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

Back to GetFilings.com

.
.
.

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549-1004

FORM 10-K

(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003

OR

[ ] TRANSITION REPORT PURSUANT TO 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.
(Exact 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 SOUTH, 77042
SUITE 300, (Zip Code)
HOUSTON, TEXAS
(Address of principal executive offices)
(713) 297-7000
(Telephone number)

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 each class)

NASDAQ NATIONAL MARKET
(Name of each exchange on which registered)

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 30, 2003, based upon the closing price on such date, the
aggregate market value of the voting stock held by non-affiliates of the
registrant was: $90,432,428

As of March 1, 2004, the number of shares outstanding of the registrant's
common stock, par value $.01 per share, was: 12,441,955

DOCUMENTS INCORPORATED BY REFERENCE

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 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;

- reimbursement rates from third party payors and deductibles and co-pays
owed by patients;

- availability, terms, and use of capital;

- the availability of sufficient numbers of qualified physical and
occupational therapists for us to realize our plan to expand the number
of our clinics, 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. 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.
This description of our business should be read in conjunction with our
financial statements and the related notes contained elsewhere in this Form
10-K.

At December 31, 2003, we operated 242 outpatient physical and occupational
therapy clinics in 35 states. Our strategy is to develop and acquire outpatient
clinics on a national basis. Our clinics are currently concentrated in 8
states -- Texas, Michigan, Wisconsin, Florida, Virginia, Oklahoma, Maine and New
Jersey. The average age of the 242 clinics in operation at December 31, 2003 was
3.96 years. We developed 236 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

1

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.

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.

Our principal executive offices are located at 1300 West Sam Houston
Parkway South, 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, 2003, 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 the majority 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%.
In 2002, we revised our accounting for these Clinic Partnership interests owned
by the therapist partners; as to Clinic Partnerships formed after January 18,
2001, whereby profit allocated to therapist partners is treated as compensation
expense. See "Significant Accounting Policies" -- Note 2 in Item 8.

Beginning in 2003, the Company significantly reduced the percentage of new
Clinic's structured as clinic partnerships and increased the percentage of
wholly owned clinics. New clinics opened, which are not satellites of clinic
partnerships, are wholly owned by the Company. As of December 31, 2003, 71
clinics have no therapist partner but rather the managing director therapist
participates in a profit sharing and residual interest program similar to our
partnership agreements, without having an equity interest in the clinic. Given
the change in accounting for partners, we expect to continue to 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 one or two years thereafter. Under each employment
agreement the therapist partner receives a base salary and may receive 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

2

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 billing procedures and
training of office support personnel, processing of accounts payable,
operational direction, ongoing accounting services and marketing support.

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 patient 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 provide services at our clinics 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 methods of providing our existing services most efficiently.

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 2003, 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. 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 was limited. After a
three-year moratorium, this financial limitation on therapy services was
implemented for services rendered on or after September 1, 2003. Effective
December 8, 2003, a moratorium was placed on the limit for the remainder of 2003
and for years 2004 and 2005. 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.

3

WE DEPEND UPON THE CULTIVATION AND MAINTENANCE OF 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 AND
OCCUPATIONAL 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, 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 a therapist
that meet our standards.

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. 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 relative economic weakness, patient visits may decline.

CONTINUED DECLINES IN AVERAGE DAILY VISITS COULD NEGATIVELY IMPACT OUR RESULTS
OF OPERATIONS.

The number of daily visits to our clinics has declined from an average of
22.9 per clinic during 2001 to an average of 19.9 per clinic during 2003. This
is partially attributable to the record number of locations opened in the two
year period 2002 and 2003 that are still in the process of ramping up referrals
and patient visits. It is also attributable to a decline in patient visits in
our older clinics. We believe this decline is in part the result of higher
patient co-payments and deductibles which has lead to some softness in the
therapy sector in general. We also believe that in certain markets this decline
is attributable to higher unemployment rates or increased competition levels. A
continuation of this trend could lead to a decline in our revenues and profits.

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.

4

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 resources or other competitive advantages. This competition
includes both publicly and privately held businesses including hospitals,
physician owned practices and clinics owned by therapists or investors. Intense
competition may adversely affect our business, financial condition or results of
operations. See "Our Business -- Competition" in Item 1.

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 marketing efforts primarily 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.

5

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 all
receivable types 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 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 through
Centers for Medicare and Medicaid Service ("CMS") and designated agencies
periodically inspects or surveys clinics for compliance. As of December 31,
2003, 181 of our clinics have been certified as rehabilitation agencies by
Medicare and an additional 48 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 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 (the "Medicare Limit"), except for services
provided in hospitals. After a three-year moratorium, this Medicare Limit on
therapy services was implemented for services rendered on or after September 1,
2003 subject to an adjusted total of $1,590 (the "Adjusted Medicare Limit").
Effective December 8, 2003, a moratorium was placed on the Adjusted Medicare
Limit for the remainder of 2003 and for years 2004 and 2005. The potential
negative impact on revenue resulting from a Medicare limit could be reduced by
receiving payments from secondary insurance carriers, patients electing to self-

6

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 the moratorium is not extended after 2005 and such
negative impact is not mitigated by such efforts, the Adjusted Medicare Limit
could have an adverse impact on 2006 and later revenue and income since the
limit scheduled to 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 specific application is not currently known. Several states have
enacted state laws similar to the Fraud and Abuse law.

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 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's stated concern in these arrangements is that, 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.

7

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.

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 may
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 and protect patient
confidentially, 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. We believe that our operations fully comply with standards for
privacy of protected healthcare information. We additionally, 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.

