

P H Y S I C A L
T H E R A P Y

U S P T

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A N N U A L
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2 0 0 B E S T
SMALL COMPANIES

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Dear Fellow Shareholders-

Our unique partnership model, combined with the
business acumen of our corporate team, has delivered
a stellar performance for 2000. New records were set
in patient visits, sales, net income and operating margins.
Our longstanding shareholders have been rewarded for
their patience with excellent returns as the stock market
began to recognize our consistent earnings growth. The
Company effected a 2-for-1 stock split in the form of
a 100% stock dividend in January 2001. We took this
action following a significant increase in share price to
increase the number of shares in the public float available
for trading, to enhance liquidity and broaden ownership.
All share and per share amounts have been adjusted to
reflect the split.

Record Net Income Validates Model.  Net income was
a record $3,735,000 for the year, which was an increase
of 56% over the previous year. Diluted earnings per
share increased 53% to $0.52. Net revenues for 2000
rose 23.1% to $63,222,000 from $51,368,000 for

ROY  SPR ADLI N       P R E S I D E N T   &   C E O

1999, due primarily to a 23.2% increase in patient visits
in 2000 to 697,000. Same store sales increased 17.2%
and same store visits increased 16.7%. I was especially
pleased  with  the  strong  increase  in  visits  and  sales
considering the detrimental impact of the December
snowstorms in areas where we have clinics. We've estimated
that 4,500 visits, or approximately $400,000 in revenues
were lost as a result of the inclement weather.

Declining Expenses Per Visit Reflect A Focus On The
Details.  Clinic direct expenses per visit for the year
declined to $62.61 from $63.91 in 1999. The decline in
expenses per visit was due to the greater availability of
therapists, the spreading of fixed expenses over a greater
number of patient visits and careful control of costs while
maintaining the quality level of patient care. These factors
should continue to benefit the Company in 2001, resulting
in a further reduction in expenses per visit. For the year
2000, the contribution margin of the clinics was the best
in  our  history  at  28.5%,  up  from  26.8%  last  year.
Corporate office costs as a percent of net revenues declined
to 12.0% from 12.6% in the previous year.

$90.73

$90.67

$89.46

$85.85

$86.93

$66.15

$65.49

$67.19

$66.44

$64.87

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NET REVENUES &
CLINIC OPERATING
COST PER VISIT

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CLINIC OPEN

CLINICS OPEN

CLINICS OPEN

CLINICS OPEN

CLINICS OPEN

CLINICS OPEN

CLINICS OPEN

CLINICS OPEN

CLINICS OPEN

CLINICS OPEN

CLINICS OPEN

Share Repurchase Effected.  Recognizing the depressed value of
the Company's stock in the first half of the year, the Company
repurchased 1,130,000 shares in August 2000, or about 17.2%
of the outstanding common stock, at a price of $5.50 per share.
The Company utilized cash on hand and borrowed another
$2,115,000 to complete the stock repurchase. In November
2000,  the  Company  repaid  $1,215,000  of  the  $2,115,000
borrowed to repurchase the stock, and the remainder was repaid
in March 2001.

Debt To Equity Improved.  In November 2000, $850,000 of
subordinated convertible debt was converted by note holders
into 145,000 shares of common stock, resulting in a balance of
$7,200,000 in subordinated convertible debt on the books as of
December 31, 2000. In January 2001, another $4,200,000 of
subordinated convertible debt was converted into 798,000 shares
of common stock, leaving $3,000,000 still unconverted. The
conversion of this debt will not only enhance the Company's

debt-to-equity ratio, but will also improve the Company's pre-
tax cash flow by approximately $400,000 per year.

Strong Openings Portend A Bright Future.  Our 28 facility
openings last year were divided equally between new partnerships
and satellites of existing facilities. Only construction delays
resulting from winter storms kept us from eclipsing 1994's record
of 29 clinic openings. My goal this year will be to continue
accelerating openings with at least 30 new clinics, including
satellites of existing partnerships. The satellite clinics generally
ramp up faster following opening as we already know the market
and have a proven partner. Our "pool" of potential new partners
continues to increase as a result of our targeted recruitment, word
of mouth and continuing therapist availability. Based upon the
actual visits to date in the first quarter and projected visits for
the remainder of the year, net earnings in the area of $5.7 million
for  2001  seems  achievable,  which  represents  a  52.6%  gain
over 2000.

 
   
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moving to  pa ss th e competition.

Maintaining Appropriate Reimbursement For Services.
We  have  been  seeing  some  positive  trends  in
reimbursement for services in our clinics. Although there
continue to be pressures to contain healthcare costs, the
Balanced Budget Act of 1997 resulted in an increase in
our Medicare reimbursement as we transitioned from cost
based reimbursement methodology to a fee schedule.
Additionally, managed care payors such as HMOs are
under pressure to pay providers at a more appropriate
level,  and  we  are  beginning  to  realize  increases  in
reimbursement by some managed care payors. This has
resulted in a higher net patient revenue per visit of $87.01
in  2000,  up  from  $86.65  in  1999.  We  continue  to
maintain a critical eye in accepting only those managed
care plans that return a reasonable margin. Through the
evaluation of potential contracts, we are diligent in avoiding
plans that have insufficient reimbursement for the services
we provide. We target more lucrative "fee for service"

FINANCIAL HIGHLIGHTS FOR YEARS ENDED DECEMBER 31

2000

1999

1998

1997

1996

STATEMENT  OF OPERAT IONS DATA

(in thous ands, excep t per s hare da ta)

Net revenues (1)

$63,222

$51,368

$44,837

$38,807

$32,207

Income before income taxes

Net income (2)

Earnings per common share:
Basic (3)
Diluted (3)

BA LANCE S HEE T DATA

$6,138

$3,735

$0.61
$0.52

$3,962

$2,704

$2,481

$1,758

$2,394

$1,596

$2,426

$1,641

$0.35
$0.34

$0.22
$0.21

$0.34
$0.33

$0.23
$0.22

Total assets (1)

 $22,970

$23,346

$24,362

$22,548

$19,483

Long-term debt, less current portion

   $7,226

$8,087

$8,126

$8,239

$8,276

Working capital (1)

 $10,420

$12,493

$12,832

$11,204

$9,214

FINA NCIAL RATI OS

Current ratio (1)

Long-term debt to total capitalization

4.14

0.46

6.79

0.43

5.45

0.41

5.07

0.45

4.56

0.52

1. Certain amounts for 1999 and 1998 have been reclassified to conform to the presentation used for 2000.  The reclassifications had no effect on net income.
2. Prior to 1998, net operating loss carryforwards were utilized to offset any federal income tax liability.
3. All per share information has been adjusted to reflect the two-for-one stock split effected in the form of a 100% stock dividend, payable on January 5, 2001

to holders of record as of December 27, 2000.

plans, workers compensation, medicare and PPO patients,
while minimizing the low reimbursed HMO and capitated
contracts.

Partnering With Therapists Is The Difference.  Our company
has  a  unique  partnership  model. The  entrepreneurial
environment of shared ownership melds the therapists’
existing referral relationships and willingness to market,
with our business systems expertise and extensive experience
in operating clinics. Our partners are rewarded for their
commitment to the partnership with both career stability
and personal financial growth. It's having people at the
front line pushing the ball forward with us that makes us
a different company.

Knowing Each Market And Its Customers Drives Our
Bottom Line Growth.  Developing successful clinics results
from precise forecasting that defines the unique situation
of every market. It begins with our partner selection process
and  continues  with  "due  diligence"  that  evaluates  the
market.  Multiple  visits  to  the  community  assure  an
understanding of the market dynamics, including politics,
demographics, competition and physician support of our
candidate. Our start-up team then tailors each clinic with
a "right-sized business plan" that addresses real estate,
equipment  and  staffing. This  in-depth  process  closely
matches expectations with actual performance, giving us
the confidence to continue to accelerate openings.

Our  Home-Office  People  Are  A  Great  Resource.    Our
partners  depend  upon  our  over  65  home-office  team
members to respond, often on a moment's notice, to the
day's challenge or opportunity. We are continually reviewing
our corporate infrastructure to ensure the adequate support
of existing clinics and the smooth integration of new clinics.
In 2000, the Company completed a major upgrade of the
payroll and human resources systems to better serve our
clinics. The  home-office  is  instrumental  in  providing
guidance in the areas of marketing and sales, accounting,
operations, billing and collection, regulatory issues and
human resources.

b

Increased profitability results from focused efforts in several
areas. Our business office liaisons assist our partners in
monitoring their billings, collections, regulatory compliance
and other business issues that therapists may not have the
expertise to handle independently. Similarly, our marketing
group is mentoring the partners to be "the sales face of
their business," thus resulting in greater market share.
Another area of focus is our expanded team of Operations
Vice Presidents who assist our partners in guiding clinic
growth, staffing efficiencies, expansion and day-to-day
challenges that were not covered in P.T. school. Each day,
our partners mature as business people, using our diverse
areas of expertise to improve the operation of their business.

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PATI E NT VI S I TS

N ET R EVE N U E S
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N U M B E R
O F C L I N I C S

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Training Lays The Foundation For Good Managers.  We have embarked
on human resources training for partners and staff with regard to
hiring techniques, motivation and team leadership. We are also
increasing the number of participants in our "Master's Institute"
marketing and sales training course for our partners. Here, we have
seen  immediate  returns  in  accelerated  growth  of  patient  visits.

Decisions Are Fast And Focused.  We are opportunistic in how we
make decisions and redirect our resources quickly in assessing and
implementing opportunities. It requires building on our expertise
and addressing the needs of each market. For example, if there is a
demand by local industry for treatment of repetitive strain injury, we
will recruit a certified hand therapist. When the market demands a
late night schedule for those patients that can only come after work
or on Saturdays, we will respond. Our competitors may not.

Both The Rehab Industry & The Market Recognize Our Value.  We
continue to achieve the goals I set since joining the company in 1994:
increasing shareholder value while maintaining quality patient care.
We are now being recognized on both these fronts. Additionally, we've
developed a solid reputation for our professional ethics and quality
clinical operations. This has resulted in a growing number of qualified
clinicians now desiring to partner with us. Similarly, in the financial
community, many respected entities have begun to notice our success,

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I N C O M E B E F O R E
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E B IT DA
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including Forbes Magazine who in October 2000 recognized us
as one of the "200 Best Small Companies."

In closing, I would like to extend my gratitude to our long-
standing director, Richard C.W. Mauran. Rick resigned from
the Board of Directors in February 2001. Understandably, he
decided to reallocate time to his many global interests. On behalf
of his fellow board members, I thank Rick for his insight, advice
and commitment.

Everyday is a new game. Everyday we wake up and the ball gets
tossed in the air again. We are committed to being respectful of
the opportunity and the trust you have placed before our team.

Thank you.

Roy W. Spradlin
President & Chief Executive Officer

D I R E CTO R S

J. Livingston Kosberg
CHAIRMAN OF THE BOARD

Mark J. Brookner
VICE CHAIRMAN OF THE BOARD

Roy W. Spradlin
PRESIDENT AND CHIEF EXECUTIVE OFFICER

Daniel C. Arnold
PRIVATE INVESTOR

Bruce D. Broussard
CHIEF FINANCIAL OFFICER - US ONCOLOGY

James B. Hoover
FOUNDING MANAGING PARTNER - DAUPHIN CAPITAL PARTNERS

Marlin W. Johnston
HEALTH & HUMAN SERVICES CONSULTANT - TONN & ASSOCIATES

Albert L. Rosen
FORMER GENERAL MANAGER, SAN FRANCISCO GIANTS
PRIVATE INVESTOR
RANCHO MIRAGE, CALIFORNIA

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MANAG E M E NT

J. Livingston Kosberg
CHAIRMAN OF THE BOARD

Mark J. Brookner
VICE CHAIRMAN OF THE BOARD

Roy W. Spradlin
PRESIDENT AND CHIEF EXECUTIVE OFFICER

Michael L. Lang
SENIOR VICE PRESIDENT

J. Michael Mullin
CHIEF FINANCIAL OFFICER

Stephen Rosenbloom
SENIOR VICE PRESIDENT

SHAREHOLDERS’
I N FORMATION

Information Request
Investors, analysts and others seeking financial
information should contact:
J. Michael Mullin, Chief Financial Officer
713.297.7000

Form 10-Q
Copies of the Company’s Form 10-Q and
quarterly press release are available by writing
the Company
Attention: Dorothy Flato, Corporate Secretary or
via the Company’s website at
www.usphysicaltherapy.com

Corporate Headquarters
U.S. Physical Therapy, Inc.
3040 Post Oak Blvd., Suite 222
Houston, Texas 77056
713.297.7000

Corporate Counsel
Mayor, Day, Caldwell & Keeton, L.L.P.
700 Louisiana, Suite 1900
Houston, Texas 77002-2778

Independent Accountants
KPMG LLP
700 Louisiana
Houston, Texas 77002

Shareholder Services
Shareholders desiring to change the name,
address or ownership of stock, to report lost
certificates or to consolidate accounts, should
contact U.S. Physical Therapy’s transfer agent:

Continental Stock Transfer & Trust Company
2 Broadway
New York, New York 10004

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

(Mark One)
≤ ANNUAL  REPORT  UNDER  SECTION  13  OR  15(d)  OF  THE  SECURITIES

EXCHANGE ACT OF 1934

FORM 10-K/A

For the ﬁscal year ended December 31, 2000

n TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the transition period from 

 to

Commission ﬁle number 1-11151

U.S. PHYSICAL THERAPY, INC.

(Name of registrant as speciﬁed in its charter)

Nevada
(State or other jurisdiction of
incorporation or organization)

3040 Post Oak Blvd., Suite 222, Houston, Texas
(Address of principal executive ofﬁces)

76-0364866
(I.R.S. Employer
Identiﬁcation No.)

77056
(Zip Code)

Registrant’s telephone number, including area code: (713) 297-7000

Securities registered pursuant to Section 12(b) of the Exchange Act: Not Applicable

Securities registered pursuant to Section 12(g) of the Exchange Act:

Common Stock, $.01 par value
(Title of Class)

Indicate by check mark whether the registrant (1) ﬁled all reports required to be ﬁled by Section 13 or 15(d) of
the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to ﬁle such
reports), and (2) has been subject to such  ﬁling requirements for the past 90 days. Yes ≤ No n

Indicate by check mark if disclosure of delinquent ﬁlers pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of registrant’s knowledge, in deﬁnitive proxy or information statements
incorporated by reference in Part III of this  Form 10-K  or any  amendment to this  Form 10-K. n

As  of  March  26,  2001,  the  aggregate  market  value  of  the  voting  stock  held  by  non-afﬁliates  of  the  registrant

was: $57,122,000

As of March 26, 2001, the number of shares outstanding of the registrant’s common stock, par value $.01 per

share, was: 6,622,016

Documents Incorporated by Reference

Portions of Deﬁnitive Proxy Statement for the  2001 Annual  Meeting of  Shareholders

PART III

Document

Part of Form 10-K

Forward Looking Statements

We make statements in this report that are considered to be forward-looking statements within the meaning of
the  Securities  and  Exchange  Act  of  1934.  Such  statements  involve  risks  and  uncertainties  that  could  cause  actual
results  to  differ  materially  from  those  we  project.  When  used  in  this  report,  the  words  ‘‘anticipates,’’  ‘‘believes,’’
‘‘estimates,’’ ‘‘intends,’’ ‘‘expects,’’ ‘‘plans,’’ ‘‘should’’ and ‘‘goal’’ and similar expressions are intended to identify such
forward-looking statements. The forward-looking statements are based on the Company’s current views and assump-
tions and involve risks and uncertainties that include, among other things:

) general  economic,  business,  and  regulatory  conditions  discussed  under  the  headings  ‘‘Sources  of  Revenue/

Reimbursement’’ and ‘‘Factors Affecting Future Results’’ below;

) competition discussed under the heading ‘‘Competition’’ below;

) federal and state regulations discussed under  the heading ‘‘Regulation  and  Healthcare Reform’’  below;

) availability, terms, and use of capital discussed under the heading ‘‘Management’s Discussion and Analysis of

Financial Condition and Results of Operations’’ below; and

) weather.

Some or all of these factors are beyond the  Company’s control.

Given these uncertainties, you should not place undue reliance on these forward-looking statements. Please see
the other sections of this report and our other periodic reports ﬁled with the Securities and Exchange Commission
(the  ‘‘SEC’’)  for  more  information  on  these  factors.  These  forward-looking  statements  represent  our  estimates  and
assumptions only as of the date of this report. The Company undertakes no obligation to update any forward-looking
statement,  whether  as  the  result  of  actual  results,  changes  in  assumptions,  new  information,  future  events,  or
otherwise.

Item 1. Business.

