U S PHYSICAL THERAPY INC /NV - 10-K Annual Report

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

FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

[ ] 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 76-0364866
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

1300 WEST SAM HOUSTON PARKWAY, SUITE 300, 77043
HOUSTON, TEXAS (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

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 [X] No [ ]

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. [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]

As of June 28, 2002, based upon the closing price on such date, the
aggregate market value of the voting stock held by non-affiliates of the
registrant was: $135,793,371

As of March 18, 2003, the number of shares outstanding of the registrant's
common stock, par value $.01 per share, was: 11,878,371

DOCUMENTS INCORPORATED BY REFERENCE

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FORWARD LOOKING STATEMENTS

We make statements in this report that are considered to be forward-looking
statements within the meaning under Section 21E of the Securities and Exchange
Act of 1934. These 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," "appear" and "goal" and similar expressions are intended to
identify forward-looking statements. The forward-looking statements are based on
our current views and assumptions and involve risks and uncertainties that
include, among other things:

- general economic, business, and regulatory conditions;

- competition discussed under the heading "Competition" below;

- federal and state regulations discussed under the heading "Regulation and
Healthcare Reform" below;

- the availability of sufficient numbers of physical therapists with a
following in the community for us to realize our plan to expand the
number of our clinics by 20% of our base per year, discussed under the
heading "Factors Affecting Future Results" in the "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
and "Risk Factors", below; and

- weather.

These factors are beyond our control.

Given these uncertainties, you should not place undue reliance on our
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. Our forward-looking statements
represent our estimates and assumptions only as of the date of this report.
Except as required by law, we are under no obligation to update any forward-
looking statement, regardless of the reason the statement is no longer accurate.

PART I

ITEM 1. OUR BUSINESS.

GENERAL

Our company, U.S. Physical Therapy, Inc., through our subsidiaries,
operates outpatient physical and occupational therapy clinics which provide pre-
and post-operative care and treatment for a variety of orthopedic-related
disorders and sports-related injuries. U.S. Physical Therapy, Inc. was formed in
April 1992 under the corporate laws of the state of Nevada. We are organized as
a Nevada corporation with operating subsidiaries organized in the form of
limited partnerships and wholly-owned corporations. Unless the context otherwise
requires, references in this Form 10-K to "we", "our" or "us" includes U.S.
Physical Therapy, Inc. and all our subsidiaries.

At December 31, 2002, we operated 202 outpatient physical and occupational
therapy clinics in 34 states. Our strategy is to develop and acquire outpatient
clinics on a national basis, though our clinics are currently concentrated in 6
states -- Texas, Michigan, Wisconsin, Florida, Virginia and New Jersey. The
average age of the 202 clinics in operation at December 31, 2002 was 4.15 years.
We developed 196 of the clinics and acquired six.

Our clinics provide pre- and post-operative treatment for
orthopedic-related disorders, sports-related injuries, preventative care,
rehabilitation of injured workers and neurological-related injuries. Our clinics
initially perform a tailored and comprehensive evaluation of each patient, which
is then followed by a treatment plan specific to the injury. The treatment plan
may include a number of procedures, including ultrasound, electrical
stimulation, hot packs, iontophoresis, therapeutic exercise, manual therapy
techniques, education on management of daily life skills and home exercise
programs. A clinic's business primarily comes from referrals by local
physicians. 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.

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We continue to seek to attract physical and occupational therapists who
have established relationships with physicians by offering them a competitive
salary; a bonus based on his or her clinic's net revenue and profitability; and
a share of the profits of the clinic operated by that therapist.

In addition to our owned clinics, we also manage five physical therapy
facilities for third parties, including physicians.

On January 5, 2001, we 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.
On June 28, 2001, we effected a three-for-two common stock split in the form of
a 50% stock dividend to stockholders of record as of June 7, 2001. Fractional
shares resulting from the three-for-two stock split were paid to shareholders in
cash. All share and per share amounts stated in this report have been adjusted
to reflect the effect of the stock splits.

Our principal executive offices are located at 1300 West Sam Houston
Parkway, Suite 300, Houston, Texas 77042, and our telephone number is (713)
297-7000.

OUR CLINICS

Most of our clinics are owned by limited partnerships (the "Clinic
Partnerships") in which we own the general partnership interest, and the
managing therapists of the clinics own limited partnership interests. The
therapist partners have no interest in the net losses of Clinic Partnerships,
except to the extent of their capital accounts. Increasingly we have developed
satellite clinic facilities that are extensions of existing clinics; accordingly
Clinic Partnerships may consist of more than one clinic location. As of December
31, 2002, through wholly-owned subsidiaries, we owned a 1% general partnership
interest in all the Clinic Partnerships, except for one clinic in which we own a
6% general partnership interest. Our limited partnership interests range from
49% to 99% in the Clinic Partnerships, but with respect to 73% of our clinics,
we own a limited partnership interest of 64%. For the great majority of the
Clinic Partnerships the managing therapist of each clinic (along with other
therapists at the clinic in several of the partnerships) own the remaining
limited partnership interests in the Clinic Partnerships.

In the majority of the Clinic 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%.
We have recently revised our accounting for these Clinic Partnership interests
owned by the therapist partners; as to Clinic Partnerships formed after January
18, 2001, profit allocated to therapist partners is treated as compensation
expense. See "Significant Accounting Policies" -- Note 2 in Item 8.

We also own 43 clinics that have no therapist partner; the managing
director therapist participates in a profit interest program similar to our
partnership agreements, without having any ownership interest in the clinic.
Given our change in accounting for therapist partners, we may expand our number
of wholly owned clinics.

Typically each therapist partner or director enters into an employment
agreement for a term ranging from one to two years with his or her Clinic
Partnership; each agreement provides for a covenant not to compete during his or
her employment and for two years thereafter. Under 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 upon termination we can require the therapist to sell
his or her partnership interest in the Clinic Partnership to us or the Clinic
Partnership for the amount of his or her capital account if the termination is
for "cause" or for breach of the employment agreement; if the termination is
occasioned by or because of the therapist's death or disability, or the
expiration of the initial or any extended term of the employment agreement, the
buy out price is for an amount set in a predetermined formula based on a
multiple of prior profitability.

Each clinic maintains an independent local identity, while at the same time
enjoying the benefits of national purchasing, third-party payor contracts and
centralized management practices. Under a management agreement, one of our
subsidiaries 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, operational direction, ongoing accounting services and
marketing support.

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Our typical clinic occupies approximately 1,500 to 3,000 square feet of
space under a lease in an office building or shopping center. We attempt to
lease ground level space for ease of access to our clinics. We also attempt to
make the decor in our clinics less institutional and more aesthetically pleasing
than hospital clinics. Typical minimum staff at a clinic consists of a licensed
physical or occupational therapist and an office manager. As patient visits
grow, staffing may also include additional physical or occupational therapists,
therapy assistants, aides, exercise physiologists, athletic trainers and office
personnel. All therapy services are performed under the direct supervision of a
licensed therapist.

We currently provide services at our clinics only on an outpatient basis.
Patients are usually treated for approximately one hour per day, two to five
times a week, typically for two to six weeks. We generally charge for treatment
on a "per procedure" basis. In addition, our clinics will develop, when
appropriate, individual maintenance and self-management exercise programs to be
continued after treatment. We continually assess the potential for developing
new services and expanding the method of providing our services, with an
emphasis on cost containment.

RISK FACTORS

Our business, operations and financial condition are subject to various
risks. Some of these risks are described below, and readers of this Annual
Report on Form 10-K should take such risks into account in evaluating our
company or making any decision to invest in us. This section does not describe
all risks applicable to our company, our industry or our business, and it is
intended only as a summary of material factors affecting our business.

We depend upon reimbursement by third-party payors.

Substantially all of our revenues are derived from private and governmental
third-party payors. In 2002, approximately 79% of our revenues were derived from
commercial insurers, managed care plans, workers' compensation payors and other
private pay revenue sources, approximately 20% from Medicare and approximately
1% from Medicaid. Initiatives undertaken by major insurers and managed care
companies to contain healthcare costs affect the profitability of our clinics.
These payors attempt to control healthcare costs by contracting with healthcare
providers to obtain services on a discounted basis. We believe that this trend
will continue and may limit reimbursements for healthcare services. If insurers
or managed care companies from whom we receive substantial payments were to
reduce the amounts they pay for services, our profit margins may decline, or we
may lose patients if we choose not to renew our contracts with these insurers at
lower rates. We also receive payments from the Medicare program under a fee
schedule. These payments will be subject to an annual limit of $1,590 per
patient, effective for services rendered on or after July 1, 2003. Bills have
been introduced in both houses of Congress (S569/HR1125) to permanently repeal
this financial limit on therapy services, but if not repealed such limitation
could have a adverse impact on our revenues beginning in 2004. We expect that
efforts to contain federal spending for Medicare will continue to seek
limitations on Medicare reimbursement for various services, and we cannot
predict whether any of these efforts will be successful or what effect, if any,
such limitations would have on our business. See "Our Business -- Regulation and
Healthcare Reform" in Item 1.

We depend upon the cultivation and maintenance of established relationships
with the physicians in our markets.

Our success is dependent upon referrals from physicians in the communities
our clinics serve and our ability to maintain good relations with these
physicians. Physicians referring patients to our clinics are free to refer their
patients to other providers. If we are unable to successfully cultivate and
maintain strong relationships with these physicians, our business may decrease
and our net operating revenues may decline.

