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EX-32.1 - EXHIBIT 32.1 - U S PHYSICAL THERAPY INC /NVex32_1.htm
EX-31.3 - EXHIBIT 31.3 - U S PHYSICAL THERAPY INC /NVex31_3.htm
EX-31.2 - EXHIBIT 31.2 - U S PHYSICAL THERAPY INC /NVex31_2.htm
EX-31.1 - EXHIBIT 31.1 - U S PHYSICAL THERAPY INC /NVex31_1.htm
EX-23.1 - EXHIBIT 23.1 - U S PHYSICAL THERAPY INC /NVex23_1.htm
EX-21.1 - EXHIBIT 21.1 - U S PHYSICAL THERAPY INC /NVex21_1.htm

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

Form 10-K

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2016

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 INCORPORATION OR ORGANIZATION)
 
(I.R.S. EMPLOYER IDENTIFICATION NO.)
     
1300 WEST SAM HOUSTON PARKWAY SOUTH,
SUITE 300,
HOUSTON, TEXAS
 
77042
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
 
(ZIP CODE)
     
 
REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE: (713) 297-7000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE EXCHANGE ACT:
 
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, $.01 par value
 
New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT: NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes No
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes 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 a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
Accelerated filer
Non-accelerated filer
☐ (Do not check if a smaller reporting company)
Smaller reporting company
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

The aggregate market value of the shares of the registrant’s common stock held by non-affiliates of the registrant at June 30, 2016 was $547,917,000 based on the closing sale price reported on the NYSE for the registrant’s common stock on June 30, 2016, the last business day of the registrant’s most recently completed second fiscal quarter. For purposes of this computation, all executive officers, directors and 5% or greater beneficial owners of the registrant were deemed to be affiliates. Such determination should not be deemed an admission that such executive officers, directors and beneficial owners are, in fact, affiliates of the registrant.

As of June 6, 2017, the number of shares outstanding of the registrant’s common stock, par value $.01 per share, was: 12,581,237.

DOCUMENTS INCORPORATED BY REFERENCE
 
DOCUMENT
 
PART OF FORM 10-K
None
   
 


Explanatory Note

This Annual Report on Form 10-K includes the restatement of certain of our previously issued consolidated financial statements and selected financial data.  It also amends previously filed management’s discussion and analysis of financial condition and results of operations and other disclosures for the periods presented in this Annual Report on Form 10-K.  As indicated in Note 1, Organization, Nature of Operations and Basis of Presentation – Restatement of Prior Financial Statements, in the Notes to Consolidated Financial Statements and as additionally disclosed in our current report on Form 8-K filed March 16, 2017, prior to issuing the 2016 annual financial statements, we determined we had previously incorrectly accounted for the non-controlling interests which were mandatorily redeemable.  See Footnote 2 – Significant Accounting Policies – Mandatorily Redeemable Non-Controlling Interests – for a description of the accounting for mandatorily redeemable non-controlling interests. We determined this correction was material to previously issued annual and quarterly consolidated financial statements.  The Company, in this Annual Report on Form 10-K for the year ended December 31, 2016, restated the following:

·
Consolidated Financial Statements
·
for the balance sheet as of December 31, 2015; and
·
the statements of net income, cash flows and equity for the periods ended December 31, 2015 and 2014, which will include a cumulative adjustment to the beginning balances as of January 1, 2014.
·
Selected Financial Data for the years ended December 31, 2015, 2014, 2013 and 2012.
·
Unaudited quarterly financial information for the quarters ended September 30, 2016, June 30, 2016, March 31, 2016, December 31, 2015, September 30, 2015, June 30, 2015 and March 31, 2015.
·
Management’s discussion and analysis of financial condition and results of operations as of and for the years ended December 31, 2015 and 2014.

We believe that presenting all of the amended and restated information, as detailed above, in this Annual Report on Form 10-K allows investors to review all pertinent data in a single report.  In addition, our quarterly reports on Form 10-Q to be filed during 2017 will include the 2016 comparable prior quarter and year-to-date periods.  We have not filed and do not intend to file amendments to (i) our previously filed Quarterly Reports on Form 10-Q or (ii) previously filed Annual Reports on Form 10-K.  Accordingly, investors should rely only on the financial information and other disclosures regarding previous periods in this Annual Report on Form 10-K or in future filings with the SEC (as applicable), and not on any previously issued or filed reports, earnings releases or similar communications related to the quarterly periods ended September 30, 2016, June 30, 2016 and March 31, 2016 and related to the quarters within and the years ended December 31, 2015, 2014, 2013 and 2012.
 

Table of Contents

The combined impact of the adjustments and specified line items regarding the restatement is set forth in Note 1, Organization, Nature of Operations and Basis of Presentation – Restatement of Prior Financial Statements, in the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.  The following items of this Annual Report on Form 10-K are impacted as a result of the restatement.

Part I. Item 1.
Business
Part I, Item 1A.
Risk Factors
Part II, Item 6.
Selected Financial Data
Part II, Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Part II, Item 8.
Financial Statements and Supplementary Data
Part II, Item 9A.
Controls and Procedures
 
   
Page
PART I
   
Item 1.
4
Item 1A.
13
Item 1B.
19
Item 2.
19
Item 3.
19
Item 4.
19
     
PART II
   
Item 5.
20
Item 6.
22
Item 7.
23
Item 7A.
34
Item 8.
35
 
42
Item 9.
82
Item 9A.
82
Item 9B.
83
     
PART III
   
Item 10.
83
Item 11.
86
Item 12.
97
Item 13.
100
Item 14.
100
     
PART IV
   
Item 15.
101
106
 
FORWARD-LOOKING STATEMENTS

We make statements in this report that are considered to be forward-looking statements within the meaning given such term under Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements contain forward-looking information relating to the financial condition, results of operations, plans, objectives, future performance and business of our Company. These statements (often using words such as “believes”, “expects”, “intends”, “plans”, “appear”, “should” and similar words) involve risks and uncertainties that could cause actual results to differ materially from those we project. Included among such statements are those relating to opening new clinics, availability of personnel and the reimbursement environment. The forward-looking statements are based on our current views and assumptions and actual results could differ materially from those anticipated in such forward-looking statements as a result of certain risks, uncertainties, and factors, which include, but are not limited to:
 
·
the risk that the restatement of prior financial statements due to the correction in the accounting method for redeemable non-controlling interests could adversely affect the Company’s ability to make timely filings with the Securities and Exchange Commission;

·
cost, risks and uncertainties associated with the Company’s recent restatement of its prior financial statements due to the correction of its  accounting methodology for redeemable non-controlling partnership interests, and including any pending and future claims or proceedings relating to such matters;

·
changes as the result of government enacted national healthcare reform;

·
changes in Medicare rules and guidelines and reimbursement or failure of our clinics to maintain their Medicare certification status;

·
revenue we receive from Medicare and Medicaid being subject to potential retroactive reduction;

·
business and regulatory conditions including federal and state regulations;
 
·
governmental and other third party payor inspections, reviews, investigations and audits;
 
·
compliance with federal and state laws and regulations relating to the privacy of individually identifiable patient information, and associated fines and penalties for failure to comply;
 
·
legal actions; which could subject us to increased operating costs and uninsured liabilities;
 
·
changes in reimbursement rates or payment methods from third party payors including government agencies and deductibles and co-pays owed by patients;
 
·
revenue and earnings expectations;
 
·
general economic conditions;
 
·
availability and cost of qualified physical therapists;
 
·
personnel productivity and retaining key personnel;
 
·
competitive, economic or reimbursement conditions in our markets which may require us to reorganize or close certain clinics and thereby incur losses and/or closure costs including the possible write-down or write-off of goodwill and other intangible assets;
 
·
acquisitions, purchase of non-controlling interests (minority interests) and the successful integration of the operations of the acquired businesses;
 
·
maintaining adequate internal controls;
 
·
maintaining necessary insurance coverage;

·
our ability to design and maintain effective internal control over financial reporting and remediate the material weakness in internal control over financial reporting related to our accounting for redeemable non-controlling partnership interests;
 
·
availability, terms, and use of capital; and
 
·
weather and other seasonal factors.

Many 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 may no longer be accurate.
 
PART I

ITEM 1.
BUSINESS.
 