General

PART I

U.S.  Physical  Therapy,  Inc.  (the  ‘‘Company’’)  operates  outpatient  physical  and  occupational  therapy  clinics
which  provide  post-operative  care  and  treatment  for  a  variety  of  orthopedic-related  disorders  and  sports-related
injuries. At December 31, 2000, the Company operated 139 outpatient physical and occupational therapy clinics in
30 states. The average age of the 139 clinics in operation at December 31, 2000 was 3.78 years. Since the inception of
the  Company,  146  clinics  have  been  developed  and  six  clinics  have  been  acquired  by  the  Company.  To  date,  the
Company  has  closed  eight  facilities  due  to  adverse  clinic  performance,  consolidated  the  operations  of  three  of  its
clinics with other existing clinics to more efﬁciently serve various geographic markets and sold certain ﬁxed assets at
two  of  the  Company’s  clinics,  which  facilities  it  then  closed.  The  Company  opened  28  new  clinics  in  2000.
Management’s goal for 2001 is to open between 30 and 35  clinics.

The  clinics  provide  post-operative  care  and  treatment  for  a  variety  of  orthopedic-related  disorders  and  sports-
related injuries, treatment for neurologically-related injuries, rehabilitation of injured workers and preventative care.
Each clinic’s staff typically includes one or more licensed physical and/or occupational therapists and ofﬁce personnel,
and may also include physical and/or occupational therapy assistants, aides, exercise physiologists and athletic trainers.
The clinics perform a tailored and comprehensive evaluation of each patient which is followed by a treatment plan
speciﬁc  to  the  injury.  The  treatment  plan  may  include  the  use  of  modalities  and  procedures  such  as  ultrasound,
electrical  stimulation,  hot  packs,  iontophoresis,  therapeutic  exercise,  manual  therapy  techniques,  education  on
management of daily life skills and home exercise programs. The clinics’ business primarily originates from physician
referrals.  The  principal  sources  of  payment  for  the  clinics’  services  are  commercial  health  insurance,  workers’
compensation insurance, managed care programs, Medicare and proceeds from personal injury cases. The Company’s
strategy is to develop and acquire outpatient clinics on a national basis.

1

The  Company’s  development  strategy  is  to  attract  physical  and  occupational  therapists  who  have  established
relationships with physicians by offering them the opportunity to acquire a partnership interest in a new clinic to be
developed by the Company. In addition, the therapist partner receives a competitive salary and bonus based on his or
her clinic’s net revenue and proﬁtability. The Company is presently engaged in discussions with several prospective
therapist partners.

In addition to the Company’s partnership program, it also manages physical therapy facilities for third parties,
including  physicians,  with  seven  such  third-party  facilities  under  the  Company’s  management  as  of  December  31,
2000.

In  March  2000,  the  Company  decided  to  discontinue  its  surgery  center  initiative  which  originally  began  in
1999. Costs incurred related to the surgery center initiative, including severance beneﬁts for terminated employees,
totaled $369,000 and $384,000 for the  years  ended  December  31, 2000 and 1999, respectively.

On  January  5,  2001,  the  Company  effected  a  two-for-one  common  stock  split  in  the  form  of  a  100%  stock
dividend to stockholders of record as of December 27, 2000. All share and per share amounts contained herein have
been adjusted to reﬂect the effect of the stock split.

The Company was formed in June 1990 and operated as a subchapter S Corporation until August 1991 when it
reorganized into a limited partnership form of organization. In May 1992, in connection with the Company’s initial
public offering, the Company was reorganized into its present form, a Nevada corporation with operating subsidiaries
organized  in  the  form  of  limited  partnerships.  In  such  reorganization,  the  prior  owners  of  the  limited  partnership
interests and the corporate general partner corporations exchanged their interests for the Company’s common stock.

In June 1993, the Company completed the issuance and sale at par in a private placement of $3,050,000 of 8%
Convertible  Subordinated  Notes  due  June  30,  2003  (the  ‘‘Initial  Series  Notes’’).  In  May  1994,  the  Company
completed the issuance and sale at par in a private placement of $2,000,000 of 8% Convertible Subordinated Notes,
Series B due June 30, 2004 (the ‘‘Series B Notes’’) and $3,000,000 of 8% Convertible Subordinated Notes, Series C
due June 30, 2004 (the ‘‘Series C Notes,’’ and collectively, the Initial Series Notes, the Series B Notes and the Series C
Notes are hereinafter referred to as the ‘‘Convertible Subordinated Notes’’).

The  Convertible  Subordinated  Notes  are  convertible  at  the  option  of  the  holders  thereof  into  the  number  of
whole shares of Company common stock determined by dividing the principal amount of the notes so converted by
$5.00  (in  the  case  of  the  Initial  Series  Notes  and  the  Series  C  Notes)  or  $6.00  (in  the  case  of  the  Series  B  Notes),
subject to adjustment under certain circumstances.

During  2000,  $850,000  of  the  Convertible  Subordinated  Notes  were  converted  by  the  note  holders  into
144,998  shares  of  common  stock,  resulting  in  a  balance  of  $7,200,000  in  Convertible  Subordinated  Notes  at
December 31, 2000. In January 2001, an additional $650,000 was converted by a note holder into 130,000 shares of
common stock and the Company exercised its right under the Initial Series Notes and the Series B Notes to require
conversion of the remaining $3,550,000 into 668,332 shares of common stock. The Series C Notes do not contain a
mandatory conversion feature and currently remain  outstanding.

Unless the context otherwise requires, references in this Form 10-K to the Company include the Company and
all its subsidiaries. The Company’s principal executive ofﬁces are located at 3040 Post Oak Blvd., Suite 222, Houston,
Texas 77056, and its telephone number is  (713) 297-7000.

The Company’s Clinics

In general, the managing physical and/or occupational therapist of each clinic owns a partnership interest in the
clinic he or she operates. For the majority of the clinics, this is accomplished by structuring the clinic as a separate
limited  partnership  (the  ‘‘Clinic  Partnerships’’).  As  of  December  31,  2000,  the  Company,  through  wholly-owned
subsidiaries, owned a 1% general partnership interest, with the exception of one clinic in which the Company owned
a  6%  general  partnership  interest,  and  limited  partnership  interests  ranging  from  49%  to  99%  in  the  clinics  it
operates (with respect to 90% of the Company’s clinics, the Company owned a limited partnership interest of 64% as
of December 31, 2000). For the majority of the clinics, the managing therapist of each such clinic, along with other
therapists at the clinic in several of the partnerships, own the remaining limited partnership interests in the clinic. In

2

some  instances,  the  Company  develops  satellite  clinic  facilities  which  are  extensions  of  existing  clinics,  and  thus,
Clinic Partnerships may consist of one or  more  clinic locations.

In the majority of the partnership agreements, the therapist partner begins with a 20% proﬁt interest in his or
her  Clinic  Partnership  which  increases  by  3%  at  the  end  of  each  year  until  his  or  her  interest  reaches  35%.  The
therapist partners have no interest in net losses of Clinic Partnerships, except to the extent of their capital accounts.
The Company presently anticipates that future clinics developed by the Company will be structured in a comparable
manner.

In addition, typically each therapist partner enters into an employment agreement with the Company providing
for a covenant not to compete during his or her employment with the Company plus one to two years thereafter. The
terms  of  the  employment  agreements  range  from  two  to  ﬁve  years.  Pursuant  to  each  employment  agreement,  the
therapist partner receives a base salary and a bonus based on the net revenues or operating proﬁt generated by his or
her Clinic Partnership. Each employment agreement provides that the therapist partner can be required to sell his or
her partnership interest in the Clinic Partnership for the amount of his or her capital account upon termination of
employment with the Clinic Partnership before the expiration of the initial term of employment. The employment
agreements  contain  no  provisions  requiring  the  purchase  by  the  Company  of  the  therapist  partner’s  interest  in  the
Clinic Partnership in the event of death  or disability, or after  the initial term  of employment.

The Company’s business plan is to have each clinic maintain an independent local identity, while at the same
time enjoying the beneﬁts of national purchasing, third-party payor contracts and centralized management controls.
Pursuant to a management agreement, U.S. PT Management, Ltd. (‘‘USPTM’’), a Texas limited partnership owned
indirectly  by  the  Company,  provides  a  variety  of  services  to  each  clinic,  including  supervision  of  site  selection,
construction, clinic design and equipment selection, establishment of accounting systems and procedures and training
of ofﬁce support personnel, management oversight of operations, ongoing accounting services and marketing support.

The  Company’s  typical  clinic  occupies  approximately  1,500  to  4,000  square  feet  of  space  under  a  lease  in  an
ofﬁce building or shopping center. The Company seeks to obtain leases for its clinics at ground level (although it may
not always be successful in obtaining such leases) in order to make access to its clinics as easy as possible for patients.
The  Company  also  attempts  to  make  the  decor  in  its  clinics  less  institutional  and  more  aesthetically  pleasing  than
hospital  clinics.  The  typical  staff  needed  to  operate  a  clinic  in  its  initial  stages  is  a  licensed  physical  and/or
occupational  therapist  and  an  ofﬁce  manager.  Stafﬁng  may  also  include  physical  and/or  occupational  therapy
assistants,  aides,  exercise  physiologists  and  athletic  trainers.  As  patient  visits  grow,  the  stafﬁng  may  be  increased  to
include  two  or  more  additional  licensed  physical  and/or  occupational  therapists  and  one  or  two  additional  ofﬁce
personnel.  All  therapy  services  provided  are  performed  under  the  direct  supervision  of  a  licensed  physical  and/or
occupational therapist.

The Company currently provides its services at its clinics only on an outpatient basis. Patients requiring these
types  of  services  are  usually  treated  for  approximately  one  hour  per  day,  two  to  ﬁve  times  a  week.  This  form  of
treatment typically lasts two to six weeks. The Company’s charge for the treatment is generally on a per procedure
basis.  In  addition  to  the  services  mentioned,  the  clinics  will,  when  appropriate,  develop  individual  maintenance
exercise programs to be continued after treatment. Advice on postural improvements and changes in work habits or
lifestyle  is  provided  to  promote  self-management  of  the  patient’s  condition.  The  Company  continues  to  assess  the
potential for developing new services and expanding the method of providing its current services, with an emphasis
on health insurance and workers’ compensation insurance cost containment.

Industry Background

Physical and occupational therapy is the process of aiding in the rehabilitation of individuals disabled by injury
or disease or recovering from surgery. Management believes that the following factors are inﬂuencing the growth of
outpatient physical and occupational therapy services:

Economic Beneﬁts of Physical and Occupational Therapy Services. Purchasers and providers of healthcare services,
such as insurance companies, health maintenance organizations, businesses and industries, are seeking ways to save on
traditional  healthcare  services.  Management  believes  physical  and  occupational  therapy  services  are  cost-effective  by

3

helping  to  prevent  short-term  disabilities  from  becoming  chronic  conditions,  and  by  speeding  the  recovery  from
surgery and musculoskeletal injuries.

Earlier  Hospital  Discharge. Changes  in  health  insurance  reimbursement,  both  public  and  private,  have  en-
couraged  the  early  discharge  of  patients  in  order  to  contain  and  reduce  costs.  Management  believes  early  hospital
discharge  practices  foster  greater  numbers  of  individuals  requiring  outpatient  physical  and  occupational  therapy
services.

Aging  Population. The  elderly  population,  which  has  experienced  rapid  growth  over  the  past  several  decades,

has a greater incidence of major disability.  This growth has  fueled the demand for  rehabilitation services.

Marketing

On  a  local  basis,  the  Company  focuses  its  marketing  efforts  on  physicians,  mainly  orthopedic  surgeons,
neurosurgeons, physiatrists, occupational medicine and general practitioners, which generally account for the majority
of physical and occupational therapy referrals. In marketing to the physician community, the clinics emphasize their
commitment  to  quality  patient  care  and  communication  with  physicians  regarding  patient  progress.  On  a  national
level, the Company employs marketing personnel to assist the clinic directors in establishing referral relationships with
health  maintenance  organizations,  preferred  provider  organizations,  industry  and  case  managers  and  insurance
companies  for  clinic  therapy  services,  as  well  as  to  develop  and  implement  marketing  plans  for  marketing  to  the
physician community.

Sources of Revenue/Reimbursement

Payor  sources  for  clinic  services  are  primarily  commercial  health  insurance,  managed  care  programs,  workers’
compensation  insurance,  Medicare  and  proceeds  from  personal  injury  cases.  Commercial  health  insurance  and
managed care programs generally provide outpatient services coverage to patients utilizing the clinics, and the patient
is normally required to pay an annual deductible and a co-insurance payment. Workers’ compensation is a statutorily
deﬁned  employee  beneﬁt  which  varies  on  a  state-by-state  basis.  Workers’  compensation  laws  generally  require
employers to pay for employees’ costs of medical rehabilitation, lost wages, legal fees and other costs associated with
work-related injuries and disabilities and, in certain jurisdictions, mandatory vocational rehabilitation. These statutes
generally  require  that  these  beneﬁts  be  offered  to  employees  without  any  deductibles,  co-payments  or  cost  sharing.
Companies  may  provide  such  coverage  to  their  employees  through  either  the  purchase  of  insurance  from  private
insurance  companies,  participation  in  state-run  funds  or  through  self-insurance.  Treatments  for  patients  who  are
parties to personal injury cases are generally paid for from the proceeds of settlements with insurance companies or
from  favorable  judgements.  If  an  unfavorable  judgement  is  received,  collection  efforts  are  generally  not  pursued
against the patient and the patient’s account is written off against established reserves. Bad debt reserves relating to
personal injury accounts receivable are regularly  reviewed and adjusted as appropriate.

The Company’s business depends to a signiﬁcant extent on its relationships with physicians, commercial health
insurers,  workers’  compensation  insurers,  and  other  referral  sources,  such  as  health  maintenance  organizations  and
preferred  provider  organizations.  If  clinics  are  located  in  certain  geographical  areas,  it  is  important  for  them  to  be
approved as providers by certain key health maintenance organizations and preferred provider plans. If these clinics do
not obtain such approval, or if they cannot maintain such approval, the  Company could  be adversely  affected.

As  of  December  31,  2000,  112  of  the  Company’s  clinics  have  been  certiﬁed  as  rehabilitation  agencies  by
Medicare  and  14  additional  clinics  have  individual  therapists  certiﬁed  by  Medicare  to  provide  services  as  physical
therapists in private practice. Management anticipates that, in the future, newly developed clinics will generally elect
to  become  certiﬁed  as  Medicare  providers.  No  assurance  can  be  given  that  the  newly  developed  clinics  will  be
successful in becoming certiﬁed as Medicare providers.

Prior to 1999, Medicare reimbursement for outpatient physical and occupational therapy services furnished by a
Medicare-certiﬁed  rehabilitation  agency  was  based  on  a  cost  reimbursement  methodology.  The  Company  was
reimbursed  at  a  tentative  rate  with  ﬁnal  settlement  determined  after  submission  of  an  annual  cost  report  by  the
Company and audits thereof by the Medicare ﬁscal intermediary. Effective in 1999, the Balanced Budget Act of 1997
(‘‘BBA’’) provides that reimbursement for outpatient therapy services provided to Medicare beneﬁciaries is pursuant

4

to a fee schedule published by the Department of Health and Human Services (‘‘HHS’’), and the total amount paid
by Medicare in any one year for outpatient physical (including speech-language pathology) or occupational therapy to
any  one  patient  is  limited  to  $1,500,  except  for  services  provided  in  hospitals.  On  November  29,  1999,  President
Clinton  signed  into  law  the  Medicare,  Medicaid  and  SCHIP  Balanced  Budget  Reﬁnement  Act  of  1999  (‘‘BBRA’’)
which,  among  other  provisions,  placed  a  two-year  moratorium  on  the  $1,500  reimbursement  limit  for  therapy
services provided in 2000 and 2001. On December 21, 2000, the President signed into law the Medicare, Medicaid,
and SCHIP Beneﬁts Improvement and Protection Act of 2000 (‘‘BIPA’’) which, among other provisions, extended
the moratorium for one year through December 31, 2002.

Medicare regulations require that a physician certify the need for physical and/or occupational therapy services
for  each  patient  and  that  these  services  be  provided  in  accordance  with  an  established  plan  of  treatment  which  is
periodically  revised.  State  Medicaid  programs  generally  do  not  provide  coverage  for  outpatient  physical  or  occupa-
tional  therapy, and, therefore, Medicaid  is  not, nor is it expected to be, a material payor for the Company.

Regulation and Healthcare Reform

The healthcare industry is subject to numerous federal, state and local regulations. Certain states into which the
Company  may  expand  have  laws  that  require  facilities  that  employ  health  professionals  and  provide  health-related
services  to  be  licensed  and,  in  some  cases,  to  obtain  a  certiﬁcate  of  need.  Pursuant  to  certiﬁcate  of  need  laws,  the
affected entity is required to demonstrate to a state regulatory authority the need for and ﬁnancial feasibility of certain
expenditures related to such activities as the construction of new facilities or the commencement of new healthcare
services.  Based  on  its  operating  experience  to  date,  the  Company  believes  that  its  business,  as  presently  conducted,
does not require certiﬁcates of need or other facility approvals or licenses. There can be no assurance, however, that
existing laws or regulations will not be interpreted or modiﬁed to require the Company to obtain such approvals or
licenses  and,  if  so,  that  such  approvals  or  licenses  could  be  obtained.  Failure  to  obtain  any  required  certiﬁcates,
approvals or licenses could have a material adverse effect on the Company’s business, ﬁnancial condition and results of
operations.