We also depend upon our ability to recruit and retain experienced physical
therapists who have established relationships with the physicians in our
markets.

As mentioned above, our revenue generation is dependent upon referrals from
physicians in the communities our clinics serve, and our ability to maintain
good relations with these physicians. Our therapists are the front line for
generating these referrals and we are dependent on their talents and skills to
successfully cultivate and maintain strong relationships with these physicians.
If we cannot recruit and retain our base of experienced and established
therapists,

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our business may decrease and our net operating revenues may decline.
Periodically, we have clinics in isolated communities that are temporarily
unable to operate due to the unavailability to identify partner caliber
therapists.

Our revenues may decline due to weather.

We have a significant number of clinics in states that normally experience
snow and ice during the winter months. Extended periods of severe snow and ice
could cause the inability of our staff or patients to travel to our clinics,
which may cause a decrease in our net operating revenues. Winter months in which
snow is minimal for states in which we have clinics may also result in reduced
revenues because of the lower incident of injuries resulting from winter sports
and accidents.

Our revenues may decline during prolonged economic slow down or recession.

Our revenues are a reflection of the number of visits made by patients to
our clinics. Some therapy and some surgical treatments that lead to patient need
for therapy are elective or can be deferred. During periods of high unemployment
or general economic decline, patient visits decline.

Our operations are subject to extensive regulation.

The healthcare industry is subject to extensive federal, state and local
laws and regulations relating to:

- facility and professional licensure, including certificates of need;

- conduct of operations, including financial relationships among healthcare
providers, Medicare fraud and abuse, and physician self- referral;

- addition of facilities and services; and

- payment for services.

Recently, there have been heightened coordinated civil and criminal
enforcement efforts by both federal and state government agencies relating to
the healthcare industry, including our line of business. We believe we are in
substantial compliance with all laws, but differing interpretations or
enforcement of these laws and regulations could subject our current practices to
allegations of impropriety or illegality or could require us to make changes in
our methods of operations, facilities, equipment, personnel, services and
capital expenditure programs and increase our operating expenses. If we fail to
comply with these extensive laws and government regulations, we could become
ineligible to receive government program reimbursement, suffer civil or criminal
penalties or be required to make significant changes to our operations. In
addition, we could be forced to expend considerable resources responding to an
investigation or other enforcement action under these laws or regulations. See
"Our Business -- Regulation and Healthcare Reform" in Item 1.

Healthcare reform legislation may affect our business.

In recent years, many legislative proposals have been introduced or
proposed in Congress and in some state legislatures that would effect major
changes in the healthcare system, either nationally or at the state level. At
the federal level, Congress has continued to propose or consider healthcare
budgets that substantially reduce payments under the Medicare programs. There
can be no assurance as to the ultimate content, timing or effect of any
healthcare reform legislation, nor is it possible at this time to estimate the
impact of potential legislation on us. That impact may be material to our
business, financial condition or results of operations.

We operate in a highly competitive industry.

We encounter competition from local, regional or national entities, some of
which have superior competitive advantages. Intense competition may adversely
affect our business, financial condition or results of operations. See "Our
Business -- Competition" in Item 1.

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FACTORS INFLUENCING DEMAND FOR THERAPY SERVICES

We believe that the following factors, among others, influence the growth
of outpatient physical and occupational therapy services:

- Economic Benefits of Therapy Services. Purchasers and providers of
healthcare services, such as insurance companies, health maintenance
organizations, businesses and industries, continuously seek ways to save
on the cost of traditional healthcare services. We believe that our
therapy services provide a cost-effective way to prevent short-term
disabilities from becoming chronic conditions and to speed recovery from
surgery and musculoskeletal injuries.

- Earlier Hospital Discharge. Changes in health insurance reimbursement,
both public and private, have encouraged the early discharge of patients
to reduce costs. We believe that early hospital discharge practices
foster greater demand for outpatient physical and occupational therapy
services.

- Aging Population. The elderly population has a greater incidence of
major disability. As this segment of the population grows, we believe
that demand for rehabilitation services will expand.

MARKETING

We focus our local marketing efforts on physicians, mainly orthopedic
surgeons, neurosurgeons, physiatrists, occupational medicine physicians and
general practitioners. In marketing to the physician community, we emphasize our
commitment to quality patient care and communication with physicians regarding
patient progress. We employ personnel to assist clinic directors in developing
and implementing marketing plans for the physician community and to assist in
establishing referral relationships with health maintenance organizations,
preferred provider organizations, industry and case managers and insurance
companies.

SOURCES OF REVENUE

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, Medicare and
managed care programs generally provide coverage to patients utilizing our
clinics after payment of normal deductibles and co-insurance payments. Workers'
compensation laws generally require employers to provide, directly or indirectly
through insurance, for their employees' costs of medical rehabilitation from
work-related injuries and disabilities and, in some jurisdictions, mandatory
vocational rehabilitation, usually without any deductibles, co-payments or cost
sharing. Treatments for patients who are parties to personal injury cases are
generally paid from the proceeds of settlements with insurance companies or from
favorable judgments. If an unfavorable judgment 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 following table shows our payor mix for the years ended:

Our business also depends to a significant extent on our relationships with
commercial health insurers, workers' compensation insurers, and health
maintenance organizations and preferred provider organizations. In some
geographical areas, our clinics must be approved as providers by key health
maintenance organizations and preferred

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provider plans to obtain payments. As to these clinics, failure to obtain or
maintain these approvals would adversely affect their financial results.

Approximately 20% of our visits are from patients with Medicare insurance
coverage. To receive Medicare reimbursement, a rehabilitation agency or the
individual therapist must meet applicable participation conditions set by HHS
(the Health and Human Services Department of the federal government) relating to
the type of facility, equipment, record keeping, personnel and standards of
medical care, and also must comply with all state and local laws. HHS
periodically inspects or surveys clinics for compliance. As of December 31,
2002, 159 of our clinics have been certified as rehabilitation agencies by
Medicare and an additional 27 clinics, not certified as rehabilitation agencies,
have individual therapists certified by Medicare to provide services as physical
therapists in private practice. We anticipate that 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.

Since 1999, reimbursement for outpatient therapy services has been made
according to a fee schedule published by the HHS. Under the Balanced Budget Act
of 1997 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.
After a three year moratorium, this financial limitation on therapy services
will be implemented for services rendered on or after July 1, 2003. The total
amount paid by Medicare in any one year has been adjusted up to $1,590, and the
full amount will be available for the six month period between July 1, 2003 and
December 31, 2003. Effective January 1, 2004 this financial limitation, as
adjusted for inflation, will be an annual limit. Legislation has been introduced
in both houses of Congress (S569/HR1125) to permanently repeal this financial
limit on therapy services. If the limit had been in effect as of July 1, 2002,
we estimate that Medicare payments exceeding the cap for 2002 would have been
$1.2 million. The potential negative impact on revenue could be reduced by
receiving payments from secondary insurance carriers, patients electing to
self-pay, and most importantly by replacing lost revenues by more aggressive
marketing efforts focused on decreasing Medicare as a percentage of our total
business. In the event such negative impact is not mitigated by such efforts,
the limit could have a adverse impact on 2004 income (potentially as much as a
10% reduction) since the limit will apply for the entire year.

Medicare regulations require that a physician certify the need for therapy
services for each patient and that these services be provided under an
established plan of treatment, which is periodically revised. State Medicaid
programs generally do not provide coverage for outpatient physical or
occupational therapy; thus Medicaid is not, nor is it expected to be, a material
payor for us.

REGULATION AND HEALTHCARE REFORM

Numerous federal, state and local regulations regulate healthcare services.
Some states into which we may expand have laws requiring facilities employing
health professionals and providing health-related services to be licensed and,
in some cases, to obtain a certificate of need (that is, demonstrating to a
state regulatory authority the need for and financial feasibility of new
facilities or the commencement of new healthcare services). Based on our
operating experience to date, we believe that our business as presently
conducted does not require certificates of need or other facility approvals or
licenses. Our therapists, however, are required to be licensed. Failure to
obtain or maintain any required certificates, approvals or licenses could have a
material adverse effect on our business, financial condition and results of
operations.

Regulations Controlling Fraud and Abuse. 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. We
believe that our billing procedures and business arrangements are in compliance
with these provisions. However, 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 that fall within a "Safe Harbor" and, therefore, are
not viewed as illegal remuneration under the Fraud and Abuse Law. Failure to
fall within a Safe Harbor does not

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mean that the Fraud and Abuse Law has been violated; however, the OIG has
indicated that failure to fall within a Safe Harbor may subject an arrangement
to increased scrutiny.

Our business of managing physician-owned physical therapy facilities is
regulated by the Fraud and Abuse Law and falls outside the scope of the Safe
Harbors. Nonetheless, we believe that these arrangements comply with the Fraud
and Abuse Law, even though federal courts provide little guidance as to the
application of the Fraud and Abuse Law to these arrangements. If our management
contracts are held to violate the Fraud and Abuse Law, it could have a material
adverse effect on our 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 patients. The OIG is concerned that in these arrangements, 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. We rent clinic space for a number of
our clinics from referring physicians and have taken the appropriate steps that
we believe are necessary to assure that all leases comply with the space rental
Safe Harbor to the Fraud and Abuse Law.