GENERAL

Our company, U.S. Physical Therapy, Inc. (the “Company”), through its subsidiaries, operates outpatient physical therapy clinics that provide pre-and post-operative care and treatment for orthopedic-related disorders, sports-related injuries, preventative care, rehabilitation of injured workers and neurological-related injuries. We primarily operate through subsidiary clinic partnerships in which we generally own a 1% general partnership interest and a 49% through 99% limited partnership interest and the managing therapist(s) of the clinics owns the remaining limited partnership interest in the majority of the clinics (hereinafter referred to as “Clinic Partnerships”). To a lesser extent, we operate some clinics through wholly-owned subsidiaries under profit sharing arrangements with therapists (hereinafter referred to as “Wholly-Owned Facilities”). Unless the context otherwise requires, references in this Annual Report on Form 10-K to “we”, “our” or “us” includes the Company and all of its subsidiaries.

Our strategy is to develop outpatient physical therapy clinics and to acquire single and multi-clinic outpatient physical therapy practices on a national basis. At December 31, 2016, we operated 540 clinics in 42 states. The average age of the 540 clinics in operation at December 31, 2016 was 9.3 years. There were 423 clinics operated under Clinic Partnerships and the remaining clinics were operated as Wholly-Owned Facilities or through management arrangements. Of the 540 clinics, we developed 327 and acquired an interest in 213. Our highest concentration of clinics are in the following states: Texas, Tennessee, Michigan, Virginia, Washington, Maryland, Georgia, Oregon, Pennsylvania and Wisconsin. In addition to our 540 clinics, at December 31, 2016, we also managed 20 physical therapy practices for unrelated physician groups and hospitals.

During the last three years, we completed the following multi-clinic acquisitions:
 
Acquisition  
Date
 
% Interest Acquired
   
Number of Clinics
 
                 
 
  2016            
February 2016 Acquisition
 
February 29
   
55
%
   
8
 
November 2016 Acquisition
 
November 30
   
60
%
   
12
 
                     
 
  2015                
January 2015 Acquisition
 
January 31
   
60
%
   
9
 
April 2015 Acquisition
 
April 30
   
70
%
   
3
 
June 2015 Acquisition
 
June 30
   
70
%
   
4
 
December 2015 Acquisition
 
December 31
   
59
%
   
4
 
                     
 
 2014
               
April 2014 Acquisition
 
April 30
   
70
%
   
13
 
August 2014 Acquisition
 
August 1
   
100
%
   
3
 

In addition to the multi-clinic acquisitions, we acquired two single clinic practices in separate transactions during 2016.  During 2015, we acquired a 60% interest in a single clinic practice and, during 2014, we acquired four individual clinics in separate transactions.

The Company continues to seek to attract for employment physical therapists who have established relationships with physicians and other referral sources by offering these therapists a competitive salary and incentives based on the profitability of the clinic that they manage.  The Company also looks for therapists with whom to establish new, de novo clinics to be owned jointly by the Company and such therapists; in these situations, the therapist is offered the opportunity to co-invest in the new clinic and also receives a competitive salary for managing the clinic. For multi-site clinic practices in which a controlling interest is acquired by the Company, the prior owners typically continue on as employees to manage the clinic operations, retaining a non-controlling ownership interest in the clinics and receiving a competitive salary for managing the clinic operations.  In addition, we have developed satellite clinic facilities as part of existing Clinic Partnerships and Wholly-Owned facilities, with the result that a substantial number of Clinic Partnerships and Wholly-Owned facilities operate more than one clinic location. In 2017, we intend to continue to acquire clinic practices and continue to focus on developing new clinics and on opening satellite clinics where appropriate along with increasing our patient volume through marketing and new programs.
 
Therapists at our clinics initially perform a comprehensive evaluation of each patient, which is then followed by a treatment plan specific to the injury as prescribed by the patient’s physician. The treatment plan may include a number of procedures, including therapeutic exercise, manual therapy techniques, ultrasound, electrical stimulation, hot packs, iontophoresis, 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 managed care programs, commercial health insurance, Medicare/Medicaid and workers’ compensation insurance.

We were re-incorporated in April 1992 under the laws of the State of Nevada and have operating subsidiaries organized in various states in the form of limited partnerships, limited liability companies and wholly-owned corporations. This description of our business should be read in conjunction with our financial statements and the related notes contained in Item 8 in this Annual Report on Form 10-K. Our principal executive offices are located at 1300 West Sam Houston Parkway South, Suite 300, Houston, Texas 77042. Our telephone number is (713) 297-7000. Our website is www.usph.com.

OUR CLINICS

Most of our clinics are operated by Clinic Partnerships in which we own the general partnership interest and a majority of the limited partnership interests. The managing healthcare practitioner of the clinics usually owns a portion of the limited partnership interests. Generally, the therapist partners have no interest in the net losses of Clinic Partnerships, except to the extent of their capital accounts. Since we also develop satellite clinic facilities of existing clinics, most Clinic Partnerships consist of more than one clinic location. As of December 31, 2016, through wholly-owned subsidiaries, we owned a 1% general partnership interest in all the Clinic Partnerships. Our limited partnership interests range from 49% to 99% in the Clinic Partnerships, but with respect to the majority of our Clinic Partnerships, we own a limited partnership interest of 64%. For the vast majority of the Clinic Partnerships, the managing healthcare practitioner is a physical therapist who owns the remaining limited partnership interest in the Clinic Partnership.

For our Clinic Partnership agreements related to those that we acquired a majority interest, generally, the prior management continues to own a 10% to 50% interest. For our Clinic Partnership agreements related to our developed clinics, the therapist partner typically begins with a 20% interest in their Clinic Partnership earnings which increases by 3% at the end of each year thereafter up to a maximum interest of 35%.

Typically, each therapist partner or director, including those employed by Clinic Partnerships in which we acquired a majority interest, enters into an employment agreement for a term of up to five years with their Clinic Partnership. Each agreement typically provides for a covenant not to compete during the period of his or her employment and for up to 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 profits generated by their Clinic Partnership or specific clinic. In the case of Clinic Partnerships, the therapist partner receives earnings distributions based upon their ownership interest. Upon termination of employment, we typically have the right, but not the obligation, to purchase the therapist’s partnership interest in de novo Clinic Partnerships. In connection with most of our acquired clinics, in the event that a limited minority partner’s employment ceases and certain requirements are met as detailed in the respective limited partnership agreements, we have agreed to repurchase that individual’s non-controlling interest at a predetermined multiple of earnings performance as detailed in the respective agreements.

Each Clinic Partnership maintains an independent local identity, while at the same time enjoying the benefits of national purchasing, negotiated third-party payor contracts, centralized support services and management practices. Under a management agreement, one of our subsidiaries provides a variety of support 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, auditing of regulatory compliance, payroll, benefits administration, accounting services, legal services, quality assurance and marketing support.

Our typical clinic occupies approximately 1,600 to 3,000 square feet of leased space 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 traditional hospital clinics.

Typical minimum staff at a clinic consists of a licensed physical therapist and an office manager. As patient visits grow, staffing may also include additional physical therapists, occupational therapists, therapy assistants, aides, exercise physiologists, athletic trainers and office personnel. Therapy services are performed under the 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 three times a week, typically for two to six weeks. We generally charge for treatment on a per procedure basis. Medicare patients are charged based on prescribed time increments and Medicare billing standards. 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 in the most efficient manner while providing high quality patient care.
 
FACTORS INFLUENCING DEMAND FOR THERAPY SERVICES

We believe that the following factors, among others, influence the growth of outpatient physical 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 cost savings for 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 earlier discharge of patients to reduce costs. We believe that early hospital discharge practices foster greater demand for outpatient physical therapy services.

Aging Population. In general, the elderly population has a greater incidence of disability compared to the population as a whole. As this segment of the population continues to grow, we believe that demand for rehabilitation services will expand.

MARKETING

We focus our marketing efforts primarily on physicians, including orthopedic surgeons, neurosurgeons, physiatrists, internal medicine physicians, podiatrists, occupational medicine physicians and general practitioners. In marketing to the physician community, we emphasize our commitment to quality patient care and regular 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 relationships with health maintenance organizations, preferred provider organizations, industry, case managers and insurance companies.