As  of  December  31,  2000,  112  of  the  Company’s  clinics  have  been  certiﬁed  as  rehabilitation  agencies  by
Medicare  and  14  additional  clinics  have  individual  therapists  certiﬁed  by  Medicare  to  provide  services  as  physical
therapists in private practice. In order to receive Medicare reimbursement, a rehabilitation agency or the individual
therapist  must  meet  the  applicable  conditions  of  participation  set  forth  by  HHS  relating  to  the  type  of  facility,  its
equipment,  record  keeping,  personnel  and  standards  of  medical  care,  as  well  as  compliance  with  all  state  and  local
laws. Clinics are subject to periodic inspections  or  surveys  to determine compliance.

Various Federal and state laws regulate the relationships between providers of healthcare services and physicians.
These laws include Section 1128B(b) of the Social Security Act (the ‘‘Fraud and Abuse Law’’), under which civil and
criminal penalties can be imposed upon persons who pay or receive remuneration in return for referrals of patients
who  are  eligible  for  reimbursement  under  the  Medicare  or  Medicaid  programs.  The  Company  does  not  believe  its
business arrangements are out of compliance with these provisions. The provisions are broadly written and the full
extent  of  their  application  is  not  currently  known.  In  1991,  the  Ofﬁce  of  the  Inspector  General  (‘‘OIG’’)  of  the
United States Department of Health and Human Services issued regulations describing compensation arrangements
which are not viewed as illegal remuneration under the Fraud and Abuse Law (the ‘‘1991 Safe Harbor Rules’’). The
1991 Safe Harbor Rules created certain standards (‘‘Safe Harbors’’) which, if fully complied with, assure participants
that a particular business arrangement is not: (a) a criminal offense under the Fraud and Abuse Law, (b) the basis for
an exclusion from the Medicare and Medicaid programs or (c) the basis for imposition of civil sanctions. Failure to fall
within a Safe Harbor does not constitute a violation of the Fraud and Abuse Law; however, the OIG has indicated
that failure to fall within a Safe Harbor may  subject  an arrangement to increased scrutiny.

The  Fraud  and  Abuse  Law  limits  the  relationships  which  the  Company  may  have  with  referral  sources.  The
Company’s  business  of  managing  physician-owned  physical  therapy  facilities  is  subject  to  Fraud  and  Abuse  Law
issues. According to the OIG’s advisory opinion No. 98-4, these business arrangements fall outside the scope of the
Safe Harbors. Currently, federal courts provide little guidance as to the application of the Fraud and Abuse Law to
such  arrangements.  Management  considers  these  issues  in  planning  its  clinics,  marketing  and  other  activities,  and
believes its operations are in compliance with applicable law, but no assurance can be given regarding compliance in

5

any particular factual situation. In the event that management contracts of the type to which the Company is a party
are  held  to  violate  the  Fraud  and  Abuse  Law,  such  holding  could  have  a  material  adverse  effect  on  the  Company’s
business, ﬁnancial condition and results of operations.

In  February  2000,  the  OIG  issued  a  special  fraud  alert  regarding  the  rental  of  space  in  physician  ofﬁces  by
persons  or  entities  to  which  the  physicians  refer.  The  OIG  is  concerned  that  in  such  arrangements,  the  rental
payments  may  be  disguised  kickbacks  to  the  physician-landlords  to  induce  referrals.  The  Fraud  and  Abuse  Law
prohibits knowingly and willfully soliciting, receiving, offering or paying anything of value to induce referrals of items
or services payable by a federal healthcare program. Currently, eight clinics rent space from referring physicians. The
Company has taken the steps that it believes are necessary to assure that all leases comply with the space rental Safe
Harbor to the Fraud and Abuse Law. When the lease meets all of the criteria of a Safe Harbor, the arrangement is
immune from prosecution under the Fraud and Abuse Law.

The Company believes its operations are in compliance with the current requirements of applicable federal and
state law, but no assurances can be given that a federal or state agency charged with enforcement of the Fraud and
Abuse Law and similar laws might not assert an adverse position or new interpretation of existing laws that could have
a material adverse effect on its business.

The  federal  law  known  as  the  ‘‘Stark  II’’  provisions  of  the  Omnibus  Budget  Reconciliation  Act  of  1993  (the
‘‘Stark  Law’’)  amended  the  federal  Medicare  statute  to  prohibit  referrals  by  a  physician  for  ‘‘designated  health
services,’’  including  physical  therapy  and  occupational  therapy,  to  an  entity  in  which  the  physician  (or  family
member)  has  an  investment  interest  or  other  ﬁnancial  relationship,  subject  to  certain  exceptions.  This  prohibition
took effect on January 1, 1995.

This  law  also  prohibits  billing  for  services  rendered  pursuant  to  a  prohibited  referral.  Penalties  for  violation
include denial of payment for the services, signiﬁcant civil monetary penalties, and exclusion from the Medicare and
Medicaid programs. Several states have enacted laws similar to the Stark Law, but these state laws cover all (not just
Medicare and Medicaid) patients; and many healthcare reform proposals in the last few years would have expanded
the Stark Law to cover all patients as well. The Stark Law covers a management contract with a physician group and
any ﬁnancial relationship between the Company and referring physicians, including any ﬁnancial transaction resulting
from  a  clinic  acquisition.  As  with  the  Fraud  and  Abuse  Law,  management  considers  the  Stark  Law  in  planning  its
clinics,  marketing  and  other  activities,  and  believes  that  its  operations  are  in  compliance  with  applicable  law.
However, as noted above, no assurance can be  given  regarding compliance in  any particular  factual situation.

Health Insurance Portability and Accountability Act

In an effort to combat healthcare fraud, Congress included several anti-fraud measures in the Health Insurance
Portability  and  Accountability  Act  of  1996  (‘‘HIPAA’’).  HIPAA  amends  existing  criminal  legislation  and  criminal
penalties  for  Medicare  fraud  and  enacts  new  federal  healthcare  anti-fraud  legislation.  HIPAA  creates  a  source  of
funding for fraud control divided between HHS and the Department of Justice and is used to coordinate federal, state
and local healthcare law enforcement programs, conduct investigations, provide guidance to the healthcare industry
on fraudulent healthcare practices, and establish a national data bank to receive and report ﬁnal adverse actions. The
Company  cannot  predict  what  effect,  if  any,  these  expanded  enforcement  authorities  will  have  on  the  healthcare
industry generally or on the Company’s business.

Additionally, HIPAA mandates the adoption of certain standards regarding the exchange of electronic healthcare
information in an effort to ensure the privacy and security of patient information. HIPAA’s security and privacy ﬁnal
regulations were released by HHS on December 28, 2000; however, these regulations are currently under review and
will  not  be  ﬁnalized  until  April  14,  2001.  Once  the  regulations  are  ﬁnalized,  the  Company  will  have  two  years  to
comply. Sanctions for failing to comply  with HIPAA include criminal penalties and civil  sanctions.

The Company is evaluating the impact of HIPAA. At this time, the Company anticipates that it will be able to
fully comply with the HIPAA requirements that have been adopted. Since the HIPAA regulations have not yet been
ﬁnalized, the Company cannot at this time estimate the cost of such compliance. Based on its current knowledge, the
Company  believes  that  the  cost  of  its  compliance  will  not  have  a  material  adverse  effect  on  its  business,  ﬁnancial
condition or results of operations.

6

Political,  economic  and  regulatory  inﬂuences  are  subjecting  the  healthcare  industry  in  the  United  States  to
fundamental change. The Company anticipates that Congress, state legislatures and the private sector will continue to
review and assess alternative healthcare delivery and payment systems. Potential approaches that have been considered
include  mandated  basic  healthcare  beneﬁts,  controls  on  healthcare  spending  through  limitations  on  the  growth  of
private health insurance premiums and Medicare and Medicaid spending, the creation of large insurance purchasing
groups, price controls and other fundamental changes to the healthcare delivery system. Managed care entities, which
represent an ever-growing percentage of healthcare payors, are demanding lower costs from healthcare providers, and
in many cases, requiring or encouraging providers to accept capitated payments that may not be adequate to allow
providers to cover their full costs or may reduce their proﬁtability. Legislative debate is expected to continue in the
future  and  market  forces  are  expected  to  demand  reduced  costs.  The  Company  cannot  predict  what  impact  the
adoption of any federal or state healthcare reform measures or future private sector reform may have on its business.

Competition

The healthcare industry, generally, and the physical and occupational therapy businesses, in particular, are highly
competitive and subject to continual changes in the manner in which services are delivered and in which providers are
selected.  The  competitive  factors  in  the  physical  and  occupational  therapy  businesses  include,  without  limitation,
quality  of  care,  cost,  treatment  outcomes,  convenience  of  location,  and  relationships  with  and  ability  to  meet  the
needs  of  referral  and  payor  sources.  The  Company’s  clinics  compete  directly  or  indirectly  with  the  physical  and
occupational therapy departments of acute care hospitals, physician-owned therapy clinics, private therapy clinics and
chiropractors.

The Company believes that its main sources of competition are acute care hospital outpatient therapy clinics and
private  therapy  clinic  organizations  that  provide  therapy  services.  The  Company  will  face  further  competition  as
consolidation  of  the  therapy  industry  continues  through  the  acquisition  of  physician-owned  and  other  privately-
owned therapy practices.

Management believes that providing the key therapists with an opportunity to participate in clinic ownership is a
competitive advantage because it helps to ensure commitment by local management to the success of the clinic and
minimizes turnover of managing therapists.

The  Company  also  believes  its  competitive  position  is  enhanced  by  its  strategy  of  locating  its  clinics,  when
possible, on the ground ﬂoor in ofﬁce buildings and shopping centers with nearby parking, thereby making the clinics
more easily accessible to patients. The Company attempts to make the decor in its clinics less institutional and more
aesthetically pleasing than hospital clinics. Management also believes it can generally provide its services at a lesser cost
than comparable services of hospitals due  to  hospitals’ higher overhead.

Employees

At December 31, 2000, the Company employed 1,056 total employees, of which 610 were full-time employees.
At that date, none of the Company’s employees were subject to collective bargaining agreements or were members of
unions. Management considers the relations  between the  Company  and  its employees to be  good.

In the states in which the Company’s current clinics are located, persons performing physical and occupational
therapy  services  are  required  to  be  licensed  by  the  state.  All  persons  currently  employed  by  the  Company  and  its
clinics  who  are  required  to  be  licensed  are  licensed,  and  the  Company  intends  that  all  future  employees  who  are
required to be licensed will be licensed. Management is not aware of any federal licensing requirements applicable to
its employees.

Insurance

The  Company  maintains  professional  liability  coverage  on  professionals  employed  in  each  of  its  clinics,  in
addition  to  general  liability  insurance  and  coverage  for  the  customary  risks  inherent  in  the  operation  of  healthcare
facilities and businesses in general. Management believes its insurance policies in force to be adequate in amount and
coverage for its current operations.

7

Item 2. Properties.

The Company presently leases, under noncancellable operating leases with terms ranging from one to ﬁve years,
all of the properties used for its clinics with the exception of two clinics located in Brownwood, Texas and Mineral
Wells,  Texas,  for  which  the  Company  owns  the  buildings.  The  Company  also  owns  a  building  in  Clovis,  New
Mexico, which it intends to sell or lease, related to a clinic closed in 2000. The Company intends, where feasible, to
lease the premises in which new clinics will be located. The Company’s typical clinic occupies approximately 1,500 to
4,000 square feet of space.

The  Company  also  leases,  under  a  noncancellable  operating  lease  expiring  in  July  2003,  its  executive  ofﬁces
located  in  Houston,  Texas.  The  executive  ofﬁces  currently  occupy  approximately  18,726  square  feet  of  space
(including allocations for common areas).

Item 3. Legal Proceedings.

The Company is subject to litigation and other proceedings arising in the ordinary course of business. While the
ultimate outcome of lawsuits or other proceedings cannot be predicted with certainty, management does not believe
the  impact  of  such  lawsuits  or  other  proceedings,  if  any,  would  be  material  to  the  Company’s  business,  ﬁnancial
condition or results of operations.

Item 4. Submission of Matters to a Vote of Security Holders.

No  matters  were  submitted  to  a  vote  of  security  holders  of  the  Company,  through  solicitation  of  proxies  or

otherwise, during the fourth quarter of 2000.

Item 5. Market for Common Equity and Related Stockholder Matters.

Price Quotations

PART II

The Company’s common stock trades on the Nasdaq Stock Market, Inc. (‘‘Nasdaq’’) National Market under the
symbol ‘‘USPH.’’ The range of Nasdaq reported trading prices for each quarterly period, as set forth below, reﬂect the
two-for-one  stock  split  effected  in  the  form  of  a  100%  stock  dividend,  payable  on  January  5,  2001,  to  holders  of
record as of December 27, 2000. The reported quotations reﬂect inter-dealer prices, without retail mark-up, mark-
down or commission and may not represent  actual transactions.

Quarter
First ***********************************
Second *********************************
Third **********************************
Fourth *********************************

2000

1999

High

Low

High

Low

$4.984
5.375
7.875
12.688

$4.125
4.375
5.188
6.875

$4.750
4.688
4.719
4.813

$3.750
3.750
3.875
3.625

Record Holders

As  of March 12, 2001, there were 43 holders  of record  of the Company’s outstanding common  stock.

Dividends

Since  inception,  the  Company  has  not  declared  or  paid  cash  dividends  or  made  distributions  on  its  equity
securities (other than as described in the next paragraph), and the Company does not anticipate that it will pay cash
dividends or make distributions in the foreseeable  future.

On January 5, 2001, the Company effected a two-for-one stock split in the form of a 100% stock dividend to

stockholders of record as of December 27,  2000.

8

Recent Sales of Unregistered Securities

There were no sales of unregistered securities during  the quarter ended December 31, 2000.

Item 6. Selected Financial Data.

Net revenues(1) ****************************
Income before income taxes ******************
Net income(2)*****************************
Earnings per common share:

Basic(3) ********************************
Diluted(3) ******************************
Total assets(1) *****************************
Long-term debt, less current portion ***********
Working capital(1) *************************
Current ratio(1)****************************
Long-term debt to total capitalization **********

2000

$63,222
$ 6,138
$ 3,735

0.61
$
$
0.52
$22,970
$ 7,226
$10,420
4.14
0.46

Year Ended December 31,
1997
1998
1999
(in thousands, except per share data)
$44,837
$ 2,704
$ 1,596

$51,368
$ 3,962
$ 2,394

$38,807
$ 2,481
$ 2,426

0.35
$
$
0.34
$23,346
$ 8,087
$12,493
6.79
0.43

0.22
$
$
0.21
$24,362
$ 8,126
$12,832
5.45
0.41

0.34
$
$
0.33
$22,548
$ 8,239
$11,204
5.07
0.45

1996

$32,207
$ 1,758
$ 1,641

0.23
$
$
0.22
$19,483
$ 8,276
$ 9,214
4.56
0.52

(1) Certain amounts for 1999 and 1998 have been  reclassiﬁed to conform  to  the presentation  used for  2000. The

reclassiﬁcations had no effect on net income.

(2) Prior to 1998, net operating loss carryforwards were utilized to offset any federal  income tax liability.

(3) All per share information has been adjusted to reﬂect the two-for-one stock split effected in the form of a 100%

stock dividend, payable on January 5, 2001 to  holders  of  record as  of December 27, 2000.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Overview

The  Company  operates  outpatient  physical  and/or  occupational  therapy  clinics  which  provide  post-operative
care and treatment for a variety of orthopedic-related disorders and sports-related injuries. At December 31, 2000, the
Company operated 139 outpatient physical and/or occupational therapy clinics in 30 states. The average age of the
139 clinics in operation at December 31, 2000 was 3.78 years. Since the inception of the Company, 146 clinics have
been developed and six clinics have been acquired by the Company. To date, the Company has closed eight facilities
due to adverse clinic performance, consolidated the operations of three of its clinics with other existing clinics to more
efﬁciently serve various geographic markets and closed two of the Company’s clinics after selling certain ﬁxed assets at
such facilities. The closure of one of the Company’s clinics, due to adverse clinic performance, occurred during 1998.
See  ‘‘Loss  on  Closure  of  Facility’’  for  additional  information.  During  1999,  three  clinics  were  closed  with  no  loss
being recognized related to these closures. These three clinics combined accounted for net patient revenues and clinic
operating  costs  for  the  year  ended  December  31,  1999  of  $263,000  and  $333,000,  respectively,  and  for  the  year
ended  December  31,  1998  of  $815,000  and  $728,000,  respectively.  Two  clinics  were  closed  in  2000  with  no  loss
being recognized. These two clinics combined accounted for net patient revenues and clinic operating costs for the
year  ended  December  31,  2000  of  $97,000  and  221,000,  respectively,  for  the  year  ended  December  31,  1999  of
$222,000  and  $328,000,  respectively,  and  for  the  year  ended  December  31,  1998  of  $211,000  and  $228,000,
respectively.

In addition to the Company’s partnership program, it also manages physical therapy facilities for third parties,

including physicians, with seven such third-party  facilities  under management as of  December 31, 2000.