Stark II. Provisions of the Omnibus Budget Reconciliation Act of 1993 (the
"Stark Law") prohibits referrals by a physician for "designated health services"
to an entity in which the physician or family member has an investment interest
or other financial relationship, with several exceptions. This law applies to
us.

The Stark Law covers a management contract with a physician group and any
financial relationship between us and referring physicians, including any
financial transaction resulting from a clinic acquisition. This law also
prohibits billing for services rendered from a prohibited referral Several
states have enacted laws similar to the Stark Law, but these state laws cover
all (not just Medicare and Medicaid) patients. Many federal healthcare reform
proposals in the past few years have expanded the Stark Law to cover all
patients as well. As with the Fraud and Abuse Law, we consider the Stark Law in
planning our clinics, marketing and other activities, and believe that our
operations are in compliance with applicable law. If we fail to comply with the
Stark Law our financial results and operations would be adversely affected.
Penalties for violation include denial of payment for the services, significant
civil monetary penalties, and exclusion from the Medicare and Medicaid programs.

HIPAA. In an effort to further combat healthcare fraud, Congress included
several anti-fraud measures in the Health Insurance Portability and
Accountability Act of 1996 ("HIPAA"). HIPAA created a source of funding for
fraud control to coordinate federal, state and local healthcare law enforcement
programs, conduct investigations, provide guidance to the healthcare industry
concerning fraudulent healthcare practices, and establish a national data bank
to receive and report final adverse actions. Additionally, HIPAA mandates the
adoption of standards regarding the exchange of electronic healthcare
information in an effort to ensure the privacy and security of patient
information and standards relating to the privacy of health information and
security of electronic health information. We must fully comply with the
standards for the exchange of electronic healthcare information by October 16,
2003. We must fully comply with the standards relating to privacy of protected
health information by April 14, 2003. Finally, we must comply with HIPAA
standards for the security of electronic health information by April 21, 2005.
Sanctions for failing to comply with HIPAA include criminal penalties and civil
sanctions.

We cannot predict what effect, if any, the expanded enforcement authorities
will have on our business. We believe that our operations comply with HIPAA
requirements. We expect that our costs of compliance with HIPAA will not have a
material effect on our business, financial condition or results of operations.

Other Regulatory Factors. Political, economic and regulatory influences
are fundamentally changing the healthcare industry in the United States
Congress, state legislatures and the private sector will continue to review and
assess alternative healthcare delivery and payment systems. Potential
alternative approaches 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, and price controls. Legislative debate is expected
to continue in the future and market forces are expected to demand reduced
costs. For instance, managed care entities, which represent an ever-growing
percentage of healthcare payors, are demanding lower reimbursement rates from
healthcare providers, and in some cases, are requiring or encouraging providers
to accept capitated payments that may not allow providers to cover their full
costs or realize traditional levels of

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profitability. We cannot predict what impact the adoption of any federal or
state healthcare reform measures or future private sector reform may have on our
business.

COMPETITION

The healthcare industry generally, and the physical and occupational
therapy businesses in particular, are highly competitive and undergo continual
changes in the manner in which services are delivered and in which providers are
selected. Competitive factors affecting our business include quality of care,
cost, treatment outcomes, convenience of location, and relationships with and
ability to meet the needs of referral and payor sources. Our clinics compete
directly or indirectly with the physical and occupational therapy departments of
acute care hospitals, physician-owned therapy clinics, other private therapy
clinics and chiropractors.

Of these sources, we believe acute care hospital outpatient therapy clinics
and private therapy clinic organizations are our primary competitors. We will
face more intense competition as consolidation of the therapy industry continues
through the acquisition of physician-owned and other privately-owned therapy
practices.

We believe that our strategy of providing key therapists in a community
with an opportunity to participate in clinic profitability provides us with a
competitive advantage because their participation helps ensure the commitment of
local management to the success of the clinic and minimizes turnover of managing
therapists.

We also believe that our competitive position is enhanced by our strategy
of locating our clinics, when possible, on the ground floor of office buildings
and shopping centers with nearby parking, thereby making the clinics more easily
accessible to patients. We also attempt to make the decor in our clinics less
institutional and more aesthetically pleasing than hospital clinics. Finally, we
believe that we can generally provide services at a lower cost than hospitals
due to hospitals' higher overhead.

EMPLOYEES

At December 31, 2002, we employed 1,239 total employees, of which 880 were
full-time employees. At that date, none of our employees were governed by
collective bargaining agreements or were members of unions. We consider our
relations with our employees to be good.

In the states in which our current clinics are located, persons performing
physical and occupational therapy services are required to be licensed by the
state. All persons currently employed by us who are required to be licensed are
licensed. We are not aware of any federal licensing requirements applicable to
our employees.

AVAILABLE INFORMATION

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and amendments to those reports filed or furnished pursuant
to Section 13(a) or 15(d) of the Exchange Act are made available free of charge
on our internet website at http://www.usphysicaltherapy.com as soon as
reasonably practicable after we electronically file such material with, or
furnish it to, the Securities and Exchange Commission.

ITEM 2. PROPERTIES.

We lease all of the properties used for our clinics under non-cancelable
operating leases with terms ranging from one to five years, with the exception
of two clinics located in Brownwood, Texas and Mineral Wells, Texas, which we
own. In addition, we own a building relating to a closed facility, which is for
sale, in Clovis, New Mexico. We intend to lease the premises in which new
clinics will be located except in rare instances in which leasing is not a cost
effective alternative. Our typical clinic occupies 1,500 to 3,000 square feet.

We also lease our executive offices located in Houston, Texas, under a
non-cancelable operating lease expiring in June 2010. We currently occupy
approximately 35,000 square feet of space (including allocations for common
areas) at our executive offices and have the option to lease an additional
24,000 square feet.

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ITEM 3. LEGAL PROCEEDINGS.

We are involved in 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, we do not believe the impact of existing
lawsuits or other proceedings would have a material impact on our 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 our security holders during the
fourth quarter of 2002.

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

PRICE QUOTATIONS

Our common stock is traded on the Nasdaq National Market ("Nasdaq") under
the symbol "USPH." As of March 18, 2003, there were 41 holders of record of our
outstanding common stock. The range of Nasdaq reported trading prices shown
below reflects the two-for-one stock split on January 5, 2001, to holders of
record as of December 27, 2000 and the three-for-two stock split on June 28,
2001, to holders of record as of June 7, 2001. The reported quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commission and may not
represent actual transactions.

In a May 1994 private offering, we issued $3 million in subordinated notes.
The notes have the following material terms:

- Matures on June 30, 2004.

- Has a remaining principal balance of $2.3 million.

- Interest rate of 8% payable quarterly.

- Convertible into common stock at a conversion price of $3.33.

Since inception we have not declared or paid cash dividends or made
distributions on our equity securities, and we do not anticipate that we will
pay cash dividends or make distributions in the foreseeable future.

9

EQUITY COMPENSATION PLAN INFORMATION

The following table provides information about our common stock that may be
issued upon the exercise of options and rights under all of our existing equity
compensation plans as of December 31, 2002, including the 1992 Stock Option
Plan, 1999 Employee Stock Option Plan, Executive Option Plan and Inducement
option agreements.

- ---------------

(1) The 1992 Stock Option Plan, as amended (the "1992 Plan") permits us to grant
to key employees and outside directors incentive and non-qualified options.

The Executive Option Plan (the "Executive Plan") permits us to grant to
officers or our affiliates, options to purchase shares of our common stock.
No further grants of options will be made under the Executive Plan.

(2) The 1999 Employee Stock Option Plan (the "1999 Plan") permits us to grant to
certain non-officer employees non-qualified options to purchase shares of
our common stock.

We granted Inducement options to certain individuals in connection with
their offers of employment. Each inducement option has its own plan.

For further descriptions of the 1999 Plan and the Inducements, see
"Financial Statements and Supplementary Data -- Stock Option Plans" in Note
8 of Item 8.

ITEM 6. SELECTED FINANCIAL DATA.

- ---------------

(1) All per share information has been adjusted to reflect a two-for-one stock
split on January 5, 2001, and a three-for-two stock split on June 28, 2001.

(2) A reclassification has been made in 2001 to conform to the presentation used
for 2002. The reclassifications had no effect on net income.

10

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

OVERVIEW

We operate outpatient physical and occupational therapy clinics that
provide pre- and post-operative care and treatment for a variety of
orthopedic-related disorders and sports-related injuries. At December 31, 2002,
we operated 202 outpatient physical and occupational therapy clinics in 34
states. The average age of our clinics at December 31, 2002, was 4.15 years. We
have developed 196 of the clinics and acquired six. To date, we have sold one
clinic, closed 14 facilities due to substandard clinic performance, and
consolidated three clinics with other existing clinics. We added 40 new clinics
in 2002 and plan to open between 40 and 45 clinics in 2003.

In addition to our owned clinics, we also manage physical therapy
facilities for third parties, primarily physicians, with five third-party
facilities under management as of December 31, 2002.