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 captivated payments that may not allow providers to cover their full
costs or realize traditional levels of 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
hospitals, physician-owned therapy clinics, other private therapy clinics and
chiropractors.

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

8

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 reduces 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, 2003, we employed 1,276 total employees, of which 976 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.usph.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 one clinic in each of Brownwood, Texas and Mineral Wells, Texas, which we
own. 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 37,537 square feet of space (including allocations for common
areas) at our executive offices.

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.

9

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 2003.

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 1, 2004, there were 37 holders of record of our
outstanding common stock. The reported quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commission and may not represent actual
transactions.

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

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, 2003, 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") expired in 2002 and
no new option grants can be awarded subsequent to this date.

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 or initial affiliation with us. Each inducement
option was made pursuant to an option grant agreement.

10

For further descriptions of the 1992 Plan, 1999 Plan and the Inducements,
see Stock Option Plans" in Note 7 of Item 8.

ITEM 6. SELECTED FINANCIAL DATA.

The following selected financial data should be read in conjunction with
the description of our critical accounting policies set forth in Item 7.

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

(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) Certain reclassifications have been made to prior year amounts to conform to
the presentation used for 2003. The reclassifications had no effect on net
income.

(3) In 2003, the majority of the Company's outstanding debt was classified as
short-term resulting in total long-term debt to total capitalization to be
less than 0.01.

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

EXECUTIVE SUMMARY

Our Business. 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, 2003,
we operated 242 outpatient physical and occupational therapy clinics in 35
states. The average age of our clinics at December 31, 2003, was 3.96 years. We
have developed 236 of the clinics and acquired six. To date, we have sold three
clinics, closed 22 facilities due to substandard clinic performance, and
consolidated three clinics with other existing clinics. In 2003, we added 48 new
clinics and our goal is to open between 45 and 50 clinics in 2004.

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, 2003.

Principal Economic and Industry-Wide Factors Affecting Our Business. The
following factors, among others, impact the profitability of our business and
other physical and occupational therapy businesses:

- Competition. The healthcare industry generally, and the physical and
occupational therapy business in particular, is highly competitive and
undergoes continual changes in the manner in which services are delivered
and in which providers are selected. Our clinics compete with physical
and occupational therapy departments of hospitals, physician-owned
therapy practices and other private therapy clinics.

11

- Healthcare Regulation. Numerous federal, state and local regulations
impact healthcare services such as the provision of physical and
occupational therapy. The requirement that our therapists be licensed and
other regulations that impact the management of physical and occupational
therapy clinics impose significant direct and indirect costs on our
business.

- Private Health Plan Coverage. The profitability of our business, like
all healthcare services businesses, partially depends on the level of
reimbursement we receive from private health insurers for the services
performed at our clinics.

- Physician Referrals. As a provider of physical and occupational therapy,
we depend on physicians referring their patients to our clinics. The
number of referrals that our clinics receive is a function of physician
awareness and the quality and reputation of our clinics.

- High Operating Costs. Healthcare companies such as ours face significant
operating costs. The start-up costs associated with opening new clinics
can be high, and all clinics face significant costs associated with
hiring and retaining qualified staff, renting appropriate space and
purchasing supplies and equipment.

Revenue Generation and Cost of Revenue. Our clinics generate revenue by
billing third-party payors for services at standard rates. These payor sources
primarily consist of commercial health insurance companies, managed care
programs, workers' compensation plans, Medicare and proceeds from personal
injury lawsuits. Our costs in producing revenue include salaries and related
costs associated with staffing our clinics, the cost of renting and supplying
clinics and other costs, such as the acquisition or lease of therapy equipment.
In addition, we incur expenses associated with our collection efforts in respect
of delinquent accounts.

Material Opportunities, Challenges and Risks. The growth of our business
depends on our ability to continue opening new clinics while sustaining the
profitability of our existing clinics. Our goal for 2004 is to open between 45
and 50 additional clinics if we can identify appropriate geographic locations
and hire qualified physical and occupational therapists to manage the clinics.

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 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

12

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, 2003 and 2002. We
account for our long-lived assets pursuant to Statement of Financial Accounting
Standards No. 144. This accounting standard requires 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.
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.

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% points at the beginning of each
subsequent year until his or her interest reaches 35%. Within the balance sheet
and statement of operations we record partner therapists' 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 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 partners' interest in profits. Moreover, EITF 00-23 also
requires, 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 71 wholly owned
clinics without any minority interest. Due to this change in accounting
practice, we have expanded the number of our wholly owned clinics.

In accordance with the above, for the years ended December 31, 2003 and
2002, we have classified $428,000 and $306,000, respectively, of the minority
interests in earnings of subsidiary limited partnerships relating to the 30
partnerships formed after January 18, 2001, into salaries and related costs. As
of December 31, 2003 and December 31, 2002, $346,000 and $276,000, respectively,
in undistributed minority interests related to the 30 partnerships is classified
as other long-term liabilities. This change in classification had no effect on
net income at December 31, 2003 but rather is a reclassification between
minority interests in earnings and salaries and related costs. 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. We view
these non-financial data points as key indicators of our operating performance.
As indicated below, the number of daily visits to our

13

clinics has declined from an average of 22.9 per clinic during 2001 to an
average of 19.9 per clinic during 2003.

RESULTS OF OPERATIONS

FISCAL YEAR 2003 COMPARED TO FISCAL YEAR 2002

- Net revenues rose 11% to $105.6 million from $94.7 million primarily due
to an 11% increase in patient visits to 1,111,852 and a $0.91 increase in
net patient revenues per visit to $92.84.

- Net income declined 14% to $7.3 million from $8.5 million.