9

Fiscal Year 2000 Compared to Fiscal Year 1999

Net Patient Revenues

Net  patient  revenues  increased  to  $60,667,000  for  2000  from  $49,056,000  for  1999,  an  increase  of
$11,611,000,  or  24%,  on  a  23%  increase  in  patient  visits  to  697,000.  Net  patient  revenues  from  the  28  clinics
opened  during  2000  (the  ‘‘2000  New  Clinics’’)  accounted  for  27%  of  the  increase,  or  $3,144,000.  The  remaining
increase of $8,467,000 in net patient revenues is attributable to those 111 clinics opened before 2000 (the ‘‘Mature
Clinics’’). Of the $8,467,000 increase in net patient revenues from the Mature Clinics, $8,215,000 was due to a 17%
increase in the number of patient visits to 661,000, while $252,000 was due to an increase in the average net revenue
per visit to $87.03.

Net patient revenues are based on established billing rates less allowances and discounts for patients covered by
worker’s compensation programs and other contractual programs. Payments received under these programs are based
on  predetermined  rates  and  are  generally  less  than  the  established  billing  rates  of  the  clinics.  Net  patient  revenues
reﬂect  reserves,  which  are  evaluated  quarterly  by  management,  for  contractual  and  other  adjustments  relating  to
patient discounts from certain payors. Prior to January 1, 1999, Medicare reimbursement for outpatient physical and
occupational therapy services furnished by clinics was based on a cost reimbursement methodology. The Company
was reimbursed at a tentative rate with ﬁnal settlement determined after submission of an annual cost report by the
Company and audits thereof by the Medicare ﬁscal intermediary. Effective in 1999, the Balanced Budget Act of 1997
provides  that  reimbursement  for  outpatient  therapy  services  provided  to  Medicare  beneﬁciaries  is  pursuant  to  a  fee
schedule  published  by  the  Department  of  Health  and  Human  Services,  and  the  total  amount  that  may  be  paid  by
Medicare in any one year for outpatient physical (including speech-language pathology) or occupational therapy to
any  one  patient  is  limited  to  $1,500,  except  for  services  provided  in  hospitals.  On  November  29,  1999,  President
Clinton signed into law the Medicare, Medicaid and SCHIP Balanced Budget Reﬁnement Act of 1999 which, among
other provisions, placed a two-year moratorium on the $1,500 reimbursement limit for therapy services provided in
2000 and 2001. On December 21, 2000, the President signed into law the Medicare, Medicaid, and SCHIP Beneﬁts
Improvement  and  Protection  Act  of  2000  which,  among  other  provisions,  extended  the  moratorium  for  one  year
through December 31, 2002.

Medicare regulations require that a physician certify the need for physical and/or occupational therapy services
for  each  patient  and  that  these  services  be  provided  in  accordance  with  an  established  plan  of  treatment  which  is
periodically  revised.  State  Medicaid  programs  generally  do  not  provide  coverage  for  outpatient  physical  or  occupa-
tional  therapy, and, therefore, Medicaid  is  not, nor is it expected to be, a material payor for the Company.

Management Contract Revenues

Management  contract  revenues  increased  to  $2,369,000  for  2000  from  $2,112,000  for  1999,  an  increase  of
$257,000, or 12%. Approximately $117,000 of the increase, or 46%, was due to a new management contract entered
into in March 2000. The remaining 54% increase, or $140,000, was primarily due to a 9% increase in patient visits
for management contracts entered into prior to 2000.

Other Revenues

Other  revenues  consisting  of  interest,  sublease  and  real  estate  commission  income  decreased  to  $186,000  for
2000 from $200,000 for 1999, a decrease of $14,000, or 7%. The decrease was primarily due to a sublease agreement
that was terminated in 1999, offset, in part,  by an increase  in real estate commission income.

Clinic Operating Costs

Clinic  operating  costs  as  a  percent  of  net  patient  revenues  and  management  contract  revenues  combined

decreased to 72% for 2000 from 74% for 1999.

Clinic Operating Costs — Salaries and Related Costs

Salaries  and  related  costs  increased  to  $28,683,000  for  2000  from  $23,995,000  for  1999,  an  increase  of
$4,688,000,  or  20%.  Approximately  37%  of  the  increase,  or  $1,748,000,  was  due  to  the  2000  New  Clinics.  The

10

remaining 63% increase, or $2,940,000, was due principally to increased stafﬁng to meet the increase in patient visits
for the Mature Clinics, coupled with an increase in bonuses earned by the clinic directors at the Mature Clinics. Such
bonuses are based on the net revenues or operating proﬁt generated by the individual clinics. Salaries and related costs
as a percent of net patient revenues and management contract revenues combined decreased to 46% for 2000 from
47% for 1999.

Clinic Operating Costs — Rent, Clinic Supplies and Other

Rent, clinic supplies and other increased to $14,952,000 for 2000 from $12,455,000 for 1999, an increase of
$2,497,000, or 20%. Approximately 57% of the increase, or $1,415,000, was due to the 2000 New Clinics, while
43%, or $1,082,000, of the increase was due to the Mature Clinics. The increase in rent, clinic supplies and other for
the Mature Clinics related to the fact that of the 17 clinics opened during 1999, 59% opened during the second half
of the year. Accordingly, 2000 was the ﬁrst year in which they incurred a full year of expenses. Rent, clinic supplies
and other as a percent of net patient revenues and management contract revenues combined remained unchanged at
24% for 2000 and 1999.

Clinic Operating Costs — Provision for Doubtful  Accounts

The provision for doubtful accounts increased to $1,596,000 for 2000 from $1,165,000 for 1999, an increase of
37%,  or  $431,000.  Approximately  16%  of  the  increase,  or  $70,000,  was  due  to  the  2000  New  Clinics.  The
remaining  84%  increase,  or  $361,000,  was  due  to  the  Mature  Clinics.  The  provision  for  doubtful  accounts  as  a
percent of net patient revenues was 2.6% for 2000 compared to 2.4%  for 1999.

Corporate Ofﬁce Costs — General and Administrative

General and administrative costs, consisting primarily of salaries and beneﬁts of corporate ofﬁce personnel, rent,
insurance costs, depreciation and amortization, travel and legal and professional fees increased to $5,790,000 for 2000
from $4,803,000 for 1999, an increase of $987,000, or 21%. General and administrative costs increased primarily as
a  result  of  increased  travel  and  salaries  and  beneﬁts  related  to  additional  personnel  hired  to  support  an  increasing
number  of  clinics.  General  and  administrative  costs  as  a  percent  of  net  patient  revenues  and  management  contract
revenues combined remained unchanged  at 9% for 2000 and 1999.

Corporate Ofﬁce Costs — Recruitment and Development

Recruitment  and  development  costs  primarily  represent  salaries  and  beneﬁts  of  recruitment  and  development
personnel, rent, travel, marketing and recruiting fees attributed directly to the Company’s activities in the develop-
ment  and  acquisition  of  new  clinics.  Recruitment  and  development  personnel  have  no  involvement  with  a  facility
following  opening.  All  recruitment  and  development  personnel  are  located  at  the  Company’s  corporate  ofﬁce  in
Houston,  Texas.  Recruitment  and  development  costs  increased  $133,000,  or  8%,  to  $1,817,000  in  2000  from
$1,684,000  in  1999.  Recruitment  and  development  costs  for  2000  and  1999  included  $369,000  and  $384,000,
respectively, related to the surgery center initiative discontinued in March 2000. The increase was primarily due to
increased  salaries  and  beneﬁts  of  development  personnel  and  increased  recruitment  fees  and  marketing  expenses
associated with opening 28 new clinics in 2000 over 17 in 1999. Excluding expenses related to the surgery centers,
recruitment and development costs as a percent of net patient revenues and management contract revenues combined
decreased to 2% for 2000 from 3% for 1999.

Interest Expense

Interest  expense  increased  $53,000,  or  7%,  to  $780,000  for  2000  from  $727,000  for  1999.  This  increase  in
interest was due to $2,115,000 borrowed by the Company to help ﬁnance the repurchase of 1,130,000 shares of its
common stock. In November 2000, the Company repaid $1,215,000 of this loan, leaving a balance of $900,000 at
December  31,  2000.  The  loan  bears  interest  at  a  rate  per  annum  of  prime  plus  one-half  percentage  point  and  is
repayable in quarterly installments of $250,000  beginning March 2001. See ‘‘Liquidity and  Capital Resources.’’

11

Minority Interests in Earnings of Subsidiary Limited  Partnerships

Minority interests in earnings of subsidiary limited partnerships increased $889,000, or 34%, to $3,466,000 for
2000 from $2,577,000 for 1999 due to the increase in aggregate proﬁtability of those clinics in which partners have
achieved positive retained earnings and are  accruing  partnership income.

Provision for Income Taxes

The  provision  for  income  taxes  increased  to  $2,403,000  for  2000  from  $1,568,000  for  1999,  an  increase  of
$835,000,  or  53%.  During  2000  and  1999,  the  Company  accrued  income  taxes  at  effective  tax  rates  of  39%  and
40%,  respectively.  The  2000  and  1999  rates  exceeded  the  U.S.  statutory  tax  rate  of  34%  due  primarily  to  state
income taxes.

Fiscal Year 1999 Compared to Fiscal Year 1998

Net Patient Revenues

Net patient revenues increased to $49,056,000 for 1999 from $43,179,000 for 1998, an increase of $5,877,000,
or 14%, on a 13% increase in patient visits to 566,000. Net patient revenues from the 17 clinics opened in 1999 (the
‘‘1999 New Clinics’’) accounted for 25% of the increase, or $1,488,000. The remaining increase of $4,389,000 in net
patient revenues comes from those 96 clinics opened before 1999. The $4,389,000 increase in net patient revenues
from these 96 clinics was primarily due to a 9% increase in the number of patient visits to 547,000, coupled with an
increase in the average net revenue per visit  to $86.94.

Management Contract Revenues

Management  contract  revenues  increased  to  $2,112,000  for  1999  from  $1,320,000  for  1998,  an  increase  of
$792,000, or 60%. This increase was due to the fact that three of the six management contracts were entered into in
the  second  half  of  1998.  Accordingly,  1999  was  the  ﬁrst  full  year  revenues  were  recognized  for  all  six  third-party
facilities under management at December  31,  1999.

Other Revenues

Other revenues, consisting of interest and sublease income, decreased $138,000, or 41%, to $200,000 for 1999
from  $338,000  for  1998.  This  decrease  was  due  primarily  to  a  decrease  in  interest  income  as  a  result  of  a  lower
average amount of cash and cash equivalents available for investment  during 1999  compared to 1998.

Clinic Operating Costs

Clinic  operating  costs  as  a  percent  of  net  patient  revenues  and  management  contract  revenues  combined

decreased to 74% for 1999 from 76% for 1998.

Clinic Operating Costs — Salaries and Related Costs

Salaries  and  related  costs  increased  to  $23,995,000  for  1999  from  $21,029,000  for  1998,  an  increase  of
$2,966,000,  or  14%.  Approximately  26%  of  the  increase,  or  $781,000,  was  due  to  the  1999  New  Clinics.  The
remaining 74% increase, or $2,185,000, was due principally to increased stafﬁng to meet the increase in patient visits
for the clinics opened prior to 1999, coupled with an increase in bonuses earned by the clinic directors at the clinics
opened  prior  to  1999.  Such  bonuses  are  based  on  the  net  revenues  or  operating  proﬁt  generated  by  the  individual
clinics. Salaries and related costs as a percent of net patient revenues and management contract revenues combined
remained unchanged at 47% for 1999 and  1998.

Clinic Operating Costs — Rent, Clinic Supplies and Other

Rent, clinic supplies and other increased to $12,455,000 for 1999 from $11,502,000 for 1998, an increase of
$953,000, or 8%. Approximately 71% of the increase, or $677,000, was due to the 1999 New Clinics, while 29%, or
$276,000, of the increase was due to the clinics opened prior to 1999. The $276,000 increase from the clinics opened

12

prior to 1999 was due to the fact that of the 20 clinics opened during 1998, 65% opened during the second half of
the year. Accordingly, 1999 was the ﬁrst year in which they incurred a full year of expenses. Rent, clinic supplies and
other as a percent of net patient revenues and management contract revenues combined decreased to 24% for 1999
from 26% for 1998.

Clinic Operating Costs — Provision for Doubtful  Accounts

The provision for doubtful accounts increased to $1,165,000 for 1999 from $1,143,000 for 1998, an increase of
$22,000, or 2%. This increase was due to a $32,000 increase associated with the 1999 New Clinics, offset, in part, by
a decrease of $10,000 for the clinics opened prior to 1999. The provision for doubtful accounts as a percent of net
patient revenues decreased to 2.4% in 1999  from  2.6% in 1998.

Corporate Ofﬁce Costs — General and Administrative

General and administrative costs, consisting primarily of salaries and beneﬁts of corporate ofﬁce personnel, rent,
insurance costs, depreciation and amortization, travel and legal and professional fees increased to $4,803,000 for 1999
from $4,240,000 for 1998, an increase of $563,000, or 13%. General and administrative costs increased primarily as
a result of salaries and beneﬁts related to  additional personnel hired to support an increasing number of  clinics. In
addition, in July 1998, the Company increased the square footage occupied at its corporate ofﬁce in Houston, Texas
and extended the lease for a ﬁve-year period  ending July 2003.  In connection  with these changes to the lease,  rent
expense increased substantially. General and administrative costs as a percent of net patient revenues and management
contract revenues combined decreased to  9% for  1999 from 10%  for 1998.

Corporate Ofﬁce Costs — Recruitment and Development

Recruitment  and  development  costs  primarily  represent  salaries  and  beneﬁts  of  recruitment  and  development
personnel, rent, travel, marketing and recruiting fees attributed directly to the Company’s activities in the develop-
ment  and  acquisition  of  new  clinics  and,  until  its  discontinuance  in  March  2000,  the  development  of  its  surgery
center initiative. Recruitment and development personnel have no involvement with a facility following opening. All
recruitment  and  development  personnel  are  located  at  the  Company’s  corporate  ofﬁce  in  Houston,  Texas.  Recruit-
ment  and  development  costs  increased  $288,000,  or  21%,  to  $1,684,000  in  1999  from  $1,396,000  in  1998.
Recruitment and development expenses related to the surgery center initiative accounted for 133%, or $384,000, of
the increase between 1999 and 1998. The majority of the $384,000 surgery center costs related to consulting fees,
salaries  of  development  personnel,  legal  fees  and  travel  associated  with  potential  acquisitions  of  surgery  centers  and
identifying and investigating potential sites for the development of new surgery centers. Excluding the effects of the
surgery center initiative, recruitment and development costs decreased $96,000 from 1998 to 1999. Recruitment and
development  costs  as  a  percent  of  net  patient  revenues  and  management  contract  revenues  combined  remained
unchanged at 3% for 1999 and 1998.

Loss on Closure of Facility

In August 1998, the Company closed a clinic located in Corpus Christi, Texas due to adverse clinic performance.
During  1998,  the  Company  recognized  a  $230,000  loss  related  to  this  closure.  Of  the  $230,000  loss,  $18,000
represented lease commitments, $99,000 was due to the write-off of goodwill, ﬁxed assets, leasehold improvements
and a non-compete agreement and the remainder was costs incurred in  connection with closing the facility.

The  Corpus  Christi,  Texas  clinic  accounted  for  net  patient  revenues  and  clinic  operating  costs  for  1998  of

$218,000 and $603,000, respectively.

Minority Interests in Earnings of Subsidiary Limited  Partnerships

Minority interests in earnings of subsidiary limited partnerships increased $714,000, or 38%, to $2,577,000 in
1999 from $1,863,000 in 1998 due to the increase in aggregate proﬁtability of those clinics in which partners have
achieved positive retained earnings and are  accruing  partnership income.

13

Provision for Income Taxes

The  provision  for  income  taxes  increased  to  $1,568,000  for  1999  from  $1,108,000  for  1998,  an  increase  of
$460,000,  or  42%.  During  1999  and  1998,  the  Company  accrued  income  taxes  at  effective  tax  rates  of  40%  and
41%,  respectively.  The  1999  and  1998  rates  exceeded  the  U.S.  statutory  tax  rate  of  34%  due  primarily  to  state
income taxes.

Liquidity and Capital Resources

At  December  31,  2000,  the  Company  had  $2,071,000  in  cash  and  cash  equivalents  available  to  fund  the
working capital needs of its operating subsidiaries, future clinic developments, acquisitions and investments. Included
in  cash  and  cash  equivalents  at  December  31,  2000  was  $710,000  in  a  money  market  fund  invested  in  short-term
debt instruments issued by an agency of the U.S. Government. The Company also had a revolving line of credit with
a bank which provides for borrowings up to $500,000, as needed, at a rate of prime plus one-half percentage point.

The  decrease  in  cash  of  $1,959,000  from  December  31,  1999  to  December  31,  2000  is  due  primarily  to  the
Company’s  use  of  cash  to  repurchase  1,130,000  shares  of  its  common  stock  in  August  2000  for  $6,275,000
(including expenses), fund capital expenditures primarily for physical therapy equipment and leasehold improvements
of  $2,827,000,  distribute  $3,072,000  to  minority  investors  in  subsidiary  limited  partnerships  and  pay  on  notes
payable of $1,254,000, offset, in part, by cash provided by operating activities of $8,861,000, proceeds from a bank
loan of $2,115,000 and proceeds of $394,000  from the exercise of stock  options.