CRITICAL ACCOUNTING POLICIES

Critical accounting policies are those that have a significant impact on
our results of operations and financial position involving significant estimates
requiring our judgment. Our critical accounting policies are:

Revenue Recognition. We primarily bill third-party payors for services at
standard rates. Net patient revenues are based on established billing rates,
less allowances and discounts for patients covered by 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, evaluated monthly by management, for contractual and
other adjustments agreed to or established with payors. Reimbursement for
Medicare beneficiaries is based upon a fee schedule published by HHS. See "Our
Business -- Sources of Revenue" in Item 1.

Allowance for Doubtful Accounts. We review the accounts receivable aging
and rely on prior experiences with particular payors at each clinic to determine
an appropriate reserve for doubtful accounts. Historically, clinics that have
large numbers of aged accounts generally have less favorable collection
experience, and thus they require a higher allowance. Accounts that are
ultimately determined to be uncollectible are written off against our bad debt
allowance. The amount of our aggregate bad debt allowance is periodically
reviewed for adequacy in light of current and historical experience.

Accounting for Income Taxes. As part of the process of preparing the
consolidated financial statements, we must estimate our federal and state income
tax liability, as well as assess temporary differences resulting from differing
treatment of items (such as bad debt expense and amortization of leasehold
improvements) for tax and for accounting purposes. The differences result in
deferred tax assets and liabilities, which are included in our consolidated
balance sheets. We must then assess the likelihood that deferred tax assets will
be recovered from future taxable income, and if not, establish a valuation
allowance.

Carrying Value of Long-Lived Assets. Our property and equipment,
intangible assets and goodwill (collectively, our "long-lived assets") comprise
a significant portion of our total assets at December 31, 2002 and 2001. We
account for our long-lived assets pursuant to Statement of Financial Accounting
Standards No. 142 and Statement of Financial Accounting Standards No. 144. These
accounting standards require that we periodically, and upon the occurrence of
certain events, assess the recoverability of our long-lived assets. If the
carrying value of our property and equipment or intangible assets exceeds their
undiscounted cash flows, we are required to write the carrying value down to
estimated fair value. Also, if the carrying value of our goodwill exceeds the
estimated fair value, we are required to allocate the estimated fair value to
our assets and liabilities, as if we had just acquired it in a business
combination. We then would write-down the carrying value of our goodwill to the
implied fair value. Any such write-down is included as an impairment loss in our
consolidated statement of operations. A degree of judgment is required to
estimate the fair value of our long-lived assets. We may use quoted market
prices, prices for similar assets, present value techniques and other valuation
techniques to prepare these estimates. In addition, we may obtain independent
appraisals in certain circumstances. We may need to make estimates of future
cash flows and discount rates as well as other assumptions in order to implement
these valuation techniques. Accordingly, any value ultimately derived from our
long-lived assets may differ from our estimate of fair value.

11

Accounting for Minority Interests. In the majority of our 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%. Within the balance sheet and statement of
operations we record partner therapist's profit interest in the clinic
partnerships as minority interest in earnings of subsidiary limited
partnerships. The Emerging Issues Task Force ("EITF") issued EITF 00-23, "Issues
Related to the Accounting for Stock Compensation under APB No. 25 and FASB
Interpretation No, 44", which provides specific accounting guidance relating to
various incentive compensation issues. We have reviewed EITF 00-23 with respect
to the partnerships structure and the accounting for minority interest and
concluded that for partnerships formed after January 18, 2001, EITF 00-23
requires us to expense as compensation rather than as a minority interest in
earnings, the clinic partner's interest in profits. Moreover, EITF 00-23 will
also require, as to clinic partnerships formed after January 18, 2001, that we
expense as compensation rather than capitalizing as goodwill, the purchase of
minority interest in the partnerships. At this time we operate 43 wholly owned
clinics without any minority interest. It is possible that due to this recent
change in accounting practices we will increase our development of
non-partnership clinics, and because of the revised method of accounting for
clinic partnerships, we probably will expand the number of wholly owned clinics
we have.

In accordance with the above, for the year ended December 31, 2002, we have
classified $306,000 of the minority interests in earnings of subsidiary limited
partnerships relating to the 26 partnerships formed after January 18, 2001, into
salaries and related costs. As of December 31, 2002, $276,000 of undistributed
minority interests related to the 26 partnerships is classified as other
long-term liabilities. This change in classification had no effect on net income
at December 31, 2002. No amounts were reclassified in 2001, due to the
insignificant amount of minority interest in the 13 partnerships formed between
January 18, 2001 and December 31, 2001. See "Minority Interest" (a subsection of
"Significant Accounting Policies") -- Note 2 in Item 8.

SELECTED OPERATING AND FINANCIAL DATA

The following table presents selected operating and financial data:

12

FISCAL YEAR 2002 COMPARED TO FISCAL YEAR 2001

Net Patient Revenues

Net patient revenues increased to $92.3 million for 2002 from $78.5 million
for 2001, an increase of $13.8 million, or 18%, on a 15% increase in patient
visits to 1,004,000. Net patient revenues from the 40 clinics opened during 2002
(the "2002 New Clinics") accounted for 21% of the increase, or $2.9 million. The
remaining increase of $10.9 million in net patient revenues is attributable to
the 162 clinics opened before 2002 (the "Mature Clinics"). Of the $10.9 million
increase in net patient revenues from the Mature Clinics, $9.1 million was
attributable to a 12% increase in the number of patient visits to 972,000, while
$1.8 million was attributable to a 2% increase in the average net patient
revenue per visit to $91.93.

Management Contract Revenues

Management contract revenues remained constant at $2.3 million for 2002 and
2001. We do not expect any significant expansion of our management contracting
business.

Clinic Operating Costs

Total clinic operating costs as a percent of net revenues remained constant
at 68% for 2002 and 2001.

- Clinic Operating Costs -- Salaries and Related Costs

Salaries and related costs increased to $42.2 million for 2002 from $35.4
million for 2001, an increase of $6.8 million, or 19%. Approximately 27% of the
increase, or $1.8 million, was attributable to the opening of the 2002 New
Clinics. The remaining 73% increase, or $5.0 million, was attributable
principally to increased staffing at the Mature Clinics to meet the increase in
patient visits, coupled with an increase in bonuses earned by clinic directors
at the Mature Clinics. Bonuses are based on the net revenues or operating profit
generated by the individual clinics. Salaries and related costs as a percent of
net revenues remained constant at 44% for 2002 and 2001.

- Clinic Operating Costs -- Rent, Clinic Supplies and Other

Rent, clinic supplies and other increased to $20.7 million for 2002 from
$17.6 million for 2001, an increase of $3.1 million, or 18%. Approximately 52%
of the increase, or $1.6 million, was attributable to the 2002 New Clinics,
while 48%, or $1.5 million, of the increase was incurred at the Mature Clinics.
The increase in rent, clinic supplies and other for the Mature Clinics was
primarily attributable to the fact that 8 of the 30 clinics opened during 2001
initiated operations in the fourth quarter, reflecting that 2002 was the first
year in which they incurred a full year of expenses. Rent, clinic supplies and
other as a percent of net revenues remained constant at 22% for 2002 and 2001.

- Clinic Operating Costs -- Provision for Doubtful Accounts

The provision for doubtful accounts decreased to $1.7 million for 2002 from
$1.9 million for 2001, a decrease of 14%, or $261,000. In 2002, provision for
doubtful accounts for Mature Clinics decreased $319,000 as a result of our
improved collection efforts, which was off-set by an increase of $58,000 in 2002
New Clinics. The provision for doubtful accounts as a percent of net revenues
decreased to 1.8% in 2002 compared to 2.5% for 2001. The allowance for doubtful
accounts as a percentage of total patient accounts receivable increased from 23%
to 25% from December 31, 2001 to December 31, 2002. Gross days in accounts
receivable decreased to 71 in December 31, 2002 from 81in the same period a year
earlier. The provision for doubtful accounts for each period is based on a
detailed, clinic-by-clinic review of overdue accounts.

Corporate Office Costs

Corporate office costs consist primarily of salaries and benefits of
corporate office personnel, rent, insurance costs, depreciation and
amortization, travel, legal, professional, marketing and recruiting fees. These
costs increased to $11.3 million for 2002 from $9.1 million for 2001, an
increase of $2.2 million, or 24%. Significant increases were incurred in
salaries, recruiting fees and benefits related to additional personnel hired to
support an increasing number

13

of clinics, as well as depreciation expense, insurance costs and legal fees.
Corporate office costs as a percent of net revenues increased to 12% in 2002
from 11% in 2001.

Interest Expense

Interest expense decreased $52,000, or 20%, to $214,000 for 2002 from
$266,000 for 2001, primarily because of the conversion of a portion of our
Series C Convertible Subordinated Note into 200,100 shares of our common stock
in the second quarter of 2002. See "Factors Affecting Future
Results -- Convertible Subordinated Debt" in Item 7.

Minority Interests in Earnings of Subsidiary Limited Partnerships

Minority interests in earnings of subsidiary limited partnerships decreased
$243,000, or 5%, to $4.9 million for 2002 from $5.2 million for 2001. The
decrease primarily related to the repurchase of minority partners' interests,
coupled with a change in accounting that requires us to record minority
interests in earnings of subsidiary limited partnerships opened after January
18, 2001, as salaries and related costs. See "Acquisition of Minority Interests"
and "Significant Accounting Policies" -- Note 4 and 2, respectively, in Item 8.