- Earnings per share were $0.61 and $0.67 per diluted share for the years
ended December 31, 2003 ("2003") and December 31, 2002 ("2002"),
respectively. The decrease in earnings per share is primarily
attributable to the decrease in net income from $8.5 million in 2002 to
$7.3 million in 2003 offset by a decrease in diluted shares by 708,000
from 2002 to 2003.

Net Patient Revenues

- Net patient revenues increased to $103.2 million for 2003 from $92.3
million for 2002, an increase of $10.9 million, or 12%, primarily due to
an 11% increase in patient visits to 1,111,852 and a $0.91 increase in
patient revenues per visit to $92.84.

- Total patient visits increased 107,415, or 11%, to 1,111,852 for 2003
from 1,004,437 for 2002. The growth in visits for the year was
attributable to an increase of 103,000 visits in clinics opened between
January 1, 2002 and December 31, 2002 and 40,000 visits from clinics
developed during 2003 (the "New Clinics"), offset by a 36,000 decrease in
visits for clinics opened before January 1, 2002. We believe the decrease
in visits for clinics opened before January 1, 2002 is primarily a result
of increases in patient co-payments and deductibles which has contributed
to some softness in the therapy sector. We also believe that in certain
markets this decline is attributable to higher unemployment rates or
increased competition levels.

- Net patient revenues from New Clinics accounted for approximately 36% of
the increase, or approximately $3.9 million. The remaining increase of $7
million in net patient revenues was from clinics opened prior to January
1, 2003 (the "Mature Clinics"). Of the $7 million increase, $10 million
related to 40 clinics opened during 2002, offset by a $3 million decrease
in clinics opened prior to January 1, 2002. In addition, of the $7
million increase in net patient revenues from the Mature Clinics, $6.2
million of this increase related to a 7% increase in patient visits,
while $880,000 was due to a less than 1% increase in the average net
revenue per visit.

14

Net patient revenues are based on established billing rates less allowances
and discounts for patients covered by workers' compensation programs and other
contractual programs. Net patient revenues reflect contractual and other
adjustments, which we evaluate quarterly, relating to patient discounts from
certain payors. Payments received under these programs are based on
predetermined rates and are generally less than the established billing rates of
the clinics.

Clinic Operating Costs

Clinic operating costs as a percent of net revenues were 71% for 2003 and
68% for 2002.

CLINIC OPERATING COSTS -- SALARIES AND RELATED COSTS

Salaries and related costs increased to $52.4 million for 2003 from $44.9
million for 2002, an increase of $7.5 million, or 17%. Approximately 34% of the
increase, or $2.6 million, was incurred at the New Clinics. The remaining 66%
increase, or $5 million, was due principally to an increase in salaries and
related costs of $4.5 million in Mature Clinics opened in 2002 that experienced
an increase in clinic staff to meet the increase in patient visits.
Additionally, salaries and related costs increased $218,000 and $122,000
relating to increased group health insurance cost and compensation costs
associated with minority interests in earnings of subsidiary limited
partnerships relating to the 30 partnerships formed after January 18, 2001,
respectively. Bonuses are based on the net revenues and operating profit
generated by the individual clinics. Salaries and related costs as a percent of
net revenues were 50% for 2003 and 47% for 2002.

CLINIC OPERATING COSTS -- RENT, CLINIC SUPPLIES AND OTHER

Rent, clinic supplies and other increased to $21.3 million for 2003 from
$18 million for 2002, an increase of $3.3 million, or 18%. The $3.3 million
consisted of a $2 million increase in rent, clinic supplies and other at New
Clinics with the remaining $1.3 million in our Mature Clinics. Rent, clinic
supplies and other as a percent of net revenues increased to 20% for 2003 from
19% for 2002.

CLINIC OPERATING COSTS -- PROVISION FOR DOUBTFUL ACCOUNTS

The provision for doubtful accounts decreased to $932,000 for 2003 from
$1.7 million for 2002, a decrease of $737,000 or 44%. This decrease was
primarily due to enhanced collection efforts and a resulting improvement in
experience. The provision for doubtful accounts as a percent of net patient
revenues decreased to 0.9% for 2003 from 1.8% for 2002. Our allowance for bad
debts as a percent of total patient accounts receivable was 20% at December 31,
2003, as compared to 25% at December 31, 2002. Accounts receivable days
outstanding decreased to 68 days at December 31, 2003 as compared to 71 days at
December 31, 2002. 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, consisting primarily of salaries and benefits of
corporate office personnel, rent, insurance costs, depreciation and
amortization, travel, legal, professional, marketing and recruiting fees,
increased to $14 million for 2003 from $11.3 million for 2002, an increase of
$2.7 million, or 24%. Corporate office costs increased primarily, as a result of
an increase in salaries and benefits, recruitment fees, severance costs,
depreciation expense, higher legal and accounting fees and an increase in
insurance premiums. Corporate office costs as a percent of net revenues
increased to 13% for 2003 from 12% for 2002.

MINORITY INTERESTS IN EARNINGS OF SUBSIDIARY LIMITED PARTNERSHIPS

Minority interests in earnings of subsidiary limited partnerships increased
to $5 million for 2003 from $4.9 million for 2002, an increase of $89,000, or
2%. The increase in minority interests in earnings resulted from an increase in
the limited partnerships' profit interest in Mature Clinics opened prior to
January 18,

15

2001, offset by the 2003 amount of minority interest classified as salaries and
related costs. As a percentage of operating income, minority interest increased
to 30% for 2003 from 26% for 2002. See Note 6.

PROVISION FOR INCOME TAXES

The provision for income taxes decreased to $4.5 million for 2003 from $5.2
million for 2002, a decrease of approximately $0.8 million, or 15% as a result
of lower pre-tax income. During 2003 and 2002, we accrued state and federal
income taxes at an effective tax rate of 38%.