The  Company’s  current  ratio  decreased  to  4.14  to  1.00  at  December  31,  2000  from  6.79  to  1.00  at  Decem-
ber 31, 1999. The decrease in the current ratio was due primarily to a decrease in cash and cash equivalents due to the
repurchase of common stock.

At December 31, 2000, the Company had a debt-to-equity ratio of 0.85 to 1.00 compared to 0.76 to 1.00 at
December  31,  1999.  The  increase  in  the  debt-to-equity  ratio  from  December  31,  1999  to  December  31,  2000
resulted from the decrease in equity due to the common stock repurchase in August 2000 of $6,275,000 (including
expenses),  offset,  in  part,  by  net  income  of  $3,735,000,  the  conversion  of  $850,000  convertible  subordinated  debt
into 144,998 shares of common stock and the proceeds and tax beneﬁt from the exercise of stock options of $394,000
and $255,000, respectively.

In April 1999, the Company’s Board of Directors authorized the use of available cash to purchase up to 692,000
shares of its common stock at a price not greater than $5.00 nor less than $4.25 per share. The Company conducted
the repurchases through a procedure commonly referred to as a ‘‘Dutch Auction,’’ and completed the repurchase of
692,000 shares (9.6% of the then outstanding shares) in May 1999. The shares were repurchased at a price of $4.875
per share for a total aggregate cost of $3,414,000 (including  expenses).

In July 2000, the Company’s Board of Directors authorized the repurchase for cash of up to 1,000,000 shares of
its issued and outstanding common stock for a price of $5.50 per share (the ‘‘Offer’’). Pursuant to the terms of the
Offer, the Company could buy up to an additional 2% of its outstanding shares without amending or extending the
Offer.  The  Company  completed  the  repurchase  of  1,130,000  shares  in  August  2000  for  a  total  aggregate  cost  of
$6,275,000 (including expenses). The Company utilized cash on hand and a convertible line of credit in the amount
of $2,115,000 to fund the repurchase of  the stock.

In  conjunction  with  the  Offer,  the  Company  entered  into  a  Letter  Loan  Agreement  with  a  bank  wherein  the
bank  agreed  to  lend  the  Company  up  to  $2,500,000  on  a  convertible  line  of  credit,  convertible  to  a  term  loan  on
December 31, 2000, to purchase stock tendered pursuant to the Offer. The loan bears interest at a rate per annum of
prime plus one-half percentage point and is repayable in quarterly installments of $250,000 beginning March 2001.
Additionally,  the  bank  agreed  to  loan  up  to  $500,000  for  working  capital  purposes  pursuant  to  a  revolving  line  of
credit.  The  revolving  line  of  credit  has  a  per  annum  three-eighths  of  one  percent  commitment  fee  on  the  unused
portion  and  bears  interest  on  outstanding  loans  at  a  rate  per  annum  of  prime  plus  one-half  percentage  point.  Any
amounts  borrowed  and  outstanding  under  the  revolving  line  of  credit  must  be  repaid  on  July  1,  2001.  Through
December  31,  2000,  the  Company  had  borrowed  $2,115,000  and  $-0-under  the  $2,500,000  convertible  line  of
credit and the $500,000 revolving line of credit, respectively.

14

In November 2000, the Company repaid $1,215,000 of the $2,115,000 borrowed under the convertible line of
credit.  Subsequent  to  December  31,  2000,  the  Company  repaid  the  remaining  balance  of  $900,000  on  the
convertible line of credit.

Management believes that existing funds, supplemented by cash ﬂows from existing operations and the revolving
line of credit will be sufﬁcient to meet its current operating needs and its development plans through at least 2002.

Recently Promulgated Accounting Standards

Effective  January  1,  2001,  the  Company  adopted  Statement  of  Financial  Accounting  Standards  No.  133
(‘‘SFAS  133’’),  ‘‘Accounting  for  Derivative  Instruments  and  Hedging  Activities,’’  as  amended  by  SFAS  No.  138.
SFAS 133 standardizes the accounting for derivative instruments, including certain derivative instruments embedded
in  other  contracts.  Under  the  standard,  entities  are  required  to  carry  all  derivative  instruments  in  the  statement  of
ﬁnancial  position  at  fair  value.  Adoption  of  SFAS  133  did  not  have  a  material  effect  on  the  Company’s  ﬁnancial
condition or results of operations because the Company historically has not entered into derivative or other ﬁnancial
instruments  for  trading  or  speculative  purposes  nor  does  it  use  or  intend  to  use  derivative  ﬁnancial  instruments  or
derivative commodity instruments.

Factors Affecting Future Results

Clinic Development

As  of  December  31,  2000,  the  Company  had  139  clinics  in  operation,  28  of  which  opened  in  2000.
Management’s goal for 2001 is to open between 30 and 35 additional clinics. The opening of these clinics is subject
to,  among  other  things,  the  Company’s  ability  to  identify  suitable  geographic  locations  and  physical  therapy  clinic
partners. The Company’s operating results will be adversely impacted by initial operating losses from the new clinics.
During  the  initial  period  of  operation,  operating  margins  for  newly  opened  clinics  tend  to  be  lower  than  more
seasoned clinics due to the start-up costs of newly opened clinics (including, without limitation, salaries and related
costs of the physical therapist and other clinic personnel, rent and equipment and other supplies required to open the
clinic)  and  the  fact  that  patient  revenues  tend  to  be  lower  in  the  ﬁrst  year  of  a  new  clinic’s  operation  and  increase
signiﬁcantly over the subsequent two to three years. Based on historical performance of the Company’s new clinics,
the clinics opened in 2000 should favorably  impact the  Company’s results of operations for 2001 and beyond.

Convertible Subordinated Debt

In June 1993, the Company completed the issuance and sale at par in a private placement of $3,050,000 of 8%
Convertible  Subordinated  Notes  due  June  30,  2003  (the  ‘‘Initial  Series  Notes’’).  In  May  1994,  the  Company
completed the issuance and sale at par in a private placement of $2,000,000 of 8% Convertible Subordinated Notes,
Series B due June 30, 2004 (the ‘‘Series B Notes’’) and $3,000,000 of 8% Convertible Subordinated Notes, Series C
due June 30, 2004 (the ‘‘Series C Notes’’ and collectively, the Initial Series Notes, the Series B Notes and the Series C
Notes are hereinafter referred to as the ‘‘Convertible Subordinated Notes’’).

The  Convertible  Subordinated  Notes  are  convertible  at  the  option  of  the  holders  thereof  into  the  number  of
whole shares of Company common stock determined by dividing the principal amount of the Notes so converted by
$5.00 in the case of the Initial Series Notes and the Series C Notes or $6.00 in the case of the Series B Notes. Holders
of Series B Notes were entitled to receive an interest enhancement payable in shares of Company common stock based
upon  the  market  value  of  the  Company’s  common  stock  at  June  30,  1996.  In  July  1996,  the  Company  issued
141,930 shares of its common stock in connection with  the interest enhancement provision.

During 2000, $100,000 of the Initial Series Notes and $750,000 of the Series B Notes were converted by the
note holders into 20,000 and 124,998 shares of common stock, respectively. This resulted in a balance of $2,950,000,
$1,250,000 and $3,000,000 for the Initial Series Notes, the Series B Notes and the Series C Notes, respectively, at
December 31, 2000.

In January 2001, an additional $650,000 of the Initial Series Notes was converted by a note holder into 130,000
shares of common stock. In addition, the Company exercised its right to require conversion of the remaining balance

15

of $2,300,000 of the Initial Series Notes and $1,250,000 of the Series B Notes into 460,000 and 208,332 shares of
common stock, respectively.

The  debt  conversions  increase  the  Company’s  shareholders’  equity  by  the  carrying  amount  of  the  debt  con-
verted, thus improving the Company’s debt to equity ratio and will favorably impact results of operations and cash
ﬂow due to the interest savings of approximately $400,000 per  year, before income tax, on the  debt.

Quantitative and Qualitative Disclosures About Market Risk

As of December 31, 2000, the Company had outstanding $2,950,000 aggregate principal amount of the Initial
Series  Notes,  $1,250,000  aggregate  principal  amount  of  the  Series  B  Notes  and  $3,000,000  aggregate  principal
amount of the Series C Notes (collectively,  the ‘‘Notes’’).

On November 3, 2000, $750,000 of the Series B Notes was converted into 124,998 shares of common stock.
The fair value of the $750,000 converted debt was approximately $1,184,000 based on the closing sales price of the
Company’s  common  stock  on  November  2,  2000  of  $9.469,  as  reported  by  the  National  Market  of  Nasdaq.  On
November 30, 2000, $100,000 of the Initial Series Notes was converted into 20,000 shares of common stock. The
fair  value  of  the  $100,000  converted  debt  was  approximately  $196,000  based  on  the  closing  sales  price  of  the
Company’s common stock on November 29,  2000 of $9.813, as reported  by  the National Market of  Nasdaq.

On January 8, 2001, an additional $650,000 of the Initial Series Notes was converted into 130,000 shares of the
Company’s common stock. The fair value of the $650,000 converted debt was approximately $1,857,000 based on
the closing sales price of the Company’s common stock on January 5, 2001 of $14.281, as reported by the National
Market  of  Nasdaq.  On  January  12,  2001,  the  Company  required  conversion  of  the  remaining  $2,300,000  of  the
Initial  Series  Notes  and  $1,250,000  of  the  Series  B  Notes  into  460,000  and  208,332  shares  of  common  stock,
respectively.  The  fair  value  of  the  $2,300,000  Initial  Series  Notes  and  the  $1,250,000  Series  B  Notes  was  approxi-
mately $6,404,000 and $2,900,000, respectively, based on the closing sales price of the Company’s common stock on
January 11, 2001 of $13.922, as reported by the National  Market  of Nasdaq.

As of January 12, 2001, the Company had outstanding $3,000,000 aggregate principal amount of the Series C
Notes. Based upon the closing price of the Company’s common stock on March 20, 2001 of $15.00, as reported by
the National Market of Nasdaq, the fair value of the Series C Notes was $9,000,000. See ‘‘Management’s Discussion
and Analysis of Financial Condition and Results of Operations — Convertible  Subordinated  Debt.’’

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

See ‘‘Management’s Discussion and Analysis of Financial Condition and Results of Operations — Quantitative

and Qualitative Disclosures About Market  Risk.’’

16

Item 8. Financial Statements and Supplementary Data.

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Independent Auditors’ Reports **************************************************************
Audited Financial Statements:
Consolidated Balance Sheets as of December 31, 2000 and 1999 ***********************************
Consolidated Statements of Operations for  the years  ended  December  31, 2000, 1999 and 1998 **********
Consolidated Statements of Shareholders’ Equity  for the years  ended  December  31, 2000, 1999  and 1998 **
Consolidated Statements of Cash Flows for  the years ended December 31, 2000, 1999 and 1998 *********
Notes to Consolidated Financial Statements ****************************************************

18

20
22
23
24
26

17

INDEPENDENT AUDITORS’ REPORT

Board of Directors and Shareholders
U.S. Physical Therapy, Inc.

We have audited the accompanying consolidated balance sheets of U.S. Physical Therapy, Inc. and subsidiaries
(the  ‘‘Company’’)  as  of  December  31,  2000  and  1999,  and  the  related  consolidated  statements  of  operations,
shareholders’  equity,  and  cash  ﬂows  for  the  years  then  ended.  In  connection  with  our  audits  of  the  consolidated
ﬁnancial statements, we have also audited the related ﬁnancial statement schedule for the years ended December 31,
2000 and 1999. These consolidated ﬁnancial statements and the ﬁnancial statement schedule are the responsibility of
the Company’s management. Our responsibility is to express an opinion on these consolidated ﬁnancial statements
based on our audits.

We  conducted  our  audits  in  accordance  with  auditing  standards  generally  accepted  in  the  United  States  of
America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether
the  ﬁnancial  statements  are  free  of  material  misstatement.  An  audit  includes  examining,  on  a  test  basis,  evidence
supporting the amounts and disclosures in the ﬁnancial statements. An audit also includes assessing the accounting
principles  used  and  signiﬁcant  estimates  made  by  management,  as  well  as  evaluating  the  overall  ﬁnancial  statement
presentation. We believe that our audits  provide  a reasonable basis for our  opinion.

In our opinion, the consolidated ﬁnancial statements referred to above present fairly, in all material respects, the
ﬁnancial position of U.S. Physical Therapy, Inc. and subsidiaries as of December 31, 2000 and 1999, and the results
of their operations and their cash ﬂows for the years then ended in conformity with accounting principles generally
accepted  in  the  United  States  of  America.  Also,  in  our  opinion,  the  related  ﬁnancial  statement  schedule,  when
considered  in  relation  to  the  basic  consolidated  ﬁnancial  statements  taken  as  a  whole,  presents  fairly  in  all  material
respects the information set forth therein.

Houston, Texas
March 8, 2001

KPMG LLP

18

REPORT OF INDEPENDENT AUDITORS

Board of Directors and Shareholders
U.S. Physical Therapy, Inc.

We have audited the accompanying consolidated statements of operations, shareholders’ equity, and cash ﬂows
of U.S. Physical Therapy, Inc., and subsidiaries (the ‘‘Company’’) for the year ended December 31, 1998. Our audit
also included the ﬁnancial statement schedule listed in the index at Item 14(a)(2). These ﬁnancial statements are the
responsibility  of  the  Company’s  management.  Our  responsibility  is  to  express  an  opinion  on  these  ﬁnancial  state-
ments based  on our audit.

We conducted our audit in accordance with auditing standards generally accepted in the United States. Those
standards  require  that  we  plan  and  perform  the  audit  to  obtain  reasonable  assurance  about  whether  the  ﬁnancial
statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the ﬁnancial statements. An audit also includes assessing the accounting principles used
and signiﬁcant estimates made by management, as well as evaluating the overall ﬁnancial statement presentation. We
believe that our audit provides a reasonable basis  for  our opinion.

In our opinion, the consolidated ﬁnancial statements referred to above present fairly, in all material respects, the
consolidated results of operations and cash ﬂows of U.S. Physical Therapy, Inc. and subsidiaries for the year ended
December 31, 1998, in conformity with accounting principles generally accepted in the United States. Also, in our
opinion, the related ﬁnancial statement schedule, when considered in relation to the basic ﬁnancial statements taken
as a whole, presents fairly in all material  respects the information set forth therein.

Houston, Texas
March 16, 1999

ERNST & YOUNG LLP

19

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(in thousands)

ASSETS
Current assets:

Cash and cash equivalents *************************************************
Patient accounts receivable, less allowance for  doubtful accounts of $2,780 and $2,014,
respectively ***********************************************************
Accounts receivable — other ***********************************************
Other current assets ******************************************************
Total current assets*************************************************

Fixed assets:

Furniture and equipment**************************************************
Leasehold  improvements **************************************************

Less accumulated depreciation and amortization********************************

Goodwill, net of amortization of $291 and $230, respectively ***********************
Other assets, net of amortization of $483 and $464, respectively ********************

December 31,

2000

1999

$ 2,071

$ 4,030

10,701
452
519

13,743

12,141
6,313

18,454
11,463

6,991
897
1,339

9,605
384
630

14,649

10,625
5,306

15,931
9,446

6,485
948
1,264

$22,970

$23,346

See notes to consolidated ﬁnancial statements.

20

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:

Accounts payable — trade *************************************************
Accrued expenses ********************************************************
Estimated third-party payor (Medicare) settlements *****************************
Notes payable***********************************************************
Total current liabilities **********************************************
Notes payable — long-term portion *******************************************
Convertible subordinated notes payable ****************************************
Minority interests in subsidiary limited partnerships*******************************
Commitments and contingencies**********************************************
Shareholders’ equity:

Preferred stock, $.01 par value, 500,000  shares  authorized, -0-  shares outstanding *****
Common stock, $.01 par value, 10,000,000 shares  authorized, 5,698,916 and

6,581,018 shares issued at December 31, 2000 and 1999, respectively ************
Additional paid-in capital *************************************************
Accumulated earnings ******************************************************
Treasury stock at cost, 9,800 shares held at  December 31, 2000 and 1999*************
Total shareholders’ equity********************************************

December 31,

2000

1999

$

434
1,622
355
912

3,323
26
7,200
2,858
—

$

349
1,329
439
39

2,156
37
8,050
2,383
—

—

—

57
3,504
6,049
(47)

9,563

66
8,387
2,314
(47)

10,720

$22,970

$23,346

See notes to consolidated ﬁnancial statements.