Provision for Income Taxes

The provision for federal and state income taxes increased to $5.2 million
for 2002 from $4.4 million for 2001, an increase of $804,000, or 18%, which was
directly related to our 19% increase in current year income before income taxes.
During 2002 and 2001, we provided for income taxes at an effective tax rate of
38% and 39%, respectively.

FISCAL YEAR 2001 COMPARED TO FISCAL YEAR 2000

Net Patient Revenues

Net patient revenues increased to $78.5 million for 2001 from $60.7 million
for 2000, an increase of $17.8 million, or 29%, on a 25% increase in patient
visits to 871,000. Net patient revenues from the 30 clinics opened during 2001
(the "2001 New Clinics") accounted for 21% of the increase, or $3.7 million. The
remaining increase of $14.1 million in net patient revenues is attributable to
the 132 clinics opened before 2001 (the "2001 Mature Clinics"). Of the $14.1
million increase in net patient revenues from the 2001 Mature Clinics, $11.5
million was attributable to a 19% increase in the number of patient visits to
829,000, while $2.6 million was attributable to a 4% increase in the average net
revenue per visit to $90.19.

Management Contract Revenues

Management contract revenues decreased to $2.3 million for 2001 from $2.4
million for 2000, a decrease of $58,000, or 2%. This decrease was primarily
attributable to the termination at the end of the contract of a third-party
management contract with a hospital in February 2001. We do not expect any
significant expansion of our management contracting business.

Clinic Operating Costs

Total clinic operating costs as a percent of net patient revenues decreased
to 68% in 2001 from 72% in 2000.

- Clinic Operating Costs -- Salaries and Related Costs

Salaries and related costs increased to $35.4 million for 2001 from $28.7
million for 2000, an increase of $6.7 million, or 23%. Approximately 26% of the
increase, or $1.7 million, was attributable to the opening of the 2001 New
Clinics. The remaining 74% increase, or $5 million, was attributable principally
to increased staffing to meet the increase in patient visits at the 2001 Mature
Clinics, coupled with an increase in bonuses earned by clinic directors at the
2001 Mature Clinics. Bonuses are based on the net revenues or operating profit
generated by the individual clinics. Salaries and related costs as a percent of
total net revenues decreased to 44% in 2001 from 46% in 2000, reflecting
increased patient visits and higher per-patient billings.
14

- Clinic Operating Costs -- Rent, Clinic Supplies and Other

Rent, clinic supplies and other increased to $17.6 million for 2001 from
$15 million for 2000, an increase of $2.6 million, or 17%. Approximately 50% of
the increase, or $1.3 million, was attributable to the 2001 New Clinics, while
50%, or $1.3 million, of the increase was incurred at the 2001 Mature Clinics.
The increase in rent, clinic supplies and other for the 2001 Mature Clinics was
primarily attributable to the fact that 32% of the 28 clinics opened during 2000
initiated operations in the fourth quarter, reflecting that 2001 was the first
year in which they incurred a full year of expenses. Rent, clinic supplies and
other as a percent of total revenues decreased to 22% for 2001 from 24% for
2000, reflecting increased patient visits and higher per-patient billings.

- Clinic Operating Costs -- Provision for Doubtful Accounts

The provision for doubtful accounts increased to $1.9 million for 2001 from
$1.6 million for 2000, an increase of 21%, or $334,000. Approximately 24% of the
increase, or $81,000, was attributable to the 2001 New Clinics. The remaining
76% increase, or $253,000, was attributable to the 2001 Mature Clinics. The
provision for doubtful accounts as a percent of net patient revenues remained
fairly constant at 2.5% for 2001 compared to 2.6% for 2000. The provision for
doubtful accounts for each period is based on a detailed, clinic-by-clinic
review of overdue accounts.

Corporate Office Costs

Corporate office costs consist primarily of salaries and benefits of
corporate office personnel, rent, insurance costs, depreciation and
amortization, travel, legal, professional, marketing and recruiting fees. These
costs increased to $9.1 million for 2001 from $7.6 million for 2000, an increase
of $1.5 million, or 20%. Significant increases were incurred in legal fees,
travel, recruiting fees, as well as salaries and benefits related to additional
personnel hired to support an increasing number of clinics. However, corporate
office costs as a percent of net revenues decreased to 11% in 2001 from 12% in
2000. Corporate office expense in 2000 included $369,000 related to our
discontinued surgery center initiative.

Interest Expense

Interest expense decreased $514,000, or 66%, to $266,000 for 2001 from
$780,000 for 2000, primarily because of the conversion into shares of our common
stock of $850,000 of convertible subordinated debt in the last quarter of 2000
and $4.2 million of convertible subordinated debt in the first quarter of 2001.
See "Factors Affecting Future Results -- Convertible Subordinated Debt" in Item
7.

Minority Interests in Earnings of Subsidiary Limited Partnerships

Minority interests in earnings of subsidiary limited partnerships increased
$1.7 million, or 49%, to $5.2 million for 2001 from $3.5 million for 2000,
reflecting the increase in aggregate profitability of those clinics in which
clinic therapist partners accrue their portion of partnership income.

Provision for Income Taxes

The provision for federal and state income taxes increased to $4.4 million
for 2001 from $2.4 million for 2000, an increase of $2 million, or 83%. During
2001 and 2000, we accrued income taxes at an effective tax rate of 39%.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 2002, we had $7.6 million in cash and cash equivalents
compared to $8.1 million at December 31, 2001. Our cash and cash equivalents are
available to fund the working capital needs of our operating subsidiaries,
future clinic development, acquisitions and investments. Included in cash and
cash equivalents at December 31, 2001 was $4.5 million in a money market fund
invested in short-term debt instruments issued by an agency of the U.S.
Government.

The decrease in cash of $511,000 from December 31, 2001 to December 31,
2002 is due primarily to cash used in financing activities of $13.4 million and
$6.6 million in fixed asset and intangible purchases, offset by $19.5 million in
cash provided by operating activities. In 2002, we used $10.5 million in cash to
repurchase 795,600 shares of

15

our common stock, made $5.2 million in distributions to minority investors in
subsidiary limited partnerships and repaid a $701,000 note payable. Cash was
provided by proceeds of $3 million from the exercises of stock options.

Our current ratio increased to 8.10 to 1.00 at December 31, 2002 from 6.03
to 1.00 at December 31, 2001. The increase in the current ratio is due primarily
to a decrease in the current portion of notes payable.

At December 31, 2002, we had a debt-to-equity ratio of 0.07 to 1.00
compared to 0.12 to 1.00 at December 31, 2001. The decrease in the
debt-to-equity ratio from December 31, 2001 to December 31, 2002 resulted from
achieving net income of $8.5 million, the conversion of $667,000 in subordinated
notes into common stock, and realizing proceeds of $3 million and tax benefits
of $4.2 million from the exercise of stock options.

In 2002, $667,000 of a convertible subordinated note was converted into
common stock, leaving a remaining balance of $2.3 million.

We do not currently have credit lines or other credit arrangements.
Historically, we have generated sufficient cash from operations to fund our
development activities and cover operational needs. We generally do not acquire
new clinics through acquisitions of existing clinics, but prefer developing and
opening new clinics, which we believe generally requires less capital. We
currently plan to continue developing new clinics, although this strategy may
change if attractive opportunities become available. We have from time to time
purchased the minority interests of limited partners in our clinic partnerships.
We may purchase additional minority interests in the future. Generally, any
purchases of minority interests are expected to be accomplished using a
combination of common stock and cash. We believe that existing funds,
supplemented by cash flows from existing operations, will be sufficient to meet
our current operating needs, development plans and any purchases of minority
interests through at least 2003.

In 2002, we completed the repurchase of 795,600 shares for $10.5 million
(including expenses). These purchases, combined with previous plan purchases
bring total treasury stock purchases to 930,600 at December 31, 2002 pursuant to
our stock purchase plan, which authorized 1,000,000 shares. On February 26,
2003, our Board of Directors ("Board") authorized a new share repurchase program
of up to 250,000 additional shares of our outstanding common stock. As there is
no expiration for this Board authorization, additional shares may be purchased
from time to time in the open market or private transactions depending on price,
availability and our cash position.

RECENTLY PROMULGATED ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement Financial Accounting Standards No. 143, "Accounting for Asset
Retirement Obligations," ("SFAS 143") which addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. This statement applies to all
entities that have legal obligations associated with the retirement of
long-lived assets that result from the acquisition, construction, development or
normal use of the asset. SFAS 143 is effective for fiscal years beginning after
June 15, 2002. The adoption of SFAS 143 did not have a significant impact on our
financial condition or results of operations.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statements No. 13 and Technical
Corrections," ("SFAS 145") which provides guidance for income statement
classification of gains and losses on extinguishments of debt and accounting for
certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. SFAS 145 is effective for us beginning in 2003. We
do not expect the adoption of SFAS 145 to have a material impact on our
financial condition or results of operations.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or
Disposal Activities," ("SFAS 146") which addresses significant issues regarding
the recognition, measurement, and reporting of costs that are associated with
exit and disposal activities, including restructuring activities that are
currently accounted for pursuant to the guidance set forth in EITF Issue No.
94-3, "Liability Recognition of Certain Employee Termination Benefits and Other
Costs to Exit an Activity." SFAS 146 is effective for us beginning in 2003. We
do not expect the adoption of SFAS 146 to have a material impact on our
financial condition or results of operations.