FISCAL YEAR 2002 COMPARED TO FISCAL YEAR 2001

- Net revenues rose 17% to $94.7 million from $80.9 million due to a 15%
increase in patient visits to 1,004,000 and a $1.82 increase in net
patient revenues per visit to $91.93.

- Net income increased 20% to $8.5 million from $7.1 million.

- Earnings per share were $0.67 and $0.55 per diluted share for the year
ended December 31, 2002 ("2002") and December 31, 2001 ("2001"),
respectively. Total diluted shares at December 31, 2002 were
approximately 12.9 million, a reduction of 133,000 shares from
approximately 13.1 million at December 31, 2001 primarily due to a
decrease in the dilutive effect from stock options of approximately
799,000 shares and convertible subordinated notes payable of 200,000
shares, offset by the increase in the number of weighted-average shares
outstanding of approximately 866,000 shares.

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%.

- Total patient visits increased 133,000, or 15%, to 1,004,000 for 2002
from 871,000 for 2001. The growth in visits for the year was primarily
attributable to a full twelve months of operations for clinics opened
between January 1, 2001 and December 31, 2001, together with an increase
in visits for clinics opened in 2002.

- Net patient revenues from the 40 clinics developed and seeing patients
during 2002 (the "2002 New Clinics") accounted for approximately 21% of
the increase, or approximately $2.9 million.

- The remaining increase of $10.9 million in net patient revenues is
attributable to the 162 clinics opened before 2002 (the "2002 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.

Net patient revenues are based on established billing rates less allowances
and discounts for patients covered by workers' compensation programs and other
contractual programs. Net patient revenues reflect contractual and other
adjustments, which we evaluate quarterly, relating to patient discounts from
certain payors. Payments received under these programs are based on
predetermined rates and are generally less than the established billing rates of
the clinics.

Clinic Operating Costs

Clinic operating costs as a percent of net revenues were 68% for 2002 and
2001.

CLINIC OPERATING COSTS -- SALARIES AND RELATED COSTS

Salaries and related costs increased to $44.9 million for 2002 from $37.5
million for 2001, an increase of $7.3 million, or 20%. Approximately 26% of
the increase, or $1.9 million, was incurred at the 2002

16

New Clinics. The remaining 74% increase, or $5.4 million, was due
principally to increased staffing at the 2002 Mature Clinics to meet the
increase in patient visits, coupled with an increase in bonuses earned by
clinic directors at the 2002 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 47% for
2002 and 46% for 2001.

CLINIC OPERATING COSTS -- RENT, CLINIC SUPPLIES AND OTHER

Rent, clinic supplies and other increased to $18 million for 2002 from
$15.4 million for 2001, an increase of $2.6 million, or 17%. Approximately
58% of the increase, or $1.5 million, was attributable to the 2002 New
Clinics, while 42%, or $1.1 million, of the increase was incurred at the
2002 Mature Clinics. The increase in rent, clinic supplies and other for
the 2002 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 19% 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, the
provision for doubtful accounts for 2002 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 81 in 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 for
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 in 2001, an increase
of $2.2 million, or 24%. Increases were incurred in salaries, recruiting fees
and benefits related to additional personnel hired to support an increasing
number 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.

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 in 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" -- Notes 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.

17

LIQUIDITY AND CAPITAL RESOURCES

We believe that our business is generating enough cash flow from operating
activities to allow us to meet our short-term and long-term cash requirements.
At December 31, 2003, we had $16.8 million in cash and cash equivalents compared
to $7.6 million at December 31, 2002. Although the start-up costs associated
with opening new clinics, and our planned capital expenditures are significant,
we believe that our cash and cash equivalents are sufficient to fund the working
capital needs of our operating subsidiaries, future clinic development and
investments. Included in cash and cash equivalents at December 31, 2003 were
$1.3 million in a money market fund and $10 million in a short-term debt
instrument issued by an agency of the U.S. Government.

The increase in cash of $9.2 million from December 31, 2002 to December 31,
2003 is due primarily to $17.5 million in cash provided by operating activities,
offset by cash used in financing activities of $3.3 million and $5 million in
fixed asset and intangible purchases. In 2003, we made $4.7 million in
distributions to minority investors in subsidiary limited partnerships and used
$3.3 million and $1.8 million in cash to purchase fixed assets and make
leasehold improvements, respectively. Cash was provided by proceeds of $1.5
million and a tax benefit of $2 million from the exercises of stock options.

Our current ratio decreased to 6.09 to 1.00 at December 31, 2003 from 7.93
to 1.00 at December 31, 2002. The decrease in the current ratio is due primarily
to the reclassification of Convertible Subordinated Notes from long-term debt to
current liabilities as they will become due in June 30, 2004.

At December 31, 2003, we had a debt-to-equity ratio of 0.06 to 1.00
compared to 0.07 to 1.00 at December 31, 2002. The decrease in the
debt-to-equity ratio from December 31, 2002 to December 31, 2003 resulted from
the additional note payable entered into during 2003 for the acquisition of
minority interest.

We have future obligations for debt repayments and future minimum rentals
under operating leases. The obligations as of December 31, 2003 are summarized
as follows (in thousands):

In 2002, $667,000 of a convertible subordinated note was converted into
common stock, leaving a remaining balance of $2.3 million at December 31, 2003
and 2002. On January 12, 2004, an additional $666,660 of the convertible
subordinated note was converted into common stock leaving a remaining balance of
$1.7 million. We anticipate that the remaining $1.7 million convertible
subordinated note will be converted into common stock at the June 2004 maturity
date. However, 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.