SOURCES OF REVENUE

Payor sources for clinic services are primarily managed care programs, commercial health insurance, Medicare/Medicaid and workers’ compensation insurance. Commercial health insurance, Medicare and managed care programs generally provide coverage to patients utilizing our clinics after payment by the patients of normal deductibles and co-insurance payments. Workers’ compensation laws generally require employers to provide, directly or indirectly through insurance, costs of medical rehabilitation for their employees 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:

   
December 31, 2016
   
December 31, 2015
   
December 31, 2014
 
Payor
 
Net Patient
Revenue
   
Percentage
   
Net Patient
Revenue
   
Percentage
   
Net Patient
Revenue
   
Percentage
 
   
(Net Patient Revenues in Thousands)
 
                                     
Managed Care Program
 
$
84,784
     
24.3
%
 
$
73,555
     
22.7
%
 
$
67,139
     
22.5
%
Commercial Health Insurance
   
94,861
     
27.2
%
   
91,845
     
28.3
%
   
87,890
     
29.4
%
Medicare/Medicaid
   
89,743
     
25.7
%
   
79,321
     
24.5
%
   
69,857
     
23.4
%
Workers' Compensation Insurance
   
56,478
     
16.2
%
   
60,087
     
18.5
%
   
57,643
     
19.3
%
Other
   
22,973
     
6.6
%
   
19,485
     
6.0
%
   
16,480
     
5.4
%
Total
 
$
348,839
     
100.0
%
 
$
324,293
     
100.0
%
 
$
299,009
     
100.0
%

Our business depends to a significant extent on our relationships with commercial health insurers, health maintenance organizations, preferred provider organizations and workers’ compensation insurers. In some geographical areas, our clinics must be approved as providers by key health maintenance organizations and preferred provider plans to obtain payments. Failure to obtain or maintain these approvals would adversely affect financial results.

During the year ended December 31, 2016, approximately 27.6% of our visits and 23.4% of our net patient revenues were from patients with Medicare program coverage. To receive Medicare reimbursement, a facility (Medicare Certified Rehabilitation Agency) or the individual therapist (Physical/Occupational Therapist in Private Practice) must meet applicable participation conditions set by the Department of Health and Human Services (“HHS”) relating to the type of facility, equipment, recordkeeping, personnel and standards of medical care, and also must comply with all state and local laws. HHS, through Centers for Medicare & Medicaid Services (“CMS”) and designated agencies, periodically inspects or surveys clinics/providers for approval and/or compliance. We anticipate that our newly developed and acquired clinics will become certified as Medicare providers or will be enrolled as a group of physical/occupation therapists in a private practice. Failure to obtain or maintain this certification would adversely affect financial results.
 
The Medicare program reimburses outpatient rehabilitation providers based on the Medicare Physician Fee Schedule (‘‘MPFS’’). For services provided in 2017 through 2019, a 0.5% increase will be applied each year to the fee schedule payment rates, subject to an adjustment beginning in 2019 under the Merit-Based Incentive Payment System (“MIPS”).    For services provided in 2020 through 2025, a 0.0% percent update will be applied each year to the fee schedule payment rates, subject to adjustments under MIPS and any alternative payment models (“APMs”). Beginning in 2019, payments under the fee schedule are subject to adjustment based on performance in MIPS, which measures performance based on certain quality metrics, resource use, and meaningful use of electronic health records. Under the MIPS requirements a provider's performance is assessed according to established performance standards and used to determine an adjustment factor that is then applied to the professional's payment for a year. Each year from 2019 through 2024 professionals who receive a significant share of their revenues through an APM (such as accountable care organizations or bundled payment arrangements) that involves risk of financial losses and a quality measurement component will receive a 5% bonus. The bonus payment for APM participation is intended to encourage participation and testing of new APMs and to promote the alignment of incentives across payors. The specifics of the MIPS and APM adjustments beginning in 2019 and 2020, respectively, will be subject to future notice and comment rule-making.

The Budget Control Act of 2011 increased the federal debt ceiling in connection with deficit reductions over the next ten years, and requires automatic reductions in federal spending by approximately $1.2 trillion. Payments to Medicare providers are subject to these automatic spending reductions, subject to a 2% cap. On April 1, 2013, a 2% reduction to Medicare payments was implemented. The Bipartisan Budget Act of 2015, enacted on November 2, 2015, extends the 2% reductions to Medicare payments through fiscal year 2025.

As a result of the Balanced Budget Act of 1997, the formula for determining the total amount paid by Medicare in any one year for outpatient physical therapy, occupational therapy, and/or speech-language pathology services provided to any Medicare beneficiary (i.e., the ‘‘Therapy Cap’’ or ‘‘Limit’’) was established. Based on the statutory definitions which constrained how the Therapy Cap would be applied, there is one Limit for Physical Therapy and Speech Language Pathology Services combined, and one Limit for Occupational Therapy. For 2016, the annual Limit on outpatient therapy services was  $1,960 for Physical and Speech Language Pathology Services combined and $1,960 for Occupational Therapy Services. Effective January 1, 2017, the annual Limit on outpatient therapy services is $1,980 for combined Physical Therapy and Speech Language Pathology services and $1,980 for Occupational Therapy services. Historically, these Therapy Caps applied to outpatient therapy services provided in all settings, except for services provided in departments of hospitals. However, the Protecting Access to Medicare Act of 2014, and prior legislation, extended the Therapy Caps to services furnished in hospital outpatient department settings. The application of these annual limits to hospital outpatient department settings will sunset on December 31, 2017 unless Congress extends it.

In the Deficit Reduction Act of 2005, Congress implemented an exceptions process to the annual Limit for therapy expenses for therapy services above the annual Limit. Therapy services above the annual Limit that are medically necessary satisfy an exception to the annual Limit and such claims are payable by the Medicare program. The MACRA extended the exceptions process for outpatient therapy caps through December 31, 2017. Unless Congress extends the exceptions process further, the therapy caps will apply to all outpatient therapy services beginning January 1, 2018, except those services furnished and billed by outpatient hospital departments. For any claim above the annual Limit, the claim must contain a modifier indicating that the services are medically necessary and justified by appropriate documentation in the medical record.

Furthermore, under the Middle Class Tax Relief and Job Creation Act of 2012 (‘‘MCTRA’’), since October 1, 2012, patients who met or exceeded $3,700 in therapy expenditures during a calendar year have been subject to a manual medical review to determine whether applicable payment criteria are satisfied. The $3,700 threshold is applied to Physical Therapy and Speech Language Pathology Services; a separate $3,700 threshold is applied to the Occupational Therapy. The Medicare Access and CHIP Reauthorization Act of 2015 (‘‘MACRA’’) extends the manual medical review process through December 31, 2017.

CMS adopted a multiple procedure payment reduction (‘‘MPPR’’) for therapy services in the final update to the MPFS for calendar year 2011. The MPPR applied to all outpatient therapy services paid under Medicare Part B — occupational therapy, physical therapy and speech-language pathology. Under the policy, the Medicare program pays 100% of the practice expense component of the Relative Value Unit (‘‘RVU’’) for the therapy procedure with the highest practice expense RVU, then reduces the payment for the practice expense component for the second and subsequent therapy procedures or units of service furnished during the same day for the same patient, regardless of whether those therapy services are furnished in separate sessions. Since 2013, the practice expense component for the second and subsequent therapy service furnished during the same day for the same patient was reduced by 50%. In addition, the MCTRA directed CMS to implement a claims-based data collection program to gather additional data on patient function during the course of therapy in order to better understand patient conditions and outcomes. All practice settings that provide outpatient therapy services are required to include this data on the claim form. Since 2013, therapists have been required to report new codes and modifiers on the claim form that reflect a patient’s functional limitations and goals at initial evaluation, periodically throughout care, and at discharge. Reporting of these functional limitation codes and modifiers are required on the claim for payment.,
 
Statutes, regulations, and payment rules governing the delivery of therapy services to Medicare beneficiaries are complex and subject to interpretation. We believe that we are in compliance in all material respects 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 our financial statements as of December 31, 2016. 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. For 2016, net revenue from Medicare accounts for approximately $81.8 million.