In November 2002, the FASB issued Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Guarantees of Indebtedness of Others." FIN 45 requires that a liability

16

be recorded in the guarantor's balance sheet upon issuance of a guarantee. In
addition, FIN 45 requires disclosures about the guarantees that an entity has
issued, including a reconciliation of charges in the entity's product warranty
liabilities. The initial recognition and initial measurement provision of FIN 45
are applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. The disclosure requirements of FIN 45 are effective for
financial statements of interim or annual periods ending after December 15,
2002. We do not expect the adoption of FIN 45 to have a material impact on our
financial condition or results of operations.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure, an amendment of FASB Statement No.
123," ("SFAS 148") which provides alternative methods of transition for an
entity that voluntarily changes to the fair value based method of accounting for
stock-based employee compensation. SFAS 148 also amends certain disclosures
under SFAS 123 and Accounting Principles Board Opinion No. 28, "Interim
Financial Reporting," to require prominent disclosure about the effects on
reported net income of an entity's accounting policy decisions with respect to
stock-based employee compensation. SFAS 148 is effective for fiscal years ending
after December 15, 2002. We continue to use the provisions of APB Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") to account for
employee stock options and apply the disclosures required under SFAS 123.

FACTORS AFFECTING FUTURE RESULTS

Clinic Development

As of December 31, 2002, we had 202 clinics in operation, 40 of which
opened in 2002. Our goal for 2003 is to open between 40 and 45 additional
clinics if we can identify suitable geographic locations and physical and
occupational therapists to manage the clinics. We expect to incur initial
operating losses from the new clinics, which will impact our operating results.
Generally we experience losses during the initial period of a new clinic's
operation. Operating margins for newly opened clinics tend to be lower than more
seasoned clinics because of start-up costs and lower patient visits and
revenues. Patient visits and revenues gradually increases in the first year of
operation, as patients and referral sources become aware of the new clinic.
Revenues tend to increase significantly during the two to three years following
the first anniversary of a clinic opening. Based on historical performance of
our new clinics, the clinics opened in 2002 should favorably impact our results
of operations beginning in 2003.

Convertible Subordinated Debt

In May 1994 we issued $3 million of 8% Convertible Subordinated Notes,
Series C due June 30, 2004 (the "Series C Notes"). The Series C Convertible
Subordinated Note is convertible at the option of the holder into the number of
shares of our common stock determined by dividing the principal amount of the
Notes being converted by $3.33 per share. In June 2002, $667,000 of the Series C
Notes were converted by the note holders into 200,100 shares of common stock.
The remaining principal amount under the Series C Note was $2.3 million at
December 31, 2002 and $3 million at December 31, 2001. If our share price is not
at or above $3.33 in June 2004, it is likely that the note holders would not
convert and we would have to use cash to repay the remaining Series C Note. See
"Note Payable" in Note 5 of Item 8.

The debt conversion increased our shareholders' equity by the carrying
amount of the debt converted less unamortized deferred financing costs, thus
improving our debt to equity ratio and favorably impacting results of operations
and cash flow due to the interest savings in 2002 before income taxes of
approximately $50,000.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The Company does not maintain any derivative instruments, interest rate
swap arrangements, hedging contracts, futures contracts or the like. Its only
indebtedness as of December 31, 2002, was $2.3 million in Series C Convertible
Subordinated Notes, described immediately above. See Note 5 of Item 8.

17

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Independent Auditors' Report................................ 19
Audited Financial Statements:
Consolidated Balance Sheets as of December 31, 2002 and
2001...................................................... 20
Consolidated Statements of Operations for the years ended
December 31, 2002, 2001 and 2000.......................... 21
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 2002, 2001 and 2000.............. 22
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000.......................... 23
Notes to Consolidated Financial Statements.................. 24

18

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, 2002
and 2001, and the related consolidated statements of operations, shareholders'
equity, and cash flows for each of the years in the three-year period ended
December 31, 2002. In connection with our audits of the consolidated financial
statements, we have also audited the related consolidated financial statement
schedule for each of the years in the three-year period ended December 31, 2002.
These consolidated financial statements and the consolidated financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial statements and
consolidated financial statement schedule 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, 2002 and 2001, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion, the related consolidated 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.

KPMG LLP

Houston, Texas
March 7, 2003

19

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)

See notes to consolidated financial statements.

20

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

See notes to consolidated financial statements.

21

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)

See notes to consolidated financial statements.

22

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

See notes to consolidated financial statements.

23

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002

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, 2002, the Company owned and operated 202 clinics in 34 states. The
clinics provide pre- and 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
managed care programs, commercial health insurance, Medicare, workers'
compensation insurance and proceeds from personal injury cases.

In addition to the Company's ownership of clinics, it also manages physical
therapy facilities for third parties, including physicians, with five such
third-party facilities under management as of December 31, 2002.

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 operates through subsidiary
clinic partnerships, in which the Company generally owns a 1% general
partnership interest and a 64% limited partnership interest in the clinics. The
managing therapist of each clinic owns the remaining limited partnership
interest in the majority of the clinics. In some instances, the Company
developed satellite clinic facilities as extensions of existing clinics, with
the result that some existing clinic partnerships operate more than one clinic
location.

2. SIGNIFICANT ACCOUNTING POLICIES

Common Stock Splits

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.

On June 28, 2001, the Company effected a three-for-two common stock split
in the form of a 50% stock dividend to stockholders of record as of June 7,
2001.

All share and per share information included in the accompanying
consolidated financial statements and related notes have been adjusted to
reflect these stock splits.

Cash Equivalents

The Company considers all highly liquid investments with an original
maturity of three months or less 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, 2001 was $4.5 million in a money market fund
invested in short-term debt instruments issued by an agency of the U.S.
Government. On December 31, 2002, the Company held no highly liquid investments.

Long-Lived Assets

Fixed assets are stated at cost. Depreciation is computed on 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.

24

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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

In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," ("SFAS 144") which addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets. While SFAS 144 supersedes SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," it retains
many of the fundamental provisions of that statement. SFAS 144 also supersedes
the accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," for the disposal of a segment of a business. SFAS 144 is
effective for the Company January 1, 2002. The adoption of SFAS 144 did not have
a significant impact on the Company's financial condition or results of
operations.

The Company reviews property and equipment and intangible assets for
impairment when certain events or circumstances indicate that the related
amounts might be impaired. Also, the Company evaluates goodwill for impairment
on an annual basis by comparing the fair value of its reporting segment units,
as defined by SFAS 144, to their carrying values. For the year ended December
31, 2002, the fair value of the Company's reporting segment units exceeds the
recorded carrying value. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell.

Goodwill

Goodwill represents the excess of costs over the fair value of the acquired
business's assets. In July 2001, the FASB issued SFAS No. 142, "Goodwill and
Other Intangible Assets," ("SFAS 142"). Provisions of SFAS 142 that were
effective for the Company January 1, 2002, require that goodwill and other
intangible assets with indefinite lives no longer be amortized. SFAS 142 further
requires the fair value of goodwill and other intangible assets with indefinite
lives be tested for impairment upon adoption of this statement, annually and
upon the occurrence of certain events and be written down to fair value if
considered impaired. At December 31, 2002, the Company had approximately $5.6
million of unamortized goodwill. Amortization expense related to goodwill was
$44,000 and $61,000 for the years ended December 31, 2001 and 2000,
respectively. In accordance with SFAS 142, the Company did not have any
amortization expense related to goodwill for the year ended ending December 31,
2002.

The following table reconciles previously reported net income as if SFAS
142 were in effect in 2001 and 2000. Net income excluding goodwill amortization
expense is as follows:

Prior to the adoption of SFAS 142, goodwill was amortized using the
straight-line method over 20 years.

25

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Minority Interest

In the majority of the Company's 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%. Within the balance sheet and statement of operations the Company records
partner therapist's profit interest in the clinic partnerships as minority
interest in earning of subsidiary limited partnerships. The Emerging Issues Task
Force ("EITF") issued EITF 00-23, "Issues Related to the Accounting for Stock
Compensation under APB No. 25 and FASB Interpretation No. 44", which provides
specific accounting guidance relating to various incentive compensation issues.
The Company has reviewed EITF 00-23 with respect to the partnerships structure
and the accounting for minority interest and concluded that for partnerships
formed after January 18, 2001, EITF 00-23 requires the Company to expense as
compensation rather than as a minority interest in earnings, the clinic
partner's interest in profits. Moreover, EITF 00-23 will also require, to clinic
partnerships formed after January 18, 2001, that the Company expense as
compensation rather than capitalizing as goodwill, the purchase of minority
interest in the partnerships. At this time the Company operate 43 wholly owned
clinics without any minority interest. It is possible that due to this recent
change in accounting practices the Company will increase its development of
non-partnership clinics, and because of the revised method of accounting for
clinic partnerships, the Company probably will expand the number of wholly owned
clinics we have.

In accordance with the above, for the year ended December 31, 2002, the
Company has classified $306,000 of the minority interest in earnings of
subsidiary limited partnerships relating to the 26 partnerships formed after
January 18, 2001, into salaries and related costs. As of December 31, 2002,
$276,000 of undistributed minority interests related to the 26 partnerships is
classified as other long-term liabilities. This change in classification had no
effect on net income at December 31, 2002. No amounts were reclassified in 2001,
due to the insignificant amount of minority interest in the 13 partnerships
formed between January 18, 2001 and December 31, 2001.