21

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)

Net patient revenues *********************************************
Management contract revenues *************************************
Other revenues *************************************************
Net revenues ***************************************************
Clinic operating costs:

Salaries  and related costs****************************************
Rent, clinic supplies and other ***********************************
Provision for doubtful accounts **********************************

Corporate ofﬁce costs:

General  and administrative **************************************
Recruitment and development ***********************************

Loss on  closure of facility *****************************************
Operating income before non-operating expenses **********************
Interest expense *************************************************
Minority interests in subsidiary limited partnerships ********************
Income before income taxes ***************************************
Provision for income taxes ****************************************
Net income ****************************************************
Basic  earnings per common share***********************************
Diluted earnings per common share*********************************

Year Ended December 31,
1999

1998

2000

$60,667
2,369
186

63,222

28,683
14,952
1,596

45,231

5,790
1,817

7,607
—

10,384
780
3,466

6,138
2,403

$49,056
2,112
200

51,368

23,995
12,455
1,165

37,615

4,803
1,684

6,487
—

7,266
727
2,577

3,962
1,568

$43,179
1,320
338

44,837

21,029
11,502
1,143

33,674

4,240
1,396

5,636
230

5,297
730
1,863

2,704
1,108

$ 3,735

$ 2,394

$ 1,596

$

$

.61

.52

$

$

.35

.34

$

$

.22

.21

See notes to consolidated ﬁnancial statements.

22

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(in thousands)

Balance at January 1, 1998 ***********************
Proceeds from exercise of stock options **************
Net income************************************
Balance at December  31, 1998 ********************
Proceeds from exercise of stock options **************
Repurchase of common stock *********************
Net income************************************
Balance at December  31, 1999 ********************
Proceeds from exercise of stock options **************
Tax beneﬁt from exercise of stock options ************
Repurchase of common stock *********************
8% convertible subordinated notes converted to

common stock *******************************
Net income************************************
Balance at December  31, 2000 ********************

Common Stock
Amount
Shares

7,231
2
—

7,233
40
(692)
—

6,581
103
—
(1,130)

145
—

$ 72
—
—

72
1
(7)
—

66
1
—
(11)

1
—

Add’l
Paid-In
Capital

$11,653
7
—

Accumu-
lated
Earnings /
(Deﬁcit)

$(1,676)
—
1,596

11,660
134
(3,407)
—

8,387
393
255
(6,264)

733
—

(80)
—
—
2,394

2,314
—
—
—

—
3,735

Treasury Stock
Shares Amount

(10)
—
—

(10)
—
—
—

(10)
—
—
—

—
—

$(47)
—
—

(47)
—
—
—

(47)
—
—
—

—
—

Total
Share-
holders’
Equity

$10,002
7
1,596

11,605
135
(3,414)
2,394

10,720
394
255
(6,275)

734
3,735

5,699

$ 57

$ 3,504

$ 6,049

(10)

$(47)

$ 9,563

See notes to consolidated ﬁnancial statements.

23

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

Year Ended December 31,
1999

1998

2000

Operating activities
Net income *****************************************************
Adjustments to reconcile net income to net  cash  provided by operating

activities:
Depreciation and amortization ************************************
Minority interests in earnings of subsidiary limited partnerships **********
Provision for bad debts ******************************************
Loss on  sale of ﬁxed assets ***************************************
Loss on  disposal of certain assets in closure  of facility ******************
Tax beneﬁt from exercise of stock options ***************************

Changes in operating assets and liabilities:

Increase in patient accounts receivable ******************************
Increase in accounts receivable-other********************************
Decrease (increase) in other assets**********************************
Increase (decrease) in accounts payable and accrued expenses ************
Decrease in estimated third-party payor (Medicare) settlements***********
Net cash  provided by operating activities ******************************

$ 3,735

$ 2,394

$ 1,596

2,331
3,466
1,596
35
—
255

(2,692)
(68)
(91)
378
(84)

8,861

2,090
2,577
1,165
9
—
—

(2,265)
(114)
(94)
(207)
(505)

5,050

2,071
1,863
1,143
—
144
—

(1,941)
(83)
61
326
(151)

5,029

See notes to consolidated ﬁnancial statements.

24

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

Year Ended December 31,
1999

1998

2000

Investing activities
Purchase of ﬁxed assets ********************************************
Purchase of intangibles ********************************************
Proceeds on sale of ﬁxed assets **************************************
Net cash  used in investing activities **********************************
Financing activities
Proceeds from notes payable ****************************************
Payment of notes payable ******************************************
Repurchase of common stock ***************************************
Proceeds from investment of minority investors in subsidiary  limited

partnerships ***************************************************
Proceeds from exercise of stock options *******************************
Conversion of notes payable into common stock************************
Distributions to minority investors in subsidiary limited partnerships********
Net cash  used in ﬁnancing activities**********************************
Net increase (decrease) in cash and cash equivalents *********************
Cash and cash equivalents — beginning  of  year *************************
Cash and cash equivalents — end of year******************************

$(2,827)
(10)
35

$(2,097)
(24)
25

$(2,357)
(192)
26

(2,802)

(2,096)

(2,523)

2,115
(1,253)
(6,275)

81
394
(8)
(3,072)

(8,018)

(1,959)
4,030

—
(32)
(3,414)

29
135
—
(1,970)

(5,252)

(2,298)
6,328

—
(55)
—

6
7
—
(1,692)

(1,734)

772
5,556

$ 2,071

$ 4,030

$ 6,328

Supplemental disclosures of cash ﬂow information
Cash paid during the year for:

Income taxes **************************************************
Interest ******************************************************

$ 2,639

$ 1,763

$

709

$

651

$

$

816

657

See notes to consolidated ﬁnancial statements.

25

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000

1. Organization, Nature of Operations and Basis of Presentation

U.S.  Physical  Therapy,  Inc.  and  its  subsidiaries  (the  ‘‘Company’’)  develops,  owns  and  operates  outpatient
physical and occupational therapy clinics. As of December 31, 2000, the Company owned and operated 139 clinics in
30  states.  The  clinics  provide  post-operative  care  and  treatment  for  a  variety  of  orthopedic-related  disorders  and
sports-related injuries, treatment for neurologically-related injuries, rehabilitation of injured workers and preventative
care.  The  clinics’  business  primarily  originates  from  physician  referrals.  The  principal  sources  of  payment  for  the
clinics’ services are commercial health insurance, workers’ compensation insurance, managed care programs, Medicare
and proceeds from personal injury cases.

In addition to the Company’s partnership program, it also manages physical therapy facilities for third parties,

including physicians, with seven such third-party  facilities  under management as of  December 31, 2000.

The consolidated ﬁnancial statements include the accounts of U.S. Physical Therapy, Inc. and its subsidiaries.
All  signiﬁcant  intercompany  transactions  and  balances  have  been  eliminated.  The  Company,  through  its  wholly-
owned subsidiaries, currently owns a 1% general partnership interest, with the exception of one clinic in which the
Company owns a 6% general partnership interest, and limited partnership interests ranging from 49% to 99% in the
clinics  it  owns  and  operates  (with  respect  to  90%  of  the  Company’s  clinics,  the  Company  owned  a  limited
partnership interest of 64%). For the majority of the clinics, the managing therapist of each such clinic, along with
other  therapists  at  the  clinic  in  several  of  the  partnerships,  own  the  remaining  limited  partnership  interests  in  the
clinic. In some instances, the Company develops satellite clinic facilities which are extensions of existing clinics, and
thus, clinic partnerships may consist of one or more clinic locations. In the majority of the partnership agreements the
therapist partner begins with a 20% proﬁt interest in his or her clinic limited partnership which increases by 3% at
the  end  of  each  year  until  his  or  her  interest  reaches  35%.  The  minority  interest  in  the  equity  and  earnings  of  the
clinic limited partnerships is presented separately in  the consolidated  ﬁnancial  statements.

2. Signiﬁcant Accounting Policies

Common Stock

On  January  5,  2001,  the  Company  effected  a  two-for-one  common  stock  split  in  the  form  of  a  100%  stock
dividend  to  stockholders  of  record  as  of  December  27,  2000.  All  share  and  per  share  information  included  in  the
accompanying consolidated ﬁnancial statements and related notes has  been  adjusted to  reﬂect the stock split.

Cash Equivalents

The Company considers all highly liquid investments with a maturity of three months or less, when purchased,
to  be  cash  equivalents.  The  Company,  pursuant  to  its  investment  policy,  invests  its  cash  in  deposits  with  major
ﬁnancial institutions, in highly rated commercial paper and short-term treasury and United States government agency
securities.  Included  in  cash  and  cash  equivalents  at  December  31,  2000  and  1999  was  $710,000  and  $1,245,000,
respectively,  in  a  money  market  fund  invested  in  short-term  debt  instruments  issued  by  an  agency  of  the  U.S.
Government and $-0- and $993,000, respectively,  of short-term commercial paper.

Long-Lived Assets

Fixed assets are stated at cost. Depreciation is provided using the straight-line method over the estimated useful
lives  of  the  related  assets.  Estimated  useful  lives  for  furniture  and  equipment  range  from  three  to  eight  years.
Leasehold  improvements  are  amortized  over  the  estimated  useful  lives  of  the  assets  or  the  related  lease  terms,
whichever  is shorter.

Non-compete agreements are being amortized on a straight-line basis over their respective terms, ranging from

two to seven years. Goodwill is being amortized on a  straight-line basis  over twenty  years.

26

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

In August 1998, the Company closed a clinic located in Corpus Christi, Texas due to adverse clinic performance.
During  1998,  the  Company  recognized  a  $230,000  loss  relating  to  this  closure.  Of  the  $230,000  loss,  $18,000
represented lease commitments, $99,000 was due to the write-off of goodwill, ﬁxed assets, leasehold improvements
and a non-compete agreement and the remainder was costs incurred in  connection with closing the facility.

Impairment of Long-Lived Assets and Long-Lived Assets to  Be Disposed Of

The  Company  accounts  for  long-lived  assets  in  accordance  with  the  provisions  of  Statement  of  Financial
Accounting Standards (‘‘SFAS’’) No. 121, ‘‘Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets  to  Be  Disposed  Of.’’  This  statement  requires  that  long-lived  assets  and  certain  identiﬁable  intangibles  be
reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset
may  not  be  recoverable.  Recoverability  of  assets  to  be  held  and  used  is  measured  by  a  comparison  of  the  carrying
amount of an asset to future net cash ﬂows expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair
value less costs to sell.

Net Patient Revenues

Net patient revenues are reported at the estimated net realizable amounts from patients, third-party payors, and
others for services rendered. The Company has agreements with third-party payors that provide for payments to the
Company at amounts different from its established rates.

Prior  to  January  1,  1999,  Medicare  reimbursement  for  outpatient  physical  and  occupational  therapy  services
furnished by clinics was based on a cost reimbursement methodology. The Company was reimbursed at a tentative
rate with ﬁnal settlement determined after submission of an annual cost report by the Company and audits thereof by
the  Medicare  ﬁscal  intermediary.  Effective  in  1999,  the  Balanced  Budget  Act  of  1997  (‘‘BBA’’)  provides  that
reimbursement  for  outpatient  therapy  services  provided  to  Medicare  beneﬁciaries  is  pursuant  to  a  fee  schedule
published by the Department of Health and Human Services (‘‘HHS’’), and the total amount that may be paid by
Medicare in any one year for outpatient physical (including speech-language pathology) or occupational therapy to
any  one  patient  is  limited  to  $1,500,  except  for  services  provided  in  hospitals.  On  November  29,  1999,  President
Clinton  signed  into  law  the  Medicare,  Medicaid  and  SCHIP  Balanced  Budget  Reﬁnement  Act  of  1999  (‘‘BBRA’’)
which,  among  other  provisions,  placed  a  two-year  moratorium  on  the  $1,500  reimbursement  limit  for  Medicare
therapy  services  provided  in  2000  and  2001.  On  December  21,  2000,  the  President  signed  into  law  the  Medicare,
Medicaid, and SCHIP Beneﬁts Improvement and Protection Act of 2000 (‘‘BIPA’’) which, among other provisions,
extended the moratorium for one year through December 31, 2002.

Laws and regulations governing the Medicare program are complex and subject to interpretation. The Company
believes that it is in compliance with all applicable laws and regulations and is not aware of any pending or threatened
investigations  involving  allegations  of  potential  wrongdoing  that  would  have  a  material  effect  on  the  Company’s
ﬁnancial statements as of December 31, 2000. Compliance with such laws and regulations can be subject to future
government review and interpretation, as well as signiﬁcant regulatory action including ﬁnes, penalties, and exclusion
from the Medicare program.

Income Taxes

Deferred tax assets and liabilities are determined based on differences between ﬁnancial reporting and tax bases
of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse.

27

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Comprehensive Earnings

On  January  1,  1998,  the  Company  adopted  the  provisions  of  SFAS  No.  130,  ‘‘Reporting  Comprehensive
Income,’’  which  requires  reporting  of  comprehensive  income  (earnings)  and  its  components,  in  the  statement  of
operations and statement of stockholders’ equity, including net earnings as a component. Comprehensive earnings is
the change in equity of a business from transactions and other events and circumstances from non-owner sources. The
Company does not have any components of other comprehensive income other than net earnings and activity from
owner sources.

Fair Values

The carrying amounts reported in the balance sheet for cash and cash equivalents approximate their fair values.
The  fair  values  of  the  long-term  convertible  subordinated  notes  are  based  on  the  Company’s  stock  price  and  the
number  of  shares  that  would  be  acquired  upon  conversion.  The  long-term  convertible  subordinated  notes  are
described fully in Note 4.

Use of Estimates

Management is required to make estimates and assumptions that affect the amounts reported in the consolidated

ﬁnancial statements and accompanying notes.  Actual results could differ from those estimates.

Reclassiﬁcations

Certain amounts presented in the accompanying consolidated ﬁnancial statements for 1998 and 1999 have been

reclassiﬁed to conform with the presentation used  for 2000.

Revenue Recognition

In  December  1999,  the  Securities  and  Exchange  Commission  issued  Staff  Accounting  Bulletin  No.  101
(‘‘SAB  101’’),  ‘‘Revenue  Recognition  in  Financial  Statements.’’  SAB  101  summarizes  certain  of  the  staff’s  views  in
applying accounting principles generally accepted in the United States of America to revenue recognition in ﬁnancial
statements. The Company believes that its  accounting practices are currently in compliance  with  SAB 101.

Stock  Options

The Company has elected to follow Accounting Principles Board Opinion No. 25, ‘‘Accounting for Stock Issued
to  Employees’’  (APB  25)  and  related  interpretations  in  accounting  for  its  employee  stock  options.  Pro  forma
information regarding net income and earnings per share is required by FASB Statement No. 123, ‘‘Accounting and
Disclosure  of  Stock-Based  Compensation,’’  and  has  been  determined  as  if  the  Company  had  accounted  for  its
employee stock options under the fair value method of that Statement. The fair value of these options was estimated
at  the  date  of  grant  using  a  Black-Scholes  option  pricing  model.  All  of  the  Company’s  stock  option  plans  are
administered  by  a  committee  comprised  of  selected  members  of  the  Board  of  Directors  (the  ‘‘Stock  Option
Committee’’).

3. Non-Cash Transaction

In  May  1994,  the  Company  issued  $2,000,000  aggregate  principal  amount  of  8%  Convertible  Subordinated
Notes, Series B (the ‘‘Series B Notes’’). The Series B Notes contained a Contingent Interest Enhancement provision
which allowed the Series B Note Holders to receive an interest enhancement payable in shares of Company common
stock based upon the market value of the Company’s shares for the month of June 1996. In 1996, a total of 141,930
shares  of  the  Company’s  common  stock  were  issued  in  connection  with  the  Contingent  Interest  Enhancement
provision. Deferred ﬁnancing costs, included in ‘‘Other Assets’’ on the balance sheet and being amortized over the life
of the Series B Notes, totaling $765,000  were recorded in connection with the  issuance of the 141,930 shares.

28

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

On November 3, 2000, $750,000 of the Series B Notes were converted by the note holders into 124,998 shares
of Company common stock. In conjunction with this conversion, the unamortized portion of the deferred ﬁnancing
costs related to the converted notes was taken to additional paid-in capital. Interest expense for 2000, 1999 and 1998
included $71,000, $75,000 and $75,000,  respectively, of amortization relating  to the deferred ﬁnancing costs.

On November 30, 2000, $100,000 of the 8% Convertible Subordinated Notes due June 30, 2003 was converted

by the note holder into 20,000 shares of  common  stock.

4. Notes Payable

On June 2, 1993, the Company completed the issuance and sale of $3,050,000 aggregate principal amount of
8%  Convertible  Subordinated  Notes  due  June  30,  2003  (the  ‘‘Notes’’).  The  Notes,  which  are  subordinated  to  any
indebtedness  for  borrowed  money,  were  issued  at  par  in  a  private  placement  transaction  to  a  total  of  six  investors,
including  two  directors  who  purchased  a  total  of  $175,000  of  the  Notes  and  a  company  controlled  by  one  of  the
Company’s directors, Mr. Richard C.W. Mauran, who purchased $2,000,000 of the Notes. The Notes bear interest at
8% per annum, payable quarterly, and are convertible at the option of the note holders into common stock of the
Company at any time during the life of the Notes. The conversion price is $5.00 per share (subject to adjustment as
provided in the Notes). The Company can require the note holders to convert the Notes into shares of common stock
at  any  time  that  the  average  trading  price  of  the  Company’s  common  stock  equals  or  exceeds  $10.00  per  share
(subject  to  adjustment  as  provided  in  the  Notes)  during  the  immediately  preceding  90-day  period.  During  2000,
$100,000 of the Notes were converted into  20,000 shares of  common stock of the  Company.