REGULATION AND HEALTHCARE REFORM

Numerous federal, state and local regulations regulate healthcare services and those who provide them. 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). Only one of the states in which we currently operate requires a certificate of need for the operation of our physical therapy business functions. Our therapists and/or clinics, however, are required to be licensed, as determined by the state in which they provide services. 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 financial relationships involving providers of healthcare services. These laws include Section 1128B(b) of the Social Security Act (42 U.S. C. § 1320a-7b[b]) (the “Fraud and Abuse Law”), under which civil and criminal penalties can be imposed upon persons who, among other things, offer, solicit, pay or receive remuneration in return for (i) the referral of patients for the rendering of any item or service for which payment may be made, in whole or in part, by a Federal health care program (including Medicare and Medicaid); or (ii) purchasing, leasing, ordering, or arranging for or recommending purchasing, leasing, ordering any good, facility, service, or item for which payment may be made, in whole or in part, by a Federal health care program (including Medicare and Medicaid). We believe that our business procedures and business arrangements are in compliance with these provisions. However, the provisions are broadly written and the full extent of their specific application to specific facts and arrangements to which we are a party is uncertain and difficult to predict. In addition, several states have enacted state laws similar to the Fraud and Abuse Law, which may be more restrictive than the federal Fraud and Abuse Law.

The Office of the Inspector General (“OIG”) of HHS has issued regulations describing compensation financial 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 under a “facts and circumstances” test.

The OIG also has issued special fraud alerts and special advisory bulletins to remind the provider community of the importance and application of certain aspects of the Fraud and Abuse Law. One of the OIG special fraud alerts related to 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. We rent clinic space for a few of our clinics from referring physicians and have taken the steps that we believe are necessary to ensure that all leases comply to the extent possible and applicable with the space rental Safe Harbor to the Fraud and Abuse Law.

One of the OIG’s special advisory bulletins addressed certain complex contractual arrangements for the provision of items and services. This special advisory bulletin identified several characteristics commonly exhibited by suspect arrangements, the existence of one or more of which could indicate a prohibited arrangement to the OIG. Generally, the indicia of a suspect contractual joint venture as identified by the special advisory bulletin and an associated OIG advisory opinion include the following:
 
New Line of Business. A provider in one line of business (“Owner”) expands into a new line of business that can be provided to the Owner’s existing patients, with another party who currently provides the same or similar item or service as the new business (“Manager/Supplier”).
 
Captive Referral Base. The arrangement predominantly or exclusively serves the Owner’s existing patient base (or patients under the control or influence of the Owner).
 
Little or No Bona Fide Business Risk. The Owner’s primary contribution to the venture is referrals; it makes little or no financial or other investment in the business, delegating the entire operation to the Manager/Supplier, while retaining profits generated from its captive referral base.
 
Status of the Manager/Supplier. The Manager/Supplier is a would-be competitor of the Owner’s new line of business and would normally compete for the captive referrals. It has the capacity to provide virtually identical services in its own right and bill insurers and patients for them in its own name.
 
Scope of Services Provided by the Manager/Supplier. The Manager/Supplier provides all, or many, of the new business’ key services.
 
Remuneration. The practical effect of the arrangement, viewed in its entirety, is to provide the Owner the opportunity to bill insurers and patients for business otherwise provided by the Manager/Supplier. The remuneration from the venture to the Owner (i.e., the profits of the venture) takes into account the value and volume of business the Owner generates.
 
Exclusivity. The arrangement bars the Owner from providing items or services to any patients other than those coming from Owner and/or bars the Manager/Supplier from providing services in its own right to the Owner’s patients.

Due to the nature of our business operations, many of our management service arrangements exhibit one or more of these characteristics. However, the we believe we have taken steps regarding the structure of such arrangements as necessary to sufficiently distinguish them from these suspect ventures, and to comply with the requirements of the Fraud and Abuse Law. However, if the OIG believes we have entered into a prohibited contractual joint venture, it could have an adverse effect on our business, financial condition and results of operations.

Although the business of managing physician-owned physical therapy facilities is regulated by the Fraud and Abuse Law, the manner in which we contract with such facilities often falls outside the complete scope of available Safe Harbors. We believe our arrangements comply with the Fraud and Abuse Law, even though federal courts provide limited 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 an adverse effect on our business, financial condition and results of operations.

Stark Law. Provisions of the Omnibus Budget Reconciliation Act of 1993 (42 U.S.C. § 1395nn) (the “Stark Law”) prohibit referrals by a physician of “designated health services” which are payable, in whole or in part, by Medicare or Medicaid, to an entity in which the physician or the physician’s immediate family member has an investment interest or other financial relationship, subject to several exceptions. Unlike the Fraud and Abuse Law, the Stark Law is a strict liability statute. Proof of intent to violate the Stark Law is not required. Physical therapy services are among the “designated health services”. Further, the Stark Law has application to our management contracts with individual physicians and physician groups, as well as, any other financial relationship between us and referring physicians, including medical advisor arrangements and any financial transaction resulting from a clinic acquisition. The Stark Law also prohibits billing for services rendered pursuant to a prohibited referral. Several states have enacted laws similar to the Stark Law. These state laws may cover all (not just Medicare and Medicaid) patients. As with the Fraud and Abuse Law, we consider the Stark Law in planning our clinics, establishing contractual and other arrangements with physicians, marketing and other activities, and believe that our operations are in substantial compliance with the Stark Law. If we violate the Stark Law or any similar state laws, our financial results and operations could be adversely affected. Penalties for violations 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. HIPAA also criminalized certain forms of health fraud against all public and private payors. Additionally, HIPAA mandates the adoption of standards regarding the exchange of healthcare information in an effort to ensure the privacy and electronic security of patient information and standards relating to the privacy of health information. Sanctions for failing to comply with HIPAA include criminal penalties and civil sanctions. In February of 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was signed into law. Title XIII of ARRA, the Health Information Technology for Economic and Clinical Health Act (“HITECH”), provided for substantial Medicare and Medicaid incentives for providers to adopt electronic health records (“EHRs”) and grants for the development of health information exchange (“HIE”). Recognizing that HIE and EHR systems will not be implemented unless the public can be assured that the privacy and security of patient information in such systems is protected, HITECH also significantly expanded the scope of the privacy and security requirements under HIPAA. Most notable are the mandatory breach notification requirements and a heightened enforcement scheme that includes increased penalties, and which now apply to business associates as well as to covered entities. In addition to HIPAA, a number of states have adopted laws and/or regulations applicable in the use and disclosure of individually identifiable health information that can be more stringent than comparable provisions under HIPAA.

We believe that our operations comply with applicable standards for privacy and security of protected healthcare information. We cannot predict what negative effect, if any, HIPAA/HITECH or any applicable state law or regulation 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 continue to review and assess alternative healthcare delivery and payment systems. Potential alternative approaches could 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 only modest increases or reduced costs. For instance, managed care entities are demanding lower reimbursement rates from healthcare providers and, in some cases, are requiring or encouraging providers to accept capitated payments that may not allow providers to cover their full costs or realize traditional levels of profitability. We cannot reasonably predict what impact the adoption of federal or state healthcare reform measures or future private sector reform may have on our business.

COMPETITION

The healthcare industry, including the physical therapy business, is highly competitive. The physical therapy business is highly fragmented with no company having a significant market share nationally. We believe that we are currently the fourth largest national outpatient rehabilitation provider.

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 many types of healthcare providers including the physical therapy departments of hospitals, private therapy clinics, physician-owned therapy clinics, and chiropractors. We may face more intense competition if consolidation of the therapy industry continues.

We believe that our strategy of providing key therapists in a community with an opportunity to participate in ownership or clinic profitability provides us with a competitive advantage by helping to ensure the commitment of local management to the success of the clinic.

We also believe that our competitive position is enhanced by our strategy of locating our clinics, when possible, on the ground floor of buildings and shopping centers with nearby parking, thereby making the clinics more easily accessible to patients. We offer convenient hours. We also attempt to make the decor in our clinics less institutional and more aesthetically pleasing than traditional hospital clinics.

ENFORCEMENT ENVIRONMENT

In recent years, federal and state governments have launched several initiatives aimed at uncovering behavior that violates the federal civil and criminal laws regarding false claims and fraudulent billing and coding practices. Such laws require providers to adhere to complex reimbursement requirements regarding proper billing and coding in order to be compensated for their services by government payors. Our compliance program requires adherence to applicable law and promotes reimbursement education and training; however, a determination that our clinics’ billing and coding practices are false or fraudulent could have a material adverse effect on us.