We do not currently have a credit line or other credit arrangements.
Historically, we have generated sufficient cash from operations to fund our
development activities and cover operational needs. We generally develop new
clinics rather than acquire them which require less capital. We plan to continue
developing new clinics and may also consider acquisitions in select markets. 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 cash, notes and common stock. 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 2004.

In September 2001, the Board of Directors ("Board") authorized us to
purchase, in the open market or in privately negotiated transactions, up to
1,000,000 shares of our common stock. Shares purchased are

18

held as treasury shares and may be used for valid corporate purposes or retired
as the Board deems advisable. During the year ended December 31, 2002, we
purchased 795,600 shares of our common stock on the open market for $10.5
million. During January 2003, we purchased an additional 1,800 shares of common
stock on the open market for a total of $20,000.

On February 26, 2003, our Board authorized a new share repurchase program
of up to 250,000 additional shares of our outstanding common stock. As there is
no specific expiration date 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. As of December 31, 2003,
no shares have been repurchased under the new share repurchase program.

CASH MANAGEMENT

We believe that our business is generating sufficient cash flow to satisfy
our short-term and long-term cash needs, including capital expenditures needed
to fund our expected growth in clinics for 2004. Excess cash is invested in
short-term highly liquid investments, primarily money market funds and debt
instruments issued by an agency of the U.S. Government.

RECENTLY PROMULGATED ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of 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 was effective for us on January 1, 2003. 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 was effective for us on January 1, 2003.
The adoption of SFAS 145 did not have a significant 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 was effective for us on January 1, 2003.
The adoption of SFAS 146 did not have a significant 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 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 changes 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. The adoption of FIN 45 did not have a significant 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

19

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.

In December 2003, the FASB issued FASB Interpretation No. 46, (revised
December 2003), Consolidation of Variable Interest Entities, which addresses how
a business enterprise should evaluate whether it has a controlling financial
interest in an entity through means other than voting rights and accordingly
should consolidate the entity. FIN 46F replaces FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, which was issued in January 2003.
We will be required to apply FIN 46R to variable interests in VIEs created after
December 31, 2003. For variable interests in VIEs created before January 1,
2004, the Interpretation will be applied beginning on January 1, 2005. For any
VIEs that must be consolidated under FIN 46R that were created before January 1,
2004, the assets, liabilities and noncontrolling interests of the VIE initially
would be measured at their carrying amounts with any difference between the net
amount added to the balance sheet and any previously recognized interest being
recognized as the cumulative effect of an accounting change. If determining the
carrying amounts is not practicable, fair value at the date FIN 46R first
applies may be used to measure the assets, liabilities, and noncontrolling
interest of the VIE.

We are evaluating the impact of applying FIN 46R to existing VIEs in which
it has variable interests and has not yet completed this analysis.

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities," ("SFAS 149") which amends and
clarifies accounting and reporting for certain derivative instruments, including
certain derivative instruments embedded in other contracts and for hedging
activities under FASB Statement No. 133, "Accounting for Derivative Instruments
and Hedging Activities". SFAS 149 provides greater clarification of the
characteristics of a derivative instrument so that contracts with similar
characteristics will be accounted for consistently. SFAS 149 is effective for
contracts entered into or modified after June 30, 2003, and for hedging
relationships designated after June 30, 2003. The adoption of SFAS 149 did not
have a significant impact on our financial condition or results of operations.

FASB Statement No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity, was issued in May 2003. This
statement establishes standards for the classification and measurement of
certain financial instruments of both liabilities and equity. The Statement also
includes disclosures for financial instruments within its scope. For us, the
Statement was effective for instruments entered into or modified after May, 31,
2003 and otherwise will be effective as of January 1, 2004, except for mandatory
redeemable financial instruments. For certain redeemable financial instruments,
the Statement will be effective for us on January 1, 2005. The effective date
has been deferred indefinitely for certain other types of mandatory financial
instruments. We currently do not have any financial instruments that are within
the scope of this Statement.

FACTORS AFFECTING FUTURE RESULTS

CLINIC DEVELOPMENT

As of December 31, 2003, we had 242 clinics in operation, 48 of which
opened in 2003. Our goal for 2004 is to open between 45 and 50 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

20

gradually increase 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 the historical performance of our new clinics, generally the
clinics opened in 2003 would favorably impact our results of operations
beginning in 2004.

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, 2003 and December 31, 2002. During January 2004, $666,660 of the
Series C Notes was converted by the note holders into 200,000 shares of common
stock leaving a remaining balance of $1.7 million. 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
"Notes Payable" in Note 5 of Item 8.

In 2002, 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 2003 and 2002 before
income taxes of approximately $77,000 and $50,000, respectively.

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, 2003, was $2.3 million in Series C Convertible
Subordinated Notes, described immediately above and other notes of $122,000. See
Note 5 of Item 8.

21

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Independent Auditors' Report................................ 23
Audited Financial Statements:
Consolidated Balance Sheets as of December 31, 2003 and
2002...................................................... 24
Consolidated Statements of Operations for the years ended
December 31, 2003, 2002 and 2001.......................... 25
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 2003, 2002 and 2001.............. 26
Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002 and 2001.......................... 27
Notes to Consolidated Financial Statements.................. 28

22

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, 2003
and 2002, 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, 2003. 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, 2003.
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, 2003 and 2002, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 2003, 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 4, 2004

23

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See notes to consolidated financial statements.

24

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

See notes to consolidated financial statements.

25

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

See notes to consolidated financial statements.

26

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

See notes to consolidated financial statements.

27

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003

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, 2003, the Company owned and operated 242 clinics in 35 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, 2003.