Revenue Recognition

Revenues are recognized in the period in which services are rendered and
are reported at estimated net realizable amounts.

Net patient revenues are reported at the estimated net realizable amounts
from insurance companies, third-party payors, patients 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. The
Company determines allowances for doubtful accounts based on the specific agings
and payor classifications at each clinic, and contractual adjustments based on
historical experience and the terms of payor contracts. Net accounts receivable
includes only those amounts the Company estimates to be collectible.

Reimbursement rates for outpatient therapy services provided to Medicare
beneficiaries are established pursuant to a fee schedule published by the
Department of Health and Human Services ("HHS"). Under the Balanced Budget Act
of 1997 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.
After a three year moratorium, this financial limitation on therapy services is
set to be implemented for services rendered on or after July 1, 2003. The total
amount paid by Medicare in any one year has been adjusted up to $1,590 and the
full amount will be available for the six month period between July 1, 2003 and
December 31, 2003. Effective January 1, 2004 this financial limitation, as
adjusted for inflation, will be an annual limit.

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, 2002.
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.

26

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Income Taxes

The Company is required to estimate its federal and state income tax
liability as well as account for temporary differences between its tax and
accounting treatment of some of its expenses, such as bad debt expense and
amortization of leasehold improvements. The differences result in deferred tax
assets and liabilities, which are included in the consolidated balance sheets.
The Company must also assess the likelihood that deferred tax assets will be
recovered from future taxable income, and if not recoverable, establish a
valuation reserve.

Fair Values of Financial Instruments

The carrying amounts reported in the balance sheet for cash and cash
equivalents, accounts receivable, accounts payable and notes payable -- current
portion approximate their fair values due to the short-term maturity of these
financial instruments. 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. Based upon the closing price of the Company's
common stock on December 31, 2002 of $11.15, the fair value of the convertible
subordinated notes was $7.8 million.

Use of Estimates

In preparing the Company's consolidated financial statements, management
makes certain estimates and assumptions that affect the amounts reported in the
consolidated financial statements and related disclosures. Actual results may
differ from these estimates.

Reclassifications

Certain reclassifications have been made to prior year amounts to conform
to current year presentation.

Stock Options

The Company issues stock options to key employees and outside directors as
described in Note 8. SFAS 123, "Accounting for Stock-Based Compensation,"
encourages, but does not require, companies to record compensation cost for
stock-based employee compensation plans at fair value. The Company has chosen to
continue to account for employee stock-based compensation using the intrinsic
value method as prescribed in Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees," and related FASB
Interpretations, under which no compensation cost related to stock plans has
been recognized in net income for the years ended December 31, 2002, 2001 and
2000.

The fair value of these options was estimated at the date of grant using a
Black-Scholes option pricing model. 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 2002, 2001 and 2000 is not representative of the pro
forma effect on net income in future years because it does not take into
consideration pro forma compensation

27

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

expense related to grants made prior to 1995. The Company's pro forma
information follows (in thousands except for earnings per share information):

The weighted-average fair value per share of options granted during the
years ended December 31, 2002, 2001 and 2000 follows:

The following weighted-average assumptions for 2002, 2001 and 2000 were
used in estimating the fair value per share of the options granted under the
stock option plans and assuming no dividends:

Recently Promulgated Accounting Pronouncements

In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," ("SFAS 143") which addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. This statement applies to all
entities that have legal obligations associated with the retirement of
long-lived assets that result from the acquisition, construction, development or
normal use of the asset. SFAS 143 is effective for fiscal years beginning after
June 15, 2002. The adoption of SFAS 143 did not have a significant impact on the
Company's financial condition or results of operations.

In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement Financial Accounting Standards No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statements No. 13 and Technical
Corrections," ("SFAS 145") which provides guidance for income statement
classification of gains and losses on extinguishments of debt and accounting for
certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. SFAS 145 is effective beginning in 2003. The
Company does not expect the adoption of SFAS 145 to have a material impact on
the Company's financial condition or results of operations.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or
Disposal Activities," ("SFAS 146") which addresses significant issues regarding
the recognition, measurement, and reporting of costs that are associated with
exit and disposal activities, including restructuring activities that are
currently accounted for pursuant to the guidance set forth in EITF Issue No.
94-3, "Liability Recognition of Certain Employee Termination Benefits and

28

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Other Costs to Exit an Activity." SFAS 146 is effective beginning in 2003. The
Company does not expect the adoption of SFAS 146 to have a material impact on
the Company's financial condition or results of operations.

In November 2002, the FASB issued Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Guarantees of Indebtedness of Others." FIN 45 requires that a liability be
recorded in the guarantor's balance sheet upon issuance of a guarantee. In
addition, FIN 45 requires disclosures about the guarantees that an entity has
issued, including a reconciliation of charges in the entity's product warranty
liabilities. The initial recognition and initial measurement provision of FIN 45
are applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. The Company does not expect the adoption of FIN 45 to have a
material impact on the Company's financial condition or results of operations.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosures, an amendment of FASB Statement No.
123," ("SFAS 148") which provides alternative methods of transition for an
entity that voluntarily changes to the fair value based method of accounting for
stock-based employee compensation. SFAS 148 also amends certain disclosures
under SFAS 123 and Accounting Principles Board Opinion No. 28, "Interim
Financial Reporting," to require prominent disclosure about the effects on
reported net income of an entity's accounting policy decisions with respect to
stock-based employee compensation. SFAS 148 is effective for fiscal years ending
after December 15, 2002. The Company continues to use the provisions of APB
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") to account
for employee stock options and apply the disclosures required under SFAS 123.

3. NON-CASH TRANSACTIONS

In June 2002, $667,000 of the Series C Notes were converted by a note
holder into 200,100 shares of common stock. See "Notes Payable" in Note 5.

During September 2001 and December 2001 the Company purchased minority
interest in two limited partnerships in the form of non-cash transactions. See
"Acquisition of Minority Interests" in Note 4.

4. ACQUISITION OF MINORITY INTERESTS

On September 30, 2001, the Company purchased the 35% minority interest in a
limited partnership which owns nine clinics in Michigan for consideration
aggregating $2.1 million. At closing, the Company delivered 95,000 shares of
restricted stock and a note payable for $630,000 which was paid in October 2001.
This non-cash investing and financing transaction has been excluded from the
consolidated statements of cash flows.

On December 31, 2001, the Company purchased the 35% minority interest in a
limited partnership which owns four clinics in Michigan for consideration
aggregating $1.5 million. At closing, the Company delivered 67,100 shares of
restricted stock and a note payable for $435,000 which was paid in January 2002.
This non-cash investing and financing transaction has been excluded from the
consolidated statements of cash flows. Additionally, as part of the purchase,
the Company agreed to pay the minority partner $261,000 of undistributed
earnings which was paid in January 2002.

On January 31, 2002, the Company purchased a 10% minority interest in a
limited partnership that owns four clinics in Michigan for $447,000. As part of
the purchase, we paid the minority partner $65,000 in undistributed earnings.

On June 1, 2002, the Company purchased a 35% minority interest in a limited
partnership for $220,000. Additional consideration may be paid in the future
based upon clinic performance. The Company paid the minority partner $73,000 in
undistributed earnings. In July the Company sold 17.5% of the purchased interest
to another therapist for $220,000, payable from future profits of the
partnership. The Company discounted the note receivable by 50% and is
recognizing the gain as payments are made.

29

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

On June 1, 2002, the Company purchased a 5% minority interest in a limited
partnership for $95,000. The Company also paid the minority partner $8,000 in
undistributed earnings.

On August 31, 2002, the Company purchased the 30% minority interest in a
limited partnership for $244,000 cash plus forgiveness of a $75,000 note
receivable from the minority partner. The Company also paid the minority partner
$19,000 in undistributed earnings.

On September 1, 2002, the Company purchased the 35% minority interest in a
limited partnership for $54,000. Also on September 1, 2002, the Company
purchased 65% of a speech therapy company for $26,000.

The Company's minority interest purchases were accounted for as purchases
and accordingly, the results of operations of the acquired minority interest
percentage are included in the accompanying financial statements from the dates
of purchase. In addition, the Company is permitted to make, and has occasionally
made, changes to preliminary purchase price allocation during the first year
after completing the purchase. Goodwill has been recognized for the amount of
the excess of the purchase price paid over the fair market value of the minority
interest acquired and accounted for in accordance with SFAS 142.

The changes in the carrying amount of goodwill consisted of the following
(in thousands):

5. NOTES PAYABLE

In May 1994, the Company issued $3 million of 8% Convertible Subordinated
Notes, Series C due June 30, 2004 (the "Series C Note"). The Series C Note is
convertible at the option of the holder into shares of the Company common stock
determined by dividing the principal amount of the Notes being converted by
$3.33. The Series C Notes bear interest from the date of issuance at a rate of
8% per annum, payable quarterly. In June 2002, $667,000 of the Series C Notes
were converted by a note holder into 200,100 shares of common stock. The
remaining principal amount under the Series C Note was $2.3 million at December
31, 2002 and $3.0 million at December 31, 2001.

The Series C Notes are unsecured and subordinated in right of payment to
all other indebtedness for borrowed money incurred by the Company.