As a result of our participation in the Medicare and Medicaid programs, we are subject to various governmental inspections, reviews, audits and investigations to verify our compliance with these programs and applicable laws and regulations. In addition, our Corporate Integrity Agreement requires annual audits to be performed by an independent review organization on a small sample of our clinics, the results of which are reported to the federal government. See “-Compliance Program – Corporate Integrity Agreement”. Managed care payors may also reserve the right to conduct audits. An adverse inspection, review, audit or investigation could result in: refunding amounts we have been paid; fines penalties and/or revocation of billing privileges for the affected clinics; expansion of the scope of our Corporate Integrity Agreement; exclusion from participation in the Medicare or Medicaid programs or one or more managed care payor network; or damage to our reputation.

We and our clinics are subject to federal and state laws prohibiting entities and individuals from knowingly and willfully making claims to Medicare, Medicaid and other governmental programs and third party payors that contain false or fraudulent information. The federal False Claims Act encourages private individuals to file suits on behalf of the government against healthcare providers such as us. As such suits are generally filed under seal with a court to allow the government adequate time to investigate and determine whether it will intervene in the action, the implicated healthcare providers often are unaware of the suit until the government has made its determination and the seal is lifted. Violations or alleged violations of such laws, and any related lawsuits, could result in (i) exclusion from participation in Medicare, Medicaid and other federal healthcare programs, or (ii) significant financial or criminal sanctions, resulting in the possibility of substantial financial penalties for small billing errors that are replicated in a large number of claims, as each individual claim could be deemed a separate violation. In addition, many states also have enacted similar statutes, which may include criminal penalties, substantial fines, and treble damages.

COMPLIANCE PROGRAM

Our Compliance Program. Our ongoing success depends upon our reputation for quality service and ethical business practices. We operate in a highly regulated environment with many federal, state and local laws and regulations. We take a proactive interest in understanding and complying with the laws and regulations that apply to our business.
 
Our Board of Directors (the “Board”) has adopted a Code of Business Conduct and Ethics and a set of Corporate Governance Guidelines to clarify the ethical standards under which the Board and management carry out their duties. In addition, the Board has created a Compliance Committee of the Board (“Compliance Committee”) whose purpose is to assist the Board in discharging their oversight responsibilities with respect to compliance with federal and state laws and regulations relating to healthcare.

We have issued an Ethics and Compliance Manual and created compliance training materials, hand-outs and an on-line testing program. These tools were prepared to ensure that every employee of our Company and subsidiaries has a clear understanding of our mutual commitment to high standards of professionalism, honesty, fairness and compliance with the law in conducting business. These standards are administered by our Chief Compliance Officer (“CO”), who has the responsibility for the day-to-day oversight, administration and development of our compliance program. The CO, internal and external counsel, management and the Compliance Committee review our policies and procedures for our compliance program from time to time in an effort to improve operations and to ensure compliance with requirements of standards, laws and regulations and to reflect the on-going compliance focus areas which have been identified by management, counsel or the Compliance Committee. We also have established systems for reporting potential violations, educating our employees, monitoring and auditing compliance and handling enforcement and discipline.

Committees. Our Compliance Committee, appointed by the Board, consists of five independent directors. The Compliance Committee has general oversight of our Company’s compliance with the legal and regulatory requirements regarding healthcare operations. The Compliance Committee relies on the expertise and knowledge of management, the CO and other compliance and legal personnel. The CO regularly communicates with the Chairman of the Compliance Committee. The Compliance Committee meets at least four times a year or more frequently as necessary to carry out its responsibilities and reports regularly to the Board regarding its actions and recommendations.

We also have an Internal Compliance Committee, which is comprised of Company leaders in the areas of operations, clinical services, finance, human resources, legal, information technology and credentialing. The Internal Compliance Committee has the responsibility for evaluating and assessing Company areas of risk relating to compliance with federal and state healthcare laws, and generally to assist the CO. The Internal Compliance Committee meets at least four times a year or more frequently as necessary to carry out its responsibilities. In addition, management has appointed a team to address our Company’s compliance with HIPAA. The HIPAA team consists of a security officer and employees from our legal, information systems, finance, operations, compliance, business services and human resources departments. The team prepares assessments and makes recommendations regarding operational changes and/or new systems, if needed, to comply with HIPAA.

Each clinic certified as a Medicare Rehabilitation Agency has a formally appointed governing body composed of a member of our management and the director/administrator of the clinic. The governing body retains legal responsibility for the overall conduct of the clinic. The members confer regularly and discuss, among other issues, clinic compliance with applicable laws and regulations. In addition, there are Professional Advisory Committees which serve as Infection Control Committees. These committees meet in the facilities and function as advisors.

We have in place a Risk Management Committee consisting of, among others, the CO, our General Counsel. other legal and compliance department personnel and the Corporate Vice President of Administration. This committee reviews and monitors all employee and patient incident reports and provides clinic personnel with actions to be taken in response to the reports.

Reporting Violations. In order to facilitate our employees’ ability to report in confidence, anonymously and without retaliation any perceived improper work-related activities, accounting irregularities and other violations of our compliance program, we have set up an independent national compliance hotline. The compliance hotline is available to receive confidential reports of wrongdoing Monday through Friday (excluding holidays), 24 hours a day. The compliance hotline is staffed by experienced third party professionals trained to utilize utmost care and discretion in handling sensitive issues and confidential information. The information received is documented and forwarded timely to the CO, who, together with the Compliance Committee, has the power and resources to investigate and resolve matters of improper conduct.

Educating Our Employees. We utilize numerous methods to train our employees in compliance related issues. The directors/administrators of each clinic are responsible for conducting the initial training sessions on compliance with existing employees. Training is based on our Ethics and Compliance Manual, inclusive of HIPAA information, and our compliance training materials. The directors/administrators also provide periodic “refresher” training for existing employees and one-on-one comprehensive training with new hires. The corporate compliance group responds to questions from clinic personnel and conducts frequent teleconference meetings, webinars and training sessions on a variety of compliance related topics.

When a clinic opens, the Company provides a package of compliance materials containing manuals and detailed instructions for meeting Medicare Conditions of Participation Standards and other compliance requirements. During follow up training with the director/administrator of the clinic, compliance department staff explain various details regarding requirements and compliance standards. Compliance staff will remain in contact with the director/administrator while the clinic is implementing compliance standards and will provide any assistance required. All new office managers receive training (including Medicare, regulatory and corporate compliance, insurance billing, charge entry and transaction posting and coding, daily, weekly and monthly accounting reports) from the training staff at the corporate office. The corporate compliance group will assist in continued compliance, including guidance to the clinic staff with regard to Medicare certifications, state survey requirements and responses to any inquiries from regulatory agencies.
 
Monitoring and Auditing Clinic Operational Compliance. We have in place audit programs and other procedures to monitor and audit clinic operational compliance with applicable policies and procedures. We employ internal auditors who, as part of their job responsibilities, conduct periodic audits of each clinic. Most clinics are audited at least once every 24 months and additional focused audits are performed as deemed necessary. During these audits, particular attention is given to compliance with Medicare and internal policies, Federal and state laws and regulations, third party payor requirements, and patient chart documentation, billing, reporting, record keeping, collections and contract procedures. The audits typically are conducted on site and include interviews with the employees involved in management, operations, billing and accounts receivable.

Formal audit reports are prepared and reviewed with corporate management and the Compliance Committee. Each clinic director/administrator receives a letter instructing them of any corrective measures required. Each clinic director/administrator then works with the compliance team and operations to ensure such corrective measures are achieved.

Handling Enforcement and Discipline. It is our policy that any employee who fails to comply with compliance program requirements or who negligently or deliberately fails to comply with known laws or regulations specifically addressed in our compliance program should be subject to disciplinary action up to and including discharge from employment. The Compliance Committee, compliance staff, human resources staff and management investigate violations of our compliance program and impose disciplinary action as considered appropriate.

Corporate Integrity Agreement. The Company also performs certain additional compliance related functions pursuant to the Corporate Integrity Agreement (“Corporate Integrity Agreement” or “CIA”) that the Company entered into with the OIG. The CIA, which became effective as of December 21, 2015, outlines certain specific requirements relating to compliance oversight and program implementation, as well as periodic reporting. In addition, pursuant to the CIA, an independent review organization annually will perform a Medicare billing and coding audit on a small group of randomly selected Company clinics. The Company’s Compliance Program has been modified so as to comply with the requirements of the CIA. The term of the CIA is five years.