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 primarily 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. Beginning in 2003, the Company significantly reduced its development
of new clinic partnerships. New clinics opened which are not satellite clinics
are wholly owned by the Company. The clinic directors of such clinics will be
compensated based upon clinic profits. See Note 2.

2. SIGNIFICANT ACCOUNTING POLICIES

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. The Company held approximately $11
million in highly liquid investments at December 31, 2003 and held no highly
liquid investments at December 31, 2002.

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.

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

28

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Transactions," for the disposal of a segment of a business. SFAS 144 was
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. 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 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. The
Company evaluates goodwill for impairment on an annual basis by comparing the
fair value of its reporting segment units, as defined by SFAS 142, to their
carrying values. For the year ended December 31, 2003, the fair value of the
Company's reporting segment units exceeds the recorded carrying value. At
December 31, 2003 and December 31, 2002, the Company had approximately $5.7
million and $5.6 million, respectively, of unamortized goodwill. Amortization
expense related to goodwill was $44,000 for the year ended December 31, 2001. In
accordance with SFAS 142, the Company did not have any amortization expense
related to goodwill for the years ended ending December 31, 2003 and 2002.

The following table reconciles previously reported net income as if SFAS
142 were in effect in 2001. 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.

MINORITY INTERESTS

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% points 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 therapists' profit interest in the clinic partnerships as
minority interests in subsidiary limited

29

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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" (EITF 00-23), which provides specific accounting guidance
relating to various incentive compensation issues. The Company reviewed EITF
00-23 with respect to the partnership's 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 partners' interest in profits.
Moreover, EITF 00-23 also requires that the Company expense as compensation
rather than capitalizing as goodwill, the purchase of minority interest in the
partnerships, of clinic partnerships formed after January 18, 2001. At this time
the Company operates 71 wholly owned clinics without any minority interest.

Pursuant to EITF 00-23, for the year ended December 31, 2003 and December
31, 2002, the Company classified $428,000 and $306,000, respectively, of the
minority interest in earnings of subsidiary limited partnerships relating to the
30 partnerships formed after January 18, 2001, as salaries and related costs. As
of December 31, 2003 and December 31, 2002, $346,000 and $276,000, respectively,
in undistributed minority interests related to the 30 partnerships are
classified as other long-term liabilities.

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 (the "Medicare Limit"), except for services
provided in hospitals. After a three-year moratorium, this Medicare Limit on
therapy services was implemented for services rendered on or after September 1,
2003. The Medicare Limit in any one-year has been adjusted up to $1,590 (the
"Adjusted Medicare Limit") and the full amount was available for the remaining
four months in 2003. Effective December 8, 2003, a moratorium was placed on the
Adjusted Medicare Limit for the remainder of 2003 and for years 2004 and 2005.

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, 2003.
Compliance with such laws and regulations can be subject to future government
review and interpretation, as well as significant regulatory action including
fines, penalties, and exclusion from the Medicare program.

INCOME TAXES

Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement

30

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.

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 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, 2003 of $15.73, the fair value of the convertible
subordinated notes was $11 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 applies the intrinsic-value-based method of accounting
prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations including FASB
Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation, an interpretation of APB Opinion No. 25, to account for its
employee stock-based compensation. Under this method, the compensation expense
is generally recorded on the date of grant only if the current market price of
the underlying stock exceeded the exercise price. FASB Statement No. 123,
Accounting for Stock-Based Compensation and FASB Statement No. 148, Accounting
for Stock-Based Compensation -- Transition and Disclosure, an amendment of FASB
Statement No. 123, established accounting and disclosure requirements using
fair-value-based method of accounting for stock-based employee compensation
plans. As permitted by existing accounting standards, the Company has elected to
apply the intrinsic-valve-based method of accounting described above, and has
adopted only the disclosure requirements of Statement 123, as amended. Under APB
Opinion No. 25 the Company recognized $52,000 of compensation cost in net income
for the year ended December 31, 2003. No compensation cost related to stock
based compensation has been recognized for the years ended December 31, 2002 and
2001.

For purposes of FASB Statement No. 123 disclosures 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

31

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 Company's
pro forma information follows (in thousands except for earnings per share
information):

The weighted-average fair value per share of stock-based compensation
during the years ended December 31, 2003, 2002 and 2001 follows:

The following weighted-average assumptions for 2003, 2002 and 2001 were
used in estimating the fair value per share of stock-based compensation and
assuming no dividends:

RECENTLY PROMULGATED ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of 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 was effective for the Company on January 1,
2003. The adoption of SFAS 143 did not have a significant impact on the
Company's financial condition or results of operations.

32

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 was effective for the Company on January
1, 2003. The adoption of SFAS 145 did not have a significant 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 Other
Costs to Exit an Activity." SFAS 146 was effective for the Company on January 1,
2003. The adoption of SFAS 146 did not have a significant 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 changes 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. The adoption of FIN 45 did not have a significant 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 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. 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.

In December 2003, the FASB issued FASB Interpretation No. 46, (revised
December 2003), Consolidation of Variable Interest Entities, which addresses how
a business enterprise should evaluate whether it has a controlling financial
interest in an entity through means other than voting rights and accordingly
should consolidate the entity. FIN 46F replaces FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, which was issued in January 2003.
The Company will be required to apply FIN 46R to variable interests in VIEs
created after December 31, 2003. For variable interests in Variable Interest
Entities ("VIEs") created before January 1, 2004, the Interpretation will be
applied beginning on January 1, 2005. For any VIEs that must be consolidated
under FIN 46R that were created before January 1, 2004, the assets, liabilities
and non-controlling interests of the VIE initially would be measured at their
carrying amounts with any difference between the net amount added to the balance
sheet and any previously recognized interest being recognized as the cumulative
effect of an accounting change. If determining the carrying amounts is not
practicable, fair value at the date FIN 46R first applies may be used to measure
the assets, liabilities, and non-controlling interest of the VIE.