On May 5, 1994, the Company completed the issuance and sale of the Series B Notes. The Series B Notes were
issued at par in a private placement. The Series B Notes are convertible, at the option of the holder, into the number
of  whole  shares  of  the  Company’s  common  stock  determined  by  dividing  the  principal  amount  so  converted  by
$6.00,  (the  ‘‘Conversion  Price’’),  subject  to  adjustment  upon  the  occurrence  of  certain  events.  The  Company  can
require the note holders to convert the Notes into shares of common stock at any time that the average trading price
of the Company’s common stock equals or exceeds $10.00 per share (subject to adjustment as provided in the Notes)
during the immediately preceding 90-day period. The Series B Notes bear interest from the date of issuance at a rate
of  8%  per  annum,  payable  quarterly.  Holders  of  Series  B  Notes  were  entitled  to  receive  an  interest  enhancement
payable  in  shares  of  Company  common  stock  based  upon  the  market  value  of  the  Company’s  common  stock  at
June  30,  1996,  which  was  two  years  from  the  date  of  issuance  of  the  Series  B  Notes.  In  July  1996,  the  Company
issued  141,930  shares  of  its  common  stock  in  connection  with  the  interest  enhancement  provision.  During  2000,
$750,000 of the Series B Notes were converted  into 124,998 shares of  common stock of the  Company.

The Company also completed on May 5, 1994, the issuance and sale of $3,000,000 aggregate principal amount
of 8% Convertible Subordinated Notes, Series C due June 30, 2004 (the ‘‘Series C Notes’’). The Series C Notes were
issued at par in a private placement to a company controlled by one of the Company’s directors, Mr. Richard C.W.
Mauran. The Series C Notes are convertible, at the option of the holder, into the number of whole shares of common
stock determined by dividing the principal amount so converted by $5.00, subject to adjustment upon the occurrence
of  certain  events.  The  Series  C  Notes  bear  interest  from  the  date  of  issuance  at  a  rate  of  8%  per  annum,  payable
quarterly.

Both Series B Notes and Series C Notes are unsecured subordinated obligations of the Company and rank pari
passu with the Company’s 8% Convertible Subordinated Notes due June 30, 2003. Each of the Notes are subordi-
nated in right of payment to all other indebtedness for borrowed money incurred  by the Company.

Holders of the Notes have piggy-back registration rights as set forth in the Registration Agreement relating to the
Notes. Holders of the Series B Notes and Series C Notes each have demand and piggy-back registration rights as set
forth in the Registration Agreements related to the Notes.

In July 2000, the Company’s Board of Directors authorized the repurchase for cash of up to 1,000,000 shares of
its issued and outstanding common stock for a price of $5.50 per share (the ‘‘Offer’’). Pursuant to the terms of the

29

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Offer, the Company could buy up to an additional 2% of its outstanding shares without amending or extending the
Offer.  The  Company  completed  the  repurchase  of  1,130,000  shares  in  August  2000  for  a  total  aggregate  cost  of
$6,275,000 (including expenses). The Company utilized cash on hand and a convertible line of credit in the amount
of $2,115,000 to fund the repurchase of  the stock.

In conjunction with the Offer, the Company entered into an agreement with a bank wherein the bank agreed to
lend  the  Company  up  to  $2,500,000  on  a  convertible  line  of  credit,  convertible  to  a  term  loan  on  December  31,
2000, to purchase stock tendered pursuant to the Offer. The loan bears interest at a rate per annum of prime plus
one-half  percentage  point  and  is  repayable  in  quarterly  installments  of  $250,000  beginning  March  2001.  As  of
December  31,  2000,  the  Company  had  borrowed  $2,115,000  under  the  $2,500,000  convertible  line  of  credit.  In
November 2000, the Company repaid $1,215,000 of the $2,115,000 borrowed under the convertible line of credit.

The Company also had a revolving line of credit with a bank which provides for borrowings up to $500,000, as

needed, at a rate of prime plus one-half  percentage point.

Notes payable as of December 31, 2000  and 1999 consist of the following:

Promissory note at a ﬂoating interest rate of  1% above prime, payable in
monthly installments through November 1,  2001. This note  is  secured
by the facility, with a net book value of approximately $65,000,  of one
of the Company’s clinics *************************************

Promissory note with an 8% interest rate payable in  equal  monthly

installments through March 19, 2007. This note is secured by  the
facility, with a net book value of approximately  $44,000, of one of the
Company’s clinics ******************************************

Unsecured promissory notes with a 7% interest rate  payable in equal

monthly installments through December  31, 2000*****************

8% Convertible Subordinated Notes due  June 30, 2003 with  interest

payable quarterly *******************************************

8% Convertible Subordinated Notes, Series B, due June 30, 2004 with

interest payable quarterly *************************************

8% Convertible Subordinated Notes, Series C, due June  30, 2004 with

interest payable quarterly *************************************

Letter Loan Agreement with interest at a rate per annum of prime plus
one-half percentage point and is repayable in quarterly installments of
$250,000 beginning March 2001 ******************************

Less current portion *******************************************

2000

1999

$

9,000

$

17,000

29,000

—

32,000

27,000

2,950,000

3,050,000

1,250,000

2,000,000

3,000,000

3,000,000

900,000

8,138,000
(912,000)

—

8,126,000
(39,000)

$7,226,000

$8,087,000

Scheduled maturities for the next ﬁve years and thereafter as of  December 31,  2000 are as follows:

2001********************************************
2002********************************************
2003********************************************
2004********************************************
2005********************************************
Thereafter****************************************

$ 912,000
4,000
2,954,000
4,255,000
5,000
8,000

$8,138,000

30

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

5. Related Party Transactions

During 2000, 1999 and 1998, the Company recognized interest expense of $415,000, $414,000 and $414,000,

respectively, relating to Convertible Subordinated  Notes held  by directors  of the  Company.

See  Note 4 for additional information on  related party transactions.

6. Income Taxes

Signiﬁcant  components  of  deferred  tax  assets,  included  in  other  assets  on  the  balance  sheet  at  December  31,

2000 and 1999, were as follows:

2000

1999

Deferred tax assets:

Vacation accrual *************************************
Allowance for bad debt********************************
Depreciation ****************************************
Other**********************************************
Net deferred tax assets **********************************

$

81,000
624,000
386,000
—

$ 99,000
452,000
244,000
2,000

$1,091,000

$797,000

The  differences  between  the  federal  tax  rate  and  the  Company’s  effective  tax  rate  for  the  years  ended  Decem-

ber 31, 2000, 1999 and 1998 were as follows:

2000

1999

1998

U.S. tax at statutory rate *****
State income taxes***********
Nondeductible expenses ******
Other — net ***************

$2,087,000
280,000
36,000
—

34.00% $1,347,000
197,000
4.56
22,000
0.59
2,000
—

34.00% $ 919,000
156,000
32,000
1,000

4.98
0.55
0.05

34.00%
5.77
1.18
0.03

$2,403,000

39.15% $1,568,000

39.58% $1,108,000

40.98%

Signiﬁcant  components  of  the  provision  for  income  taxes  for  the  years  ended  December  31,  2000,  1999  and

1998 were as follows:

Current:

2000

1999

1998

Federal **************************************
State ****************************************
Total current *********************************

$2,273,000
424,000

$1,378,000
299,000

$ 727,000
236,000

2,697,000

1,677,000

963,000

Deferred:

Federal **************************************
State ****************************************
Total deferred *********************************
Total income tax provision ************************

(294,000)
—

(294,000)

(109,000)
—

(109,000)

145,000
—

145,000

$2,403,000

$1,568,000

$1,108,000

The  Company  is  required  to  establish  a  valuation  allowance  for  deferred  tax  assets  if,  based  on  the  weight  of
available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The
ultimate  realization  of  deferred  tax  assets  is  dependent  upon  the  generation  of  future  taxable  income  during  the
periods  in  which  those  temporary  differences  become  deductible.  Management  considers  the  scheduled  reversal  of
deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based

31

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

upon the level of historical taxable income and projections for future taxable income in the periods which the deferred
tax assets are deductible, management believes that a valuation allowance is not required, as it is more likely than not
that the results of future operations will  generate  sufﬁcient  taxable income to realize  the deferred tax assets.

7. Stock Option Plans

1992 Stock Option Plan, as Amended

The Company has a 1992 Stock Option Plan, as amended (the ‘‘Option Plan’’) which permits the Company to
grant to key employees and outside directors of the Company options to purchase up to 1,990,000 shares of common
stock (subject to proportionate adjustments in the event of stock dividends, splits, and similar corporate transactions).

Incentive stock options (those intended to satisfy the requirements of the Internal Revenue Code) granted under
the Option Plan are granted at an exercise price of not less than the fair market value of the shares of common stock
on the date of grant. The exercise prices of non-qualiﬁed options granted under the Option Plan are determined by
the Stock Option Committee. The period within which each option will be exercisable is determined by the Stock
Option Committee (in no event may the exercise period of an incentive stock option extend beyond 10 years from the
date of grant). As of December 31, 2000, 1999 and 1998, 190,000, 190,000 and 190,000 incentive stock options
and 1,983,108, 1,750,100 and 1,664,100 non-qualiﬁed stock options have been granted, respectively. As of Decem-
ber  31,  2000,  1999  and  1998,  32,500,  32,500  and  32,500  incentive  stock  options  and  232,850,  227,250  and
193,750 non-qualiﬁed stock options have been forfeited, respectively. Incentive stock options of 47,500, 7,500 and
7,500 and non-qualiﬁed stock options of 128,900, 66,000 and 26,000 have been exercised as of December 31, 2000,
1999 and 1998, respectively.

Outstanding incentive stock options vest one-fourth on each of the second, third, fourth and ﬁfth anniversaries
of the date of grant. Of the 1,621,358 non-qualiﬁed stock options granted, but not yet exercised as of December 31,
2000,  524,008  options  vested  100%  on  the  date  of  grant,  and  1,097,350  options  vest  one-fourth  on  each  of  the
second, third, fourth and ﬁfth anniversaries  of  the date of grant.

A summary of the Company’s Option Plan activity and related information for the years ended December 31,

2000, 1999 and 1998 follows:

Outstanding — beginning of year ***
Granted************************
Exercised ***********************
Forfeited ***********************
Outstanding — end of year ********
Exercisable at end of year ***********
Weighted-average fair value of options

granted during the year ********* $

2000

1999

1998

Weighted-
Average
Exercise
Price
$4.71
4.96
4.06
5.56

$4.86

$4.68

Options
1,606,850
233,008
(102,900)
(5,600)

1,731,358

1,085,207

Weighted-
Average
Exercise
Price
$4.72
4.21
3.39
5.62

$4.71

$4.46

Options
1,594,350
86,000
(40,000)
(33,500)

1,606,850

897,875

Weighted-
Average
Exercise
Price
$4.46
5.30
4.45
4.72

$4.72

$4.42

Options
1,166,500
525,600
(1,750)
(96,000)

1,594,350

772,563

2.11

$

1.96

$

2.21

Exercise prices for options outstanding as of December 31, 2000 ranged from $3.13 to $6.22. The weighted-

average remaining contractual life of those options  was 6.36 years.

Executive Option Plan

The Executive Option Plan (the ‘‘Executive Plan’’) was adopted by the Board of Directors of the Company on
March 2, 1993 and was approved by the Company’s stockholders on May 24, 1993. The Executive Plan permits the
Company  to  grant  to  any  ofﬁcer  of  the  Company  or  its  afﬁliates,  options  to  purchase  up  to  400,000  shares  of
common stock (subject to adjustments in the event of stock dividends, splits and similar corporate transactions). No

32

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

further  grants  of  options  will  be  made  under  the  Executive  Plan  as  a  result  of  an  amendment  to  the  Option  Plan
during 1998. The exercise prices of the options granted under the Executive Plan are determined by the Stock Option
Committee, and in the case of incentive and non-qualiﬁed options, may not be less than the greater of 175% of the
fair market value of a share of common stock on the date of grant of the option or the par value per share of the stock.
The period within which each option will be exercisable is determined by the Stock Option Committee (in no event
may the exercise period extend beyond 10 years from the date of grant). The outstanding options vest one-third on
each of the third, fourth and ﬁfth anniversaries of  the date  of grant.

As  of  December  31,  2000,  1999  and  1998,  250,000,  250,000  and  250,000  incentive  stock  options  and
180,000,  180,000  and  180,000  non-qualiﬁed  stock  options  have  been  granted,  respectively.  As  of  December  31,
2000, 1999 and 1998, 178,000, 178,000 and 140,000 incentive stock options and 82,000, 82,000 and 80,000 non-
qualiﬁed  stock  options  have  been  forfeited,  respectively.  No  options  have  been  exercised  under  the  Executive  Plan.

A summary of the Company’s Executive Plan activity and related information for the years ended December 31,

2000, 1999 and 1998 follows:

2000

1999

1998

Options
Outstanding — beginning of year *******
170,000
Granted****************************
—
Exercised ***************************
—
Forfeited ***************************
—
Outstanding — end of year ************ 170,000
Exercisable at end of year ************** 170,000

Weighted-
Average
Exercise
Price
$6.73
—
—
—

$6.73

$6.73

Weighted-
Average
Exercise
Price
$6.66
—
—
6.35

$6.73

$6.73

Options
210,000
—
—
(40,000)

170,000

170,000

Weighted-
Average
Exercise
Price
$6.66
—
—
—

$6.66

$6.58

Options
210,000
—
—
—

210,000

190,000

Exercise prices for options outstanding as of December 31, 2000 ranged from $6.34 to $7.44. The weighted-

average remaining contractual life of those options  was 2.82 years.

1999 Employee Stock Option Plan

During 1999, the Company adopted the 1999 Employee Stock Option Plan (the ‘‘1999 Option Plan’’) which
permits the Company to grant to certain non-ofﬁcer employees of the Company up to 200,000 non-statutory options
to purchase shares of common stock (subject to proportionate adjustments in the event of stock dividends, splits, and
similar corporate transactions).

The  exercise  prices  of  options  granted  under  the  1999  Option  Plan  are  determined  by  the  Stock  Option
Committee. The period within which each option will be exercisable is determined by the Stock Option Committee
(in no event may the exercise period of an incentive stock option extend beyond 10 years from the date of grant). As
of  December  31,  2000  and  1999,  90,250  and  48,500  options,  respectively,  had  been  granted,  23,750  and  4,000
options, respectively, had been forfeited and no shares had been exercised under the 1999 Option Plan. The options
vest one-fourth on each of the second, third,  fourth and ﬁfth  anniversaries of the  date  of grant.

33

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

A summary of the Company’s 1999 Option Plan activity and related information for the years ended Decem-

ber 31, 2000 and 1999 follows:

Outstanding — beginning of year *************************
Granted *********************************************
Forfeited*********************************************
Outstanding — end of year ******************************
Exercisable at end of year *******************************
Weighted-average fair value of options granted 

during the year *************************************

2000

1999

Weighted-
Average
Exercise
Price

$4.22
5.51
4.27

$5.02

$ —

Weighted-
Average
Exercise
Price

$ —
4.22
4.22

$4.22

$ —

Options

—
48,500
(4,000)

44,500

—

$ 1.97

Options

44,500
41,750
(19,750)

66,500

—

$ 2.84

Exercise  prices  for  options  outstanding  at  December  31,  2000  ranged  from  $4.22  to  $6.22.  The  weighted-

average remaining contractual life of those options was 9.06 years.

Non-Plan, Non-Qualifying Option Agreements

During  2000  and  1999,  the  Board  of  Directors  of  the  Company  granted  non-plan,  non-qualifying  options
covering 20,000 and 150,000 shares, respectively, of Company common stock (subject to proportionate adjustments
in the event of stock dividends, splits and similar corporate transactions) to three individuals in connection with their
offers of employment. During 2000 and 1999, 100,000 and 50,000 shares, respectively, were forfeited. The period
within which each option will be exercisable is 10 years from the date of grant. The options vest one-fourth on each of
the second, third, fourth and ﬁfth anniversaries of  the date  of grant.

A  summary  of  the  Company’s  non-plan,  non-qualifying  option  activity  and  related  information  for  the  years

ended December 31, 2000 and 1999 follows:

2000

1999

Outstanding — beginning of year ***********************
Granted *******************************************
Forfeited*******************************************
Outstanding — end of year ****************************
Exercisable at end of year *****************************
Weighted-average fair value of the 50,000  options  granted

during 1999 **************************************

Weighted-average fair value of the 100,000  options  granted

during 1999 **************************************

Weighted-
Average
Exercise
Price

$4.22
4.25
4.22

$4.25

$ —

Options

100,000
20,000
(100,000)

20,000

—

Weighted-
Average
Exercise
Price

$ —
4.27
4.38

$4.22

$ —

Options

—
150,000
(50,000)

100,000

—

2.04

1.97

$

$

Weighted-average fair value of the options granted 

during 2000 **************************************

$

1.94

The weighted-average remaining contractual life for options outstanding at December 31, 2000 was 9.13 years.