The CIA was entered into as part of the settlement by one of the Company’s Subsidiaries with the U. S. Department of Justice related to certain Medicare billings that occurred between 2007 and 2009 at a single outpatient physical therapy clinic. The settlement resolved claims relating to whether certain physical therapy services provided to a limited number of Medicare patients at the clinic satisfied all of the criteria for payment by the Medicare program, including proper supervision of physical therapist assistants. The Subsidiary paid $718,000 in 2015 to resolve the matter, and the Subsidiary and the Company entered into the CIA.  The Subsidiary no longer conducts any business.

EMPLOYEES

At December 31, 2016, we employed approximately 3,800 people, of which 2,600 were full-time employees. At that date, no Company employees were governed by collective bargaining agreements or were members of a union. We consider our relations with our employees to be good.

In the states in which our current clinics are located, persons performing designated physical therapy services are required to be licensed by the state. Based on standard employee screening systems in place, 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

This Annual Report on Form 10-K includes the restatement of certain of our previously issued consolidated financial statements and selected financial data.  It also amends previously filed management’s discussion and analysis of financial condition and results of operations and other disclosures for the periods presented in this Annual Report on Form 10-K.  As indicated in Note 1, Organization, Nature of Operations and Basis of Presentation – Restatement of Prior Financial Statements, in the Notes to Consolidated Financial Statements and as additionally disclosed in our current report on Form 8-K filed March 16, 2017, prior to issuing the 2016 annual financial statements, we determined we had previously incorrectly accounted for the non-controlling interests which were mandatorily redeemable.  See Footnote 2 – Significant Accounting Policies – Mandatorily Redeemable Non-Controlling Interests – for a description of the accounting for mandatorily redeemable non-controlling interests. We determined this correction was material to previously issued annual and quarterly consolidated financial statements.  The Company, in this Annual Report on Form 10-K for the year ended December 31, 2016, restated the following:

·
Consolidated Financial Statements
·
for the balance sheet as of December 31, 2015; and
·
the statements of net income, cash flows and equity for the periods ended December 31, 2015 and 2014, which will include a cumulative adjustment to the beginning balances as of January 1, 2014.
·
Selected Financial Data for the years ended December 31, 2015, 2014, 2013 and 2012.
·
Unaudited quarterly financial information for the quarters ended September 30, 2016, June 30, 2016, March 31, 2016, December 31, 2015, September 30, 2015, June 30, 2015 and March 31, 2015.
·
Management’s discussion and analysis of financial condition and results of operations as of and for the years ended December 31, 2015 and 2014.
 
ITEM 1A.
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.

Risks related to our business and operations

We have identified a material weakness in our internal control over financial reporting which resulted in a material misstatement in our previously issued consolidated financial statements and a failure to meet our reporting obligations.

We have identified a material weakness in our internal control over financial reporting relating to the accounting for mandatorily redeemable non-controlling interest.  As a result of such weakness, we concluded that our disclosure controls and procedures and internal controls over financial reporting were not effective and had to restate certain prior consolidated financial statements.  This contributed to a delay in the filing of this Annual Report.  For further information regarding this matter, refer to Item 9A – Controls and Procedures.

Unless remediated, this material weakness could result in additional material misstatements to our interim or annual consolidated financial statements and disclosures that may not be prevented or detected on a timely basis.  In addition, we may experience delays or be unable to meet our reporting obligations or to comply with SEC rules and regulations, which could result in investigations and sanctions by regulatory authorities.  Management’s ongoing assessment of disclosure controls and procedures as well as internal control over financial reporting may in the future identify additional weaknesses and conditions that need to be addressed.  Any failure to improve our disclosure controls and procedures or internal controls over financial reporting to address identified weaknesses in the future, if they were to occur, could prevent us from maintaining accurate accounting records and discovering material accounting errors.  Our Company could suffer damage to its business and reputation arising from the correction in accounting method for redeemable non-controlling partnership interests, including claims or proceedings relating to such matters.   Any of these results could adversely affect our business and the value of our common stock.

Failure to maintain effective internal control over our financial reporting could have an adverse effect on our ability to report our financial results on a timely and accurate basis.

We are required to produce our consolidated financial statements in accordance with the requirements of accounting principles generally accepted in the United States of America. Effective internal control over financial reporting is necessary for us to provide reliable financial reports, to help mitigate the risk of fraud and to operate successfully. We are required by federal securities laws to document and test our internal control procedures in order to satisfy the requirements of the Sarbanes-Oxley Act of 2002, which requires annual management assessments of the effectiveness of our internal control over financial reporting.

Testing and maintaining our internal control over financial reporting can be expensive and divert our management’s attention from other matters that are important to our business. We may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with applicable law, or our independent registered public accounting firm may not be able to issue an unqualified attestation report if we conclude that our internal control over financial reporting is not effective. If we fail to maintain effective internal control over financial reporting, or our independent registered public accounting firm is unable to provide us with an unqualified attestation report on our internal control, we could be required to take costly and time-consuming corrective measures, be required to restate the affected historical financial statements, be subjected to investigations and/or sanctions by federal and state securities regulators, and be subjected to civil lawsuits by security holders. Any of the foregoing could also cause investors to lose confidence in our reported financial information and in our company and would likely result in a decline in the market price of our stock and in our ability to raise additional financing if needed in the future.
 
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 affect 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. See “Business- Sources of Revenue” in Item 1 for more information. The ultimate content, timing or effect of any healthcare reform legislation and the impact of potential legislation on us is uncertain and difficult, if not impossible, to predict. That impact may be material to our business, financial condition or results of operations.

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/permits, 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
 
billing and payment for services.

In recent years, there have been heightened coordinated civil and criminal enforcement efforts by both federal and state government agencies relating to the healthcare industry. 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. For a more complete description of certain of these laws and regulations, see “Business—Regulation and Healthcare Reform” and “Business – Compliance” in Item 1.

The healthcare industry is subject to extensive federal, state and local laws and regulations relating to (1) facility and professional licensure, including certificates of need, (2) conduct of operations, including financial relationships among healthcare providers, Medicare fraud and abuse and physician self-referral, (3) addition of facilities and services and enrollment of newly developed facilities in the Medicare program, (4) payment for services and (5) safeguarding protected health information.

Both federal and state regulatory agencies inspect, survey and audit our facilities to review our compliance with these laws and regulations. While our facilities intend to comply with the existing licensing, Medicare certification requirements and accreditation standards, there can be no assurance that these regulatory authorities will determine that all applicable requirements are fully met at any given time. A determination by any of these regulatory authorities that a facility is not in compliance with these requirements could lead to the imposition of requirements that the facility takes corrective action, assessment of fines and penalties, or loss of licensure or Medicare certification of accreditation. These consequences could have an adverse effect on our Company.

The Company’s CIA imposes certain compliance related functions and reporting obligations on the Company. In addition, the CIA requires the Company to engage an independent review organization to conduct annual audits of randomly selected Company clinics in order to review compliance with federal requirements relating to the proper billing and coding for claims. While our facilities intend to comply with the federal requirements for properly coding and billing claims for reimbursement, there can be no assurance that these audits will determine that all applicable requirements are fully met at the clinics that are reviewed. In addition, a failure to fully comply with the requirements of the CIA may subject the Company to the assessment of fines and penalties, or exclusion from participation in the Medicare program. These consequences could have an adverse effect on our Company.

Decreases in Medicare reimbursement rates, implementation of annual caps, and payment reductions applied to the second and subsequent therapy services may adversely affect our financial results.

The Medicare program reimburses outpatient rehabilitation providers based on the Medicare Physician Fee Schedule (‘‘MPFS’’). For services provided in 2017 through 2019, a 0.5% increase will be applied each year to the fee schedule payment rates, subject to an adjustment beginning in 2019 under the Merit-Based Incentive Payment System (“MIPS”).    For services provided in 2020 through 2025, a 0.0% percent update will be applied each year to the fee schedule payment rates, subject to adjustments under MIPS and any alternative payment models (“APMs”). Beginning in 2019, payments under the fee schedule are subject to adjustment based on performance in MIPS, which measures performance based on certain quality metrics, resource use, and meaningful use of electronic health records. Under the MIPS requirements a provider's performance is assessed according to established performance standards and used to determine an adjustment factor that is then applied to the professional's payment for a year. Each year from 2019 through 2024 professionals who receive a significant share of their revenues through an APM (such as accountable care organizations or bundled payment arrangements) that involves risk of financial losses and a quality measurement component will receive a 5% bonus. The bonus payment for APM participation is intended to encourage participation and testing of new APMs and to promote the alignment of incentives across payors. The specifics of the MIPS and APM adjustments beginning in 2019 and 2020, respectively, will be subject to future notice and comment rule-making.
 