The Company is evaluating the impact of applying FIN 46R to existing VIEs
in which it has variable interests and has not yet completed this analysis.

33

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities," ("SFAS 149") which amends and
clarifies accounting and reporting for certain derivative instruments, including
certain derivative instruments embedded in other contracts and for hedging
activities under FASB Statement No. 133, "Accounting for Derivative Instruments
and Hedging Activities". SFAS 149 provides greater clarification of the
characteristics of a derivative instrument so that contracts with similar
characteristics will be accounted for consistently. SFAS 149 is effective for
contracts entered into or modified after June 30, 2003, and for hedging
relationships designated after June 30, 2003. The adoption of SFAS 149 did not
have a significant impact on the Company's financial condition or results of
operations.

FASB Statement No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity, was issued in May 2003. This
statement establishes standards for the classification and measurement of
certain financial instruments of both liabilities and equity. The Statement also
includes disclosures for financial instruments within its scope. For the
Company, the Statement was effective for instruments entered into or modified
after May, 31, 2003 and otherwise will be effective as of January 1, 2004,
except for mandatory redeemable financial instruments. For certain redeemable
financial instruments, the Statement will be effective for the Company on
January 1, 2005. The effective date has been deferred indefinitely for certain
other types of mandatory financial instruments. The Company currently does not
have any financial instruments that are within the scope of this Statement.

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 2001, convertible notes payable totaling $4.2 million were converted into
1.2 million shares of common stock. Additionally, during 2001, the Company
purchased the 35% minority interest in two limited partnerships for a total $3.6
million delivered in 162,100 shares of common stock and $1.1 million in notes
payable. These non-cash investing and financing transactions have been excluded
from the consolidated statements of cash flows.

4. ACQUISITION OF MINORITY INTERESTS

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. On August 6, 2003, the Company paid additional
consideration of $31,000 based on the clinic's performance. In July 2002 the
Company sold half 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.

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.

34

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

On August 1, 2003, the Company purchased the 35% minority interest in a
limited partnership for $64,000 and agreed to pay the minority partner $75,000
in undistributed earnings. The purchase was made under a note, which is payable
in three installments. On September 10, 2003, the Company paid the first
installment of $35,000. The remaining principal amount due under the note
payable was $104,000 at December 31, 2003 to be paid in two annual payments of
$34,000 and $70,000 on August 1, 2004 and August 1, 2005, respectively.

The Company's minority interest purchases all relate to entities in which
the Company is the majority owner and were accounted for as step acquisitions
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
identified tangible and intangible assets 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, 2003 and December 31, 2002. See "Subsequent Event" in Note 12.

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

35

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Notes payable as of December 31, 2003 and 2002 consist of the following (in
thousands):

Scheduled maturities as of December 31, 2003 are as follows (in thousands):

2004........................................................ $2,372
2005........................................................ 75
2006........................................................ 6
2007........................................................ 2
2008........................................................ --
------
$2,455
======

6. INCOME TAXES

Significant components of deferred tax assets, included in long-term other
assets on the balance sheet at December 31, 2003 and 2002, 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, 2003, 2002 and 2001 were as follows
(in thousands):

36

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, 2003, 2002 and 2001 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.

7. 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. The 1992 Plan expired in 2002 and no new option grants can be
awarded subsequent to this date.

Incentive stock options (those intended to satisfy the requirements of
the Internal Revenue Code) granted under the 1992 Plan were granted at an
exercise price not less than the fair market value of the shares of common
stock on 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. No further grants of options
will be made under the Executive Plan.

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.

During 2003, 2002 and 2001, the Board of Directors of the Company
granted Inducement options covering 115,000, 10,000 and 30,000 options,
respectively, to six individuals in connection with their offers of
employment or service. During 2003 and 2002, 22,500 and 22,500 options were
forfeited, respectively.

37

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The 2003 Stock Incentive Plan (the "2003 Plan") permits the Company to
grant stock-based compensation to employees, consultants and outside
directors of the Company up to 900,000 shares of common stock. The 2003
Plan is subject to approval by the shareholders of the Company at the 2004
shareholders meeting.

The Compensation Committee determines the exercise price, vesting
periods, and expiration dates of all stock options. Stock options vest over
one to five years from the date of grant. The expiration dates are
generally ten years from the date of grant. Options are generally subject
to adjustments in the event of stock dividends, splits and similar
corporate transactions.

During 2002 and 2003, the Company erroneously granted options to purchase
308,000 shares of common stock under the 1992 Plan after the plan expired.
Because the Company intends to honor the original terms of these options, the
Company recognized $52,000 of compensation cost in 2003 net income. The Company
intends to replace the grants with options to purchase common stock under the
2003 Plan, which is subject to shareholder approval, or as Inducement options.

A cumulative summary of stock options as of December 31, 2003 follows:

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

(1) The 1992 Plan expired in 2002 and no new option grants can be awarded
subsequent to this date.

38

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

A summary of the status of the Company's stock option plans as of December
31, 2003, 2002 and 2001 and the changes during the years then ended is presented
below:

The following tables summarize information about the Company's stock
options outstanding as of December 31, 2003, 2002 and 2001, respectively,
(contractual life in years):

39

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table summarizes information about the Company's stock
options outstanding and range of exercise prices as of December 31, 2003:

The Company has reserved 1,935,563 shares for the 1992 Plan, Executive
Plan, 1999 Plan, Inducement Plans and the Series C Notes.