In January 2001, $650,000 of an earlier series of notes was converted into
195,000 shares of common stock; at that time the Company exercised its right to
require conversion of the remaining balance of $3.6 million of several
outstanding series of notes into 1,002,500 shares of common stock.

30

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Notes payable as of December 31, 2002 and 2001 consist of the following (in
thousands):

Scheduled maturities as of December 31, 2002 are as follows (in thousands):

2003........................................................ $ 4
2004........................................................ 2,338
2005........................................................ 5
2006........................................................ 5
2007........................................................ 2
------
$2,354
======

6. RELATED PARTY TRANSACTION

During 2001 and 2000, the Company recognized interest expense of $6,000 and
$415,000, respectively, relating to Convertible Subordinated Notes held by
directors of the Company. For the year ended December 31, 2002, the Company had
no debt which was held by a director of the Company.

7. INCOME TAXES

Significant components of deferred tax assets, included in long-term other
assets on the balance sheet at December 31, 2002 and 2001, were as follows (in
thousands):

The differences between the federal tax rate and the Company's effective
tax rate for the years ended December 31, 2002, 2001 and 2000 were as follows
(in thousands):

31

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Significant components of the provision for income taxes for the years
ended December 31, 2002, 2001 and 2000 were as follows (in thousands):

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 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.

8. STOCK OPTION PLANS

The Company has in effect the following stock option plans:

The 1992 Stock Option Plan, as amended (the "1992 Plan") permits the
Company to grant to key employees and outside directors of the Company incentive
and non-qualified options to purchase up to 3,495,000 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 1992 Plan are granted at an exercise
price not less than the fair market value of the shares of common stock on the
date of grant. The exercise prices of options granted under the 1992 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).

The Executive Option Plan (the "Executive Plan") permits the Company to
grant to any officer of the Company or its affiliates, options to purchase up to
255,000 shares of common stock (subject to adjustments in the event of stock
dividends, splits and similar corporate transactions). No further grants of
options will be made under the Executive Plan. The exercise prices of the
options granted under the Executive Plan were determined by the Stock Option
Committee, and in the case of both incentive and non-qualified options, could
not be less than the greater of 175% of the fair market value of a share of
common stock on the date of grant or the par value per share of the stock. The
period within which each option is exercisable was determined by the Stock
Option Committee to be ten years from the date of grant.

The 1999 Employee Stock Option Plan (the "1999 Plan") permits the Company
to grant to certain non-officer employees of the Company up to 300,000
non-qualified options to purchase shares of common stock (subject to
proportionate adjustments in the event of stock dividends, splits, and similar
corporate transactions). The exercise

32

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

During 2002, 2001 and 2000, the Board of Directors of the Company granted
Inducement options covering 10,000, 30,000 and 30,000 options, respectively to
three individuals in connection with their offers of employment. During 2002 and
2000, 22,500 and 150,000 options were forfeited, respectively. The period within
which each option will be exercisable is 10 years from the date of grant.

A cumulative summary of stock options as of December 31, 2002 follows:

A summary of the status of the Company's stock option plans as of December
31, 2002, 2001 and 2000 and the changes during the years then ended is presented
below:

33

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following tables summarize information about the Company's stock
options outstanding as of December 31, 2002, 2001 and 2000, respectively
contractual life in years):

The following table summarizes information about the Company's stock
options outstanding and range of exercise prices as of December 31, 2002:

In total, the Company has 2,834,868 shares which are reserved for issuance
under the 1992 Stock Option Plan, the Executive Option Plan, the 1999 Employee
Stock Option Plan, two non-plan, non-qualifying option agreements and the Series
C Notes.

34

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

9. 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.

10. PURCHASE OF COMMON STOCK

In September 2001, the Board of Directors ("Board") authorized the Company
to purchase, in the open market or in privately negotiated transactions, up to
1,000,000 shares of its common stock. Shares purchased are held as treasury
shares and may be used for such valid corporate purposes or retired as the Board
deems advisable. During the year ended December 31, 2001, the Company purchased
135,000 shares of its common stock on the open market for a total of $1.9
million. During the year ending December 31, 2002, the Company purchased an
additional 795,600 shares of its common stock on the open market for $10.5
million.

On February 26, 2003, the Board authorized a new share repurchase program
of up to 250,000 additional shares of the Company's outstanding common stock. As
there is no expiration for this Board authorization, additional shares may be
purchased from time to time in the open market or private transactions depending
on price, availability and the Company's cash position.

11. 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, 2002, 2001 and 2000.

12. 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 $6.4 million, $5.4 million and $4.5 million for the years ended
December 31, 2002, 2001 and 2000, respectively. Several of the leases provide
for an annual increase in the rental payment based upon the Consumer Price
Index. 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.

35

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The future minimum lease commitments for the next five years and in the
aggregate as of December 31, 2002 are as follows (in thousands):

2003........................................................ $ 6,248
2004........................................................ 5,555
2005........................................................ 5,118
2006........................................................ 3,676
2007........................................................ 2,386
Thereafter.................................................. 1,780
-------
$24,763
=======

Employment Agreements

At December 31, 2002, 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 2004. The
Company also had an outstanding consulting agreement with one of its directors
for $95,000 annually for a term extending through May 2006.

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 $3.3 million in 2003 and $1 million in the
aggregate from 2004 through 2006. 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 $14.8 million, $12.3 million and $9.6
million for the years ended December 31, 2002, 2001 and 2000, respectively.

Each employment agreement provides that the Company has the right to
purchase the limited partnership interest in the clinic partnership for the
amount of the partner's 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)

13. EARNINGS PER SHARE

The computation of basic and diluted earnings per share for the years ended
December 31, 2002, 2001 and 2000 are as follows (in thousands, except per share
data)

14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

37

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

Not applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

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.

For information required by Item 201(d) of Regulation S-K, see "Market for
Common Equity and Related Stockholder Matters -- Equity Compensation Plan
Information" in Item 5. 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. CONTROL AND PROCEDURES.

(a) Evaluation of Disclosure Controls and Procedures

Within 90 days prior to the filing date of this report, we carried out an
evaluation, under the supervision and with the participation of our principal
executive officer and principal financial officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on this
evaluation, our principal executive officer and principal financial officer
concluded that our disclosure controls and procedures provide reasonable
assurance that material information required to be included in our periodic SEC
reports is recorded, processed, summarized and reported within the time periods
specified in the relevant SEC rules and forms.

(b) Changes in Internal Controls

In addition, we reviewed our internal controls, and there have been no
significant changes in our internal controls or in other factors that could
significantly affect those controls subsequent to the date of their last
evaluation.

ITEM 15. 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, 2002 and 2001

Consolidated Statements of Operations -- years ended December 31, 2002,
2001 and 2000
38

Consolidated Statements of Shareholders' Equity -- years ended December 31,
2002, 2001 and 2000

Consolidated Statements of Cash Flows -- years ended December 31, 2002,
2001 and 2000

Notes to Consolidated Financial Statements -- December 31, 2002

(2) The following consolidated financial statement schedule of U.S.
Physical Therapy, Inc. is included in Item 15(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

- ---------------

* Filed herewith

+ Management contract or compensatory plan or arrangement.

39

(b) Reports on Form 8-K

No reports on Form 8-K were filed with the Securities and Exchange
Commission during the quarter ended December 31, 2002.

40

ITEM 15. (d)

SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES
(AMOUNTS IN THOUSANDS)

- ---------------

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

41

SIGNATURES

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.

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

By: /s/ J. MICHAEL MULLIN
-----------------------------------
J. Michael Mullin,
Chief Financial Officer
(principal financial and
accounting officer)

Date: March 31, 2003

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: /s/ ROY W. SPRADLIN By: /s/ MARK J. BROOKNER
-------------------------------------------------- --------------------------------------------------
Roy W. Spradlin, Mark J. Brookner,
Chairman, President and Chief Executive Officer Vice Chairman of the Board
(principal executive officer)

By: /s/ JAMES B. HOOVER By: /s/ ALBERT L. ROSEN
-------------------------------------------------- --------------------------------------------------
James B. Hoover, Albert L. Rosen,
Director Director

By: /s/ MARLIN W. JOHNSTON By: /s/ DANIEL C. ARNOLD
-------------------------------------------------- --------------------------------------------------
Marlin W. Johnston, Daniel C. Arnold,
Director Director

By: /s/ BRUCE D. BROUSSARD
--------------------------------------------------
Bruce D. Broussard,
Director

42

CERTIFICATIONS

I, Roy Spradlin, certify that:

1. I have reviewed this annual report on Form 10-K of U.S. Physical
Therapy, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
functions):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

/s/ ROY SPRADLIN
--------------------------------------
ROY SPRADLIN
Chairman, President and Chief
Executive Officer
(principal executive officer)

Date: March 31, 2003

43

CERTIFICATIONS

I, J. Michael Mullin, certify that:

1. I have reviewed this annual report on Form 10-K of U.S. Physical
Therapy, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
functions):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

/s/ J. MICHAEL MULLIN
--------------------------------------
J. Michael Mullin
Chief Financial Officer
(principal financial and accounting
officer)

Date: March 31, 2003

44

INDEX OF EXHIBITS

- ---------------

* Filed herewith

+ Management contract or compensatory plan or arrangement.