The Budget Control Act of 2011 increased the federal debt ceiling in connection with deficit reductions over the next ten years, and requires automatic reductions in federal spending by approximately $1.2 trillion. Payments to Medicare providers are subject to these automatic spending reductions, subject to a 2% cap. On April 1, 2013, a 2% reduction to Medicare payments was implemented. The Bipartisan Budget Act of 2015, enacted on November 2, 2015, extends the 2% reductions to Medicare payments through fiscal year 2025.

As a result of the Balanced Budget Act of 1997, the formula for determining the total amount paid by Medicare in any one year for outpatient physical therapy, occupational therapy, and/or speech-language pathology services provided to any Medicare beneficiary (i.e., the ‘‘Therapy Cap’’ or ‘‘Limit’’) was established. Based on the statutory definitions which constrained how the Therapy Cap would be applied, there is one Limit for Physical Therapy and Speech Language Pathology Services combined, and one Limit for Occupational Therapy. For 2016, the annual Limit on outpatient therapy services was $1,960 for Physical and Speech Language Pathology Services combined and $1,960 for Occupational Therapy Services. Effective January 1, 2017, the annual Limit on outpatient therapy services is $1,980 for combined Physical Therapy and Speech Language Pathology services and $1,980 for Occupational Therapy services. Historically, these Therapy Caps applied to outpatient therapy services provided in all settings, except for services provided in departments of hospitals. However, the Protecting Access to Medicare Act of 2014, and prior legislation, extended the Therapy Caps to services furnished in hospital outpatient department settings. The application of these annual limits to hospital outpatient department settings will sunset on December 31, 2017 unless Congress extends it.

In the Deficit Reduction Act of 2005, Congress implemented an exceptions process to the annual Limit for therapy expenses for therapy services above the annual Limit. Therapy services above the annual Limit that are medically necessary satisfy an exception to the annual Limit and such claims are payable by the Medicare program. The MACRA extended the exceptions process for outpatient therapy caps through December 31, 2017. Unless Congress extends the exceptions process further, the therapy caps will apply to all outpatient therapy services beginning January 1, 2018, except those services furnished and billed by outpatient hospital departments. For any claim above the annual Limit, the claim must contain a modifier indicating that the services are medically necessary and justified by appropriate documentation in the medical record.

Furthermore, under the Middle Class Tax Relief and Job Creation Act of 2012 (‘‘MCTRA’’), since October 1, 2012, patients who met or exceeded $3,700 in therapy expenditures during a calendar year have been subject to a manual medical review to determine whether applicable payment criteria are satisfied. The $3,700 threshold is applied to Physical Therapy and Speech Language Pathology Services; a separate $3,700 threshold is applied to the Occupational Therapy. The Medicare Access and CHIP Reauthorization Act of 2015 (‘‘MACRA’’) extends the manual medical review process through December 31, 2017.

CMS adopted a multiple procedure payment reduction (‘‘MPPR’’) for therapy services in the final update to the MPFS for calendar year 2011. The MPPR applied to all outpatient therapy services paid under Medicare Part B — occupational therapy, physical therapy and speech-language pathology. Under the policy, the Medicare program pays 100% of the practice expense component of the Relative Value Unit (‘‘RVU’’) for the therapy procedure with the highest practice expense RVU, then reduces the payment for the practice expense component for the second and subsequent therapy procedures or units of service furnished during the same day for the same patient, regardless of whether those therapy services are furnished in separate sessions. Since 2013, the practice expense component for the second and subsequent therapy service furnished during the same day for the same patient was reduced by 50%. In addition, the MCTRA directed CMS to implement a claims-based data collection program to gather additional data on patient function during the course of therapy in order to better understand patient conditions and outcomes. All practice settings that provide outpatient therapy services are required to include this data on the claim form. Since 2013, therapists have been required to report new codes and modifiers on the claim form that reflect a patient’s functional limitations and goals at initial evaluation, periodically throughout care, and at discharge. Reporting of these functional limitation codes and modifiers are required on the claim for payment.

Statutes, regulations, and payment rules governing the delivery of therapy services to Medicare beneficiaries are complex and subject to interpretation. We believe that we are in compliance in all material respects 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 our financial statements as of December 31, 2016. 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. For 2016, net revenue from Medicare accounts for approximately $81.8 million.

Given the history of frequent revisions to the Medicare program and its reimbursement rates and rules, we may not continue to receive reimbursement rates from Medicare that sufficiently compensate us for our services or, in some instances, cover our operating costs. Limits on reimbursement rates or the scope of services being reimbursed could have a material adverse effect on our revenue, financial condition and results of operations. Additionally, any delay or default by the federal or state governments in making Medicare and/or Medicaid reimbursement payments could materially and, adversely, affect our business, financial condition and results of operations.
 
Revenue we receive from Medicare and Medicaid is subject to potential retroactive reduction.

Payments we receive from Medicare and Medicaid can be retroactively adjusted after examination during the claims settlement process or as a result of post-payment audits. Payors may disallow our requests for reimbursement, or recoup amounts previously reimbursed, based on determinations by the payors or their third-party audit contractors that certain costs are not reimbursable because either adequate or additional documentation was not provided or because certain services were not covered or deemed to not be medically necessary. Significant adjustments, recoupments or repayments of our Medicare or Medicaid revenue, and the costs associated with complying with investigative audits by regulatory and governmental authorities, could adversely affect our financial condition and results of operations.

Additionally, from time to time we become aware, either based on information provided by third parties and/or the results of internal audits, of payments from payor sources that were either wholly or partially in excess of the amount that we should have been paid for the service provided. Overpayments may result from a variety of factors, including insufficient documentation supporting the services rendered or medical necessity of the services or other failures to document the satisfaction of the necessary conditions of payment. We are required by law in most instances to refund the full amount of the overpayment after becoming aware of it, and failure to do so within requisite time limits imposed by the law could lead to significant fines and penalties being imposed on us. Furthermore, our initial billing of and payments for services that are unsupported by the requisite documentation and satisfaction of any other conditions of payment, regardless of our awareness of the failure at the time of the billing or payment, could expose us to significant fines and penalties. We, and/or certain of our operating companies, could also be subject to exclusion from participation in the Medicare or Medicaid programs in some circumstances as well, in addition to any monetary or other fines, penalties or sanctions that we may incur under applicable federal and/or state law. Our repayment of any such amounts, as well as any fines, penalties or other sanctions that we may incur, could be significant and could have a material and adverse effect on our results of operations and financial condition.

From time to time we are also involved in various external governmental investigations, audits and reviews. Reviews, audits and investigations of this sort can lead to government actions, which can result in the assessment of damages, civil or criminal fines or penalties, or other sanctions, including restrictions or changes in the way we conduct business, loss of licensure or exclusion from participation in government programs. Failure to comply with applicable laws, regulations and rules could have a material and adverse effect on our results of operations and financial condition. Furthermore, becoming subject to these governmental investigations, audits and reviews can also require us to incur significant legal and document production expenses as we cooperate with the government authorities, regardless of whether the particular investigation, audit or review leads to the identification of underlying issues.

As a result of increased post-payment reviews of claims we submit to Medicare for our services, we may incur additional costs and may be required to repay amounts already paid to us.

We are subject to regular post-payment inquiries, investigations and audits of the claims we submit to Medicare for payment for our services. These post-payment reviews have increased as a result of government cost-containment initiatives. These additional post-payment reviews may require us to incur additional costs to respond to requests for records and to pursue the reversal of payment denials, and ultimately may require us to refund amounts paid to us by Medicare that are determined to have been overpaid.

For a further description of this and other laws and regulations involving governmental reimbursements, see “Business—Sources of Revenue” and “—Regulation and Healthcare Reform” in Item 1.

An economic downturn, state budget pressures, sustained unemployment and continued deficit spending by the federal government may result in a reduction in reimbursement and covered services.