8. PREFERRED STOCK

The Board of Directors of the Company is empowered, without approval of the
shareholders, 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.

9. 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 ending December 31, 2002 and 2001, the Company
purchased 795,600 and 135,000 shares, respectively, of its common stock on the
open market for $10.5 million and

40

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

$1.9 million, respectively. During January 2003, we purchased an additional
1,800 shares of common stock on the open market for a total of $20,000.

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. As of December 31, 2003,
no shares have been repurchased under the new share repurchase program.

10. 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 has not made any contributions and
recognized no contribution expense for the years ended December 31, 2003, 2002
and 2001.

11. 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 $7.6 million, $6.4 million and $5.4 million for the years ended
December 31, 2003, 2002 and 2001, 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.

The future minimum lease commitments for the next five years and in the
aggregate as of December 31, 2003 are as follows (in thousands):

2004........................................................ $ 7,297
2005........................................................ 6,351
2006........................................................ 4,921
2007........................................................ 3,517
2008........................................................ 1,066
Thereafter.................................................. 88
-------
$23,240
=======

EMPLOYMENT AGREEMENTS

At December 31, 2003, the Company had outstanding employment agreements
with three of its executive officers with annual salaries ranging from $250,000
to $325,000, for one term extending through February 2004 and two terms
extending through September 2006. In addition, at December 31, 2003, the Company
had an employment agreement with an employee for $170,000 for a term extending
through September 30, 2004. The Company also had an outstanding consulting
agreement with one of its directors for $50,000 annually for a term extending
through November 2007.

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 $3.1 million in 2004 and $575,000 in the
aggregate from 2005 through 2007. In addition, each employment agreement with
the managing physical therapist provides for monthly bonus payments calculated
as a percentage of each clinic's net revenues

41

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(not in excess of operating profits) or operating profits. The Company
recognized salaries and bonus expense for the managing physical therapists of
$17.2 million, $14.8 million and $12.3 million for the years ended December 31,
2003, 2002 and 2001, 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.

12. SUBSEQUENT EVENT

On January 12, 2004, $666,660 of the Series C Notes was converted by the
note holder into 200,000 shares of common stock. After the January 2004
conversion, the remaining principal amount under the Series C Note was $1.7
million.

13. EARNINGS PER SHARE

The computation of basic and diluted earnings per share for the years ended
December 31, 2003, 2002 and 2001 are as follows (in thousands, except per share
data):

Options to purchase 267,750 and 344,686 shares for the years ended December
31, 2003 and 2002, respectively, were excluded from the diluted earnings per
share calculations for the respective periods because the options' exercise
prices exceeded the average market price of the common shares during the
periods.

42

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

43

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

Not applicable.

ITEM 9A. CONTROLS AND PROCEDURES.

Under the direction of our Chief Executive Officer and Chief Financial
Officer, we evaluated our disclosure controls and procedures and internal
control over financial reporting and concluded that (i) our disclosure controls
and procedures were effective as of December 31, 2003 and (ii) no change in
internal control over financial reporting occurred during the quarter ended
December 31, 2003 that has materially affected, or is reasonably likely to
materially affect, such internal control over financial reporting.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

For information regarding the Company's Directors, Code of Ethics and
compliance with Section 16(a) of the Securities Exchange Act of 1934, you are
directed to the sections entitled "Proposal 1 -- Election of Directors," "Code
of Ethics" and "Section 16(a) Beneficial Ownership Reporting Compliance,"
respectively, in the Proxy Statement that will be delivered to stockholders in
connection with the Company's Annual Meeting of Stockholders to be held on May
25, 2004. The Company incorporates the information contained in those sections
of the Company's Proxy Statement 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. PRINCIPAL ACCOUNTANT FEES AND SERVICES.

Incorporated by reference to "Independent Auditor" in the registrant's
definitive proxy statement relating to its 2004 Annual Meeting of Shareholders.

44

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 FINANCIAL STATEMENTS -- DECEMBER 31, 2003

Consolidated Balance Sheets -- December 31, 2003 and 2002

Consolidated Statements of Operations -- years ended December 31, 2003, 2002 and
2001

Consolidated Statements of Shareholders' Equity -- years ended December 31,
2003, 2002 and 2001

Consolidated Statements of Cash Flows -- years ended December 31, 2003, 2002 and
2001

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- DECEMBER 31, 2003

(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.

(b) Reports on Form 8-K

On October 30, 2003, the Company filed a current report on Form 8-K with
the Securities and Exchange Commission related to a press release announcing the
Company's earnings for the quarter and nine months ended September 30, 2003.

46

ITEM 15. (D)

SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES

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

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

47

SIGNATURES

In accordance with Section 13 or 15(d) of the Securities 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/ LAWRANCE W. MCAFEE
------------------------------------
Lawrance W. McAfee
Chief Financial Officer
(duly authorized officer and
principal
financial and accounting officer)

By: /s/ DAVID RICHARDSON
------------------------------------
David Richardson
Controller

Date: March 12, 2004

48

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

By: /s/ JAMES B. HOOVER Director
------------------------------
James B. Hoover,

By: /s/ MARLIN W. JOHNSTON Director
------------------------------
Marlin W. Johnston,

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

By: /s/ MARK J. BROOKNER Vice Chairman of the Board
------------------------------
Mark J. Brookner,

By: /s/ ALBERT L. ROSEN Director
------------------------------
Albert L. Rosen,

By: /s/ DANIEL C. ARNOLD Director
------------------------------
Daniel C. Arnold,

By: /s/ JERALD PULLINS Director
------------------------------
Jerald Pullins,

49

INDEX TO EXHIBITS

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

* Filed herewith

+ Management contract or compensatory plan or arrangement.