The following weighted-average assumptions for 2000, 1999 and 1998 were used in estimating the fair value of
the  options  granted  under  the  stock  option  plans  and  the  non-plan,  non-qualifying  option  agreements:  risk-free
interest rates ranging from 4.65% to 6.45%; dividend yield rate of 0%; volatility factors of the expected market price

34

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

of the Company’s common stock ranging from .245 to .287; and a weighted-average expected life of the option of
eight years for those options which vest one-fourth on each of the second, third, fourth and ﬁfth anniversaries of the
date of grant and weighted-average expected lives  of ﬁve to eight years for  the  remaining options.

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options
which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of
highly  subjective  assumptions  including  the  expected  stock  price  volatility.  Because  the  Company’s  employee  stock
options have characteristics signiﬁcantly different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its  employee stock options.

For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the
options’ vesting period. The pro forma effect on net income for 2000, 1999 and 1998 is not representative of the pro
forma  effect  on  net  income  in  future  years  because  it  does  not  take  into  consideration  pro  forma  compensation
expense related to grants made prior to 1995. The Company’s pro forma information follows (in thousands except for
earnings  per share information):

Pro forma net income*******************************
Pro forma earnings per share — basic*******************
Pro forma earnings per share — diluted *****************

$3,393
$ 0.55
$ 0.47

$2,117
$ 0.31
$ 0.31

$1,347
$ 0.19
$ 0.18

2000

1999

1998

In total, the Company has 3,641,936 shares which are reserved for issuance under the 1992 Stock Option Plan,
the Executive Option Plan, the 1999 Employee Stock Option Plan, a non-plan, non-qualifying option agreement, the
8% Convertible Subordinated Notes, the Series  B Notes and the Series C Notes.

8. Preferred Stock

The Board of Directors of the Company is empowered, without approval of the stockholders, to cause shares of
preferred stock to be issued in one or more series and to establish the number of shares to be included in each such
series  and  the  rights,  powers,  preferences  and  limitations  of  each  series.  There  are  no  provisions  in  the  Company’s
Articles of Incorporation specifying the vote  required by  the holders  of preferred stock to take action.

All such provisions would be set out in the designation of any series of preferred stock established by the Board
of  Directors.  The  bylaws  of  the  Company  specify  that,  when  a  quorum  is  present  at  any  meeting,  the  vote  of  the
holders of at least a majority of the outstanding shares entitled to vote who are present, in person or by proxy, shall
decide any question brought before the meeting, unless a different vote is required by law or the Company’s Articles
of Incorporation. Because the Board of Directors has the power to establish the preferences and rights of each series, it
may afford the holders of any series of preferred stock, preferences, powers, and rights, voting or otherwise, senior to
the  right  of  holders  of  common  stock.  The  issuance  of  the  preferred  stock  could  have  the  effect  of  delaying  or
preventing  a  change  in  control  of  the  Company.  The  Board  of  Directors  has  no  present  plans  to  issue  any  of  the
preferred stock.

9. Deﬁned Contribution Plan

The  Company  has  a  401(k)  proﬁt  sharing  plan  covering  all  employees  with  three  months  of  service.  The
Company may make discretionary contributions of up to 50% of employee contributions. The Company recognized
no contribution expense for the years ended December 31, 2000,  1999 and 1998.

35

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

10. Commitments and Contingencies

Operating Leases

The Company has entered into operating leases for its executive ofﬁces and clinic facilities. In connection with
these agreements, the Company incurred rent expense of $4,546,000, $3,815,000 and $3,125,000 for the years ended
December 31, 2000, 1999 and 1998, respectively. Several of the leases provide for an annual increase in the rental
payment  based  upon  the  Consumer  Price  Index  for  each  particular  year.  The  majority  of  the  leases  provide  for
renewal periods ranging from one to ﬁve years. The agreements to extend the leases specify that rental rates would be
adjusted to market rates as of each renewal date.

The future minimum lease commitments for the next ﬁve years and in the aggregate as of December 31, 2000

are as follows:

2001*******************************************
2002*******************************************
2003*******************************************
2004*******************************************
2005*******************************************
Thereafter***************************************

$ 4,173,000
3,335,000
2,449,000
1,611,000
742,000
57,000

$12,367,000

Employment Agreements

At  December  31,  2000,  the  Company  had  an  outstanding  employment  agreement  with  one  of  its  executive
ofﬁcers for $250,000 annually, subject to adjustment to reﬂect positive performance, for a term extending through
February 2002.

In  addition,  the  Company  has  outstanding  employment  agreements  with  the  managing  physical  therapist
partners of the Company’s physical therapy clinics and with certain other clinic employees which obligate subsidiaries
of  the  Company  to  pay  compensation  of  $5,699,000  in  2001  and  $4,513,000  in  the  aggregate  through  2004.  In
addition, each employment agreement with the managing physical therapists provides for monthly bonus payments
calculated as a percentage of each clinic’s net revenues (not in excess of operating proﬁts) or operating proﬁts. The
Company recognized salaries and bonus expense for the managing physical therapists of $9,576,000, $8,073,000 and
$7,044,000 for the years ended December 31,  2000, 1999 and 1998, respectively.

Each  employment  agreement  provides  that  the  therapist  partner  can  be  required  to  sell  his  or  her  partnership
interest in the clinic partnership for the amount of his or her capital account upon termination of employment with
the clinic partnership before the expiration of the initial term of employment. The employment agreements contain
no provisions requiring the purchase by the Company of the therapist partner’s interest in the clinic partnership in the
event  of  death  or  disability,  or  after  the  initial  term  of  employment.  In  addition,  the  employment  agreements
generally include non-competition and non-solicitation provisions which extend through the term of the agreement
and for one to two years thereafter.

36

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

11. Earnings per Share

The  computation  of  basic  and  diluted  earnings  per  share  for  the  years  ended  December  31,  2000,  1999  and

1998 are as follows:

Numerator:

2000

1999

1998

Net income ******************************************
Numerator for basic earnings per share *********************
Effect of dilutive securities:

Interest on convertible subordinated notes payable **********

Numerator for diluted earnings per share-income available to

common stockholders after assumed conversions ***********

$3,735,000

$2,394,000

$1,596,000

$3,735,000

$2,394,000

$1,596,000

466,000

475,000

—

$4,201,000

$2,869,000

$1,596,000

Denominator:

Denominator for basic earnings per share — weighted-average

shares *********************************************

Effect of dilutive securities:

Stock options ***************************************
Convertible subordinated notes payable ******************
Dilutive potential common shares *************************
Denominator for diluted earnings per share — adjusted

weighted-average shares and assumed conversions ***********
Basic  earnings per share ***********************************
Diluted earnings per share *********************************

6,153,000

6,800,000

7,222,000

478,000
1,521,000

1,999,000

70,000
1,544,000

1,614,000

264,000
—

264,000

8,152,000

8,414,000

7,486,000

$

$

0.61

0.52

$

$

0.35

0.34

$

$

0.22

0.21

During 2000, 1999 and 1998, the Company had outstanding The Notes, the Series B Notes and the Series C
Notes  (collectively  the  ‘‘Notes’’).  In  November  2000,  $850,000  of  the  Notes  were  converted  into  common  shares.
The  Notes  were  not  included  in  the  computation  of  diluted  earnings  per  share  for  1998  because  the  effect  on  the
computation was anti-dilutive.

12. Subsequent Events

In January 2001, the remaining $2,950,000 of the 8% Convertible Subordinated Notes due June 30, 2003 and
the  remaining  $1,250,000  of  the  8%  Convertible  Subordinated  Notes,  Series  B,  due  June  30,  2004  was  converted
into 590,000 and 208,332 shares of the Company’s common  stock, respectively.

In  March  2001,  the  Company  repaid  the  remaining  principal  balance  of  $900,000  on  the  convertible  line  of

credit used to repurchase 1,130,000 of Company common stock in  August 2000.

37

Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.

The  Board  of  Directors  of  the  Company  appointed  KPMG  LLP  as  the  Company’s  independent  auditors
effective  September  27,  1999.  KPMG  LLP  replaced  Ernst  &  Young  LLP,  which  had  served  as  the  Company’s
independent auditors since 1992. Ernst &  Young LLP  was dismissed effective  September 27,  1999.

The reports issued by Ernst & Young LLP on the Company’s ﬁnancial statements for ﬁscal 1998 did not contain
any adverse opinion or a disclaimer of opinion, or any qualiﬁcation or modiﬁcation as to uncertainty, audit scope, or
accounting principles.

The decision to change the Company’s independent auditors to KPMG LLP was recommended by the Audit

Committee of the Board of Directors of the  Company  and then  ratiﬁed by the full Board of Directors.

During the ﬁscal year ended December 31, 1998 and the subsequent interim period preceding the dismissal of
Ernst & Young LLP, there were no disagreements with Ernst & Young LLP on any matter of accounting principles or
practices, ﬁnancial statement disclosure, or auditing scope or procedure, which, if not resolved to the satisfaction of
Ernst & Young LLP, would have caused it to make reference to the subject matter of the disagreement in connection
with its reports.

PART III

Item 10. Directors, Executive Ofﬁcers, Promoters and Control Persons; Compliance With Section 16(a) of the

Exchange Act.

The information required by Items 401 and 405 of Regulation S-K is omitted from this Report as the Company
intends  to  ﬁle  its  deﬁnitive  annual  meeting  proxy  materials  within  120  days  after  its  ﬁscal  year-end  and  the
information to be included therein in response to  such  Items is  incorporated herein by reference.

Item 11. Executive Compensation.

The information required by Item 402 of Regulation S-K is omitted from this Report as the Company intends
to ﬁle its deﬁnitive annual meeting proxy materials within 120 days after its ﬁscal year-end and the information to be
included therein in response to such Item  is  incorporated herein  by reference.

Item 12. Security Ownership of Certain Beneﬁcial Owners and Management.

The information required by Item 403 of Regulation S-K is omitted from this Report as the Company intends
to ﬁle its deﬁnitive annual meeting proxy materials within 120 days after its ﬁscal year-end and the information to be
included therein in response to such Item  is  incorporated herein  by reference.

Item 13. Certain Relationships and Related Transactions.

The information required by Item 404 of Regulation S-K is omitted from this Report as the Company intends
to ﬁle its deﬁnitive annual meeting proxy materials within 120 days after its ﬁscal year-end and the information to be
included therein in response to such Item  is  incorporated herein  by reference.

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.

(a)(1) The following consolidated ﬁnancial statements of U.S. Physical Therapy, Inc. and subsidiaries are included in
Item 8:

Consolidated Balance Sheets — December  31, 2000 and 1999

Consolidated Statements of Operations — years ended December 31, 2000, 1999 and 1998

Consolidated Statements of Shareholders’ Equity — years  ended December 31,  2000, 1999 and 1998

38

Consolidated Statements of Cash Flows — years  ended  December 31,  2000, 1999  and  1998

Notes to Consolidated Financial Statements — December 31,  2000

(2) The  following  consolidated  ﬁnancial  statement  schedule  of  U.S.  Physical  Therapy,  Inc.  is  included  in

Item 14(d):

Schedule II — Valuation and Qualifying  Accounts

All  other  schedules  for  which  provision  is  made  in  the  applicable  accounting  regulation  of  the  Securities  and
Exchange  Commission  are  not  required  under  the  related  instructions  or  are  inapplicable  and  therefore  have
been omitted.

(3) List of Exhibits

3.1

3.2

10.1

10.2

10.3

10.4

10.5

10.6

10.7

Articles of Incorporation of the Company (ﬁled as an exhibit to the Company’s Registration Statement on
Form S-1 (33-47019) and incorporated herein by reference).

Bylaws of the Company, as amended (ﬁled as an exhibit to the Company’s Form 10-KSB for the year ended
December 31, 1993  and incorporated herein by reference).
Convertible Subordinated Note Purchase Agreement dated June 2, 1993 (ﬁled as an exhibit to the Company’s
Form 8-K dated June 10, 1993 and incorporated herein by reference).

Form  of  U.S.  Physical  Therapy,  Inc.  8%  Convertible  Subordinated  Notes  (ﬁled  as  an  exhibit  to  the
Company’s Form 8-K dated June 2, 1993 and incorporated herein by reference).

Amendment  to  Convertible  Subordinated  Note  Purchase  Agreement  dated  March  10,  1994  (ﬁled  as  an
exhibit to the Company’s Form 8-K dated March 25,  1994  and  incorporated herein by reference).

Form of 8% Convertible Subordinated Notes, Series B (ﬁled as an exhibit to the Company’s Form 8-K dated
May 5, 1995 and incorporated herein by reference).

Registration  Agreement  for  Series  B  Notes  (ﬁled  as  an  exhibit  to  the  Company’s  Form  8-K  dated  May  5,
1995 and incorporated herein by reference).

Form of 8% Convertible Subordinated Notes, Series C (ﬁled as an exhibit to the Company’s Form 8-K dated
May 5, 1995 and incorporated herein by reference).

Registration  Agreement  for  Series  C  Notes  (ﬁled  as  an  exhibit  to  the  Company’s  Form  8-K  dated  May  5,
1995 and incorporated herein by reference).

10.8 † 1992  Stock  Option  Plan,  as  amended  (ﬁled  as  an  exhibit  to  the  Company’s  Registration  Statement  on

Form S-8 (333-64159) and incorporated herein by reference).

10.9 † Executive Option Plan (ﬁled as an exhibit to the Company’s Registration Statement on Form S-8 (33-63444)

and incorporated herein by reference).

10.10† 1999  Employee  Stock  Option  Plan  (ﬁled  as  an  exhibit  to  the  Company’s  Form  10-K  for  the  year  ended

December 31, 1999  and incorporated herein by reference).

10.11† Non-Statutory Stock Option Agreement (ﬁled as an exhibit to the Company’s Form 10-K for the year ended

December 31, 1999  and incorporated herein by reference).

10.12† Amended  and  Restated  Employment  Agreement  between  the  Company  and  Roy  W.  Spradlin  (ﬁled  as  an
exhibit to the Company’s Form 10-KSB for the year ended December 31, 1997 and incorporated herein by
reference).

10.13* The  Southwest Bank of Texas N.A. Three Year $2.5 million  Letter Loan Agreement, dated July 1,  2000.

10.14* The  Southwest  Bank  of  Texas  N.A.  Convertible  Line  of  Credit  Note,  Exhibit  A(i)  to  the  Three  Year  $2.5

million Letter Loan Agreement dated July 1, 2000.

10.15* The  Southwest  Bank  of  Texas  N.A.  Revolving  Line  of  Credit  Note,  Exhibit  A(ii)  to  the  Three  Year  $2.5

million Letter Loan Agreement dated July 1, 2000.

16

Change  in  registrant’s  independent  public  accountants,  which  occurred  on  September  27,  1999  (ﬁled  on
Form 8-K on September 30, 1999 and incorporated herein by reference).

39

21

* Subsidiaries of the Registrant.

23.1 * Consent  of  KPMG  LLP  (Registration  Nos.  33-63446,  33-63444,  33-91004,  33-93040,  333-30071  and

333-64159).

23.2 * Consent of Ernst & Young LLP (Registration Nos. 33-63446, 33-63444, 33-91004, 33-93040, 333-30071

and 333-64159).

(a) Reports on Form 8-K

No Form 8-K was ﬁled during the quarter ended December 31, 2000.

† Management contract or compensatory  plan or  arrangement.

* Filed herewith.

40

Item 14. (d)

SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

COL. A

COL. B

COL. C
Additions

COL. D

COL. E

Description

YEAR ENDED DECEMBER 31, 2000:
Reserves and allowances deducted from

asset accounts:
Allowance for uncollectible accounts **

YEAR ENDED DECEMBER 31, 1999:
Reserves and allowances deducted from

asset accounts:
Allowance for uncollectible accounts **

YEAR ENDED DECEMBER 31, 1998:
Reserves and allowances deducted from

asset accounts:
Allowance for uncollectible accounts **

Balance at
Beginning
of Period

Charged to
Costs and
Expenses

Charged
to Other
Accounts-
Describe

Deductions-
Describe

Balance at
End of
Period

$2,014,000

$1,596,000

$ 830,000(1) $2,780,000

$1,692,000

$1,165,000

$ 843,000(1) $2,014,000

$1,595,000

$1,143,000

$1,046,000(1) $1,692,000

(1) Uncollectible accounts written off, net of recoveries.

41

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its

behalf by the undersigned, thereunto duly authorized.

SIGNATURES

U.S. PHYSICAL THERAPY, INC.
(Registrant)

By:

/s/

J. MICHAEL MULLIN

J. Michael Mullin,
Chief Financial Ofﬁcer
(principal ﬁnancial and
accounting ofﬁcer)

Date: April 12, 2001

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of

the registrant and in the capacities as of  the  date indicated above.

By:

By:

By:

By:

J. Livingston Kosberg,
Chairman of the Board

Mark J. Brookner,
Vice Chairman of the Board

Roy W. Spradlin,
President, Chief Executive Ofﬁcer and Director
(principal executive ofﬁcer)

Bruce D. Broussard,
Director

By:

By:

By:

By:

Marlin W. Johnston,
Director

James B. Hoover,
Director

Daniel  C. Arnold,
Director

Albert L. Rosen,
Director

42