An economic downturn could have a detrimental effect on our revenues. Historically, state budget pressures have translated into reductions in state spending. Given that Medicaid outlays are a significant component of state budgets, we can expect continuing cost containment pressures on Medicaid outlays for our services in the states in which we operate. In addition, an economic downturn, coupled with sustained unemployment, may also impact the number of enrollees in managed care programs as well as the profitability of managed care companies, which could result in reduced reimbursement rates.

The existing federal deficit, as well as deficit spending by federal and state governments as the result of adverse developments in the economy or other reasons, can lead to continuing pressure to reduce governmental expenditures for other purposes, including government-funded programs in which we participate, such as Medicare and Medicaid. Such actions in turn may adversely affect our results of operations.

We depend upon reimbursement by third-party payors.

Substantially all of our revenues are derived from private and governmental third-party payors. In 2016, approximately 74.3% of our revenues were derived collectively from managed care plans, commercial health insurers, workers’ compensation payors, and other private pay revenue sources while approximately 25.7% of our revenues were derived from Medicare and Medicaid. Initiatives undertaken by industry and government 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 reimbursement 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. In addition, in certain geographical areas, our clinics must be approved as providers by key health maintenance organizations and preferred provider plans. Failure to obtain or maintain these approvals would adversely affect our financial results.
 
In recent years, through legislative and regulatory actions, the federal government has made substantial changes to various payment systems under the Medicare program. See “Business—Sources of Revenue” in Item 1 for more information. President Obama signed into law comprehensive reforms to the healthcare system, including changes to Medicare reimbursement. Additional reforms or other changes to these payment systems may be proposed or adopted, either by the U.S. Congress or by CMS, including bundled payments, outcomes-based payment methodologies and a shift away from traditional fee-for-service reimbursement. If revised regulations are adopted, the availability, methods and rates of Medicare reimbursements for services of the type furnished at our facilities could change. Some of these changes and proposed changes could adversely affect our business strategy, operations and financial results.

We face inspections, reviews, audits and investigations under federal and state government programs and contracts. These audits could have adverse findings that may negatively affect our business.

As a result of our participation in the Medicare and Medicaid programs, we are subject to various governmental inspections, reviews, audits and investigations to verify our compliance with these programs and applicable laws and regulations. Managed care payors may also reserve the right to conduct audits. An adverse inspection, review, audit or investigation could result in:

refunding amounts we have been paid pursuant to the Medicare or Medicaid programs or from managed care payors;
 
state or federal agencies imposing fines, penalties and other sanctions on us;
 
temporary suspension of payment for new patients to the facility or agency;
 
decertification or exclusion from participation in the Medicare or Medicaid programs or one or more managed care payor networks;
 
expansion of the scope of our Corporate Integrity Agreement;
 
damage to our reputation;
 
the revocation of a facility’s or agency’s license; and
 
loss of certain rights under, or termination of, our contracts with managed care payors.

If adverse inspections, reviews, audits or investigations occur and any of the results noted above occur, it could have a material adverse effect on our business and operating results.

Our facilities are subject to extensive federal and state laws and regulations relating to the privacy of individually identifiable information.

HIPAA required the HHS to adopt standards to protect the privacy and security of individually identifiable health-related information. The department released final regulations containing privacy standards in 2000 and published revisions to the final regulations in 2002. The privacy regulations extensively regulate the use and disclosure of individually identifiable health-related information. The regulations also provide patients with significant rights related to understanding and controlling how their health information is used or disclosed. The security regulations require healthcare providers to implement administrative, physical and technical practices to protect the security of individually identifiable health information that is maintained or transmitted electronically. HITECH, which was signed into law in 2009, enhanced the privacy, security and enforcement provisions of HIPAA by, among other things establishing security breach notification requirements, allowing enforcement of HIPAA by state attorneys general, and increasing penalties for HIPAA violations. Violations of HIPAA or HITECH could result in civil or criminal penalties.

In addition to HIPAA, there are numerous federal and state laws and regulations addressing patient and consumer privacy concerns, including unauthorized access or theft of personal information. State statutes and regulations vary from state to state. Lawsuits, including class actions and action by state attorneys general, directed at companies that have experienced a privacy or security breach also can occur.

The Company and its clinics have established policies and procedures in an effort to ensure compliance with these privacy related requirements. However, if there is a breach, we may be subject to various penalties and damages and may be required to incur costs to mitigate the impact of the breach on affected individuals.
 
We may be adversely affected by a cyber-attack that could compromise our information technologies, which may cause a violation of HIPAA or HITECH.

In the normal course of business, our information technology systems hold sensitive patient information including patient demographic data, eligibility for various medical plans including Medicare and Medicaid and protected health information, which is subject to HIPAA and HITECH. We maintain our information technology systems with safeguards protecting against cyber-attacks, including passive intrusion protection, firewalls and virus detection software. However, these safeguards do not ensure that a significant cyber-attack could not occur. A cyber-attack that bypasses our information technology security systems could cause the loss of protected health information, or other data subject to privacy laws, the loss of proprietary business information, or a material disruption to our information technology business systems resulting in a material adverse effect on our business, financial condition, and results of operations or cash flows. In addition, our future results could be adversely affected due to the theft, destruction, loss, misappropriation or release of protected health information, other confidential data or proprietary business information, operational or business delays resulting from the disruption of information technology systems and subsequent clean-up and mitigation activities, negative publicity resulting in reputation or brand damage with clients, members, or industry peers, or regulatory action taken as a result of such incident.

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 and other referral sources. Physicians referring patients to our clinics are free to refer their patients to other therapy providers or to their own physician owned therapy practice. If we are unable to successfully cultivate and maintain strong relationships with physicians and other referral sources, our business may decrease and our net operating revenues may decline.

We depend upon our ability to recruit and retain experienced physical therapists.

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 clinically skilled 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 of a therapist who satisfies our standards.

Our revenues may fluctuate due to weather.

We have a significant number of clinics in states that normally experience snow and ice during the winter months. Also, a significant number of our clinics are located in states along the Gulf Coast and Atlantic Coast which are subject to periodic winter storms, hurricanes and other severe storm systems. Periods of severe weather may cause physical damage to our facilities or prevent our staff or patients from traveling to our clinics, which may cause a decrease in our net operating revenues.

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. Intense competition may adversely affect our business, financial condition or results of operations. For a more complete description of this competitive environment, see “Business—Competition” in Item 1. An adverse effect on our business, financial condition or results of operations may require us to write-down goodwill.

We may incur closure costs and losses.

The competitive, economic or reimbursement conditions in our markets in which we operate may require us to reorganize or to close certain clinics. In the event a clinic is reorganized or closed, we may incur losses and closure costs. The closure costs and losses may include, but are not limited to, lease obligations, severance, and write-down or write-off of goodwill and other intangible assets.

Future acquisitions may use significant resources, may be unsuccessful and could expose us to unforeseen liabilities.

As part of our growth strategy, we intend to continue pursuing acquisitions of outpatient physical therapy clinics. Acquisitions may involve significant cash expenditures, potential debt incurrence and operational losses, dilutive issuances of equity securities and expenses that could have an adverse effect on our financial condition and results of operations. Acquisitions involve numerous risks, including:

the difficulty and expense of integrating acquired personnel into our business;
 
the diversion of management’s time from existing operations;
 
the potential loss of key employees of acquired companies;
 
the difficulty of assignment and/or procurement of managed care contractual arrangements; and
 
the assumption of the liabilities and exposure to unforeseen liabilities of acquired companies, including liabilities for failure to comply with healthcare regulations.
 
Issuance of shares in connection with financing transactions or under stock incentive plans will dilute current stockholders.

Pursuant to our stock incentive plans, our Compensation Committee of the Board, consisting solely of independent directors, is authorized to grant stock awards to our employees, directors and consultants. Shareholders will incur dilution upon the exercise of any outstanding stock awards or the grant of any restricted stock. In addition, if we raise additional funds by issuing additional common stock, or securities convertible into or exchangeable or exercisable for common stock, further dilution to our existing stockholders will result, and new investors could have rights superior to existing stockholders.

The number of shares of our common stock eligible for future sale could adversely affect the market price of our stock.

At December 31, 2016, we had reserved approximately 566,000 shares for future equity grants. 216,000 shares of common stock pursuant to our equity plans are registered for sale or resale on currently effective registration statements and have been approved by stockholders. The remaining 350,000 shares have been approved by the stockholders and will be register for sale or resale in 2017.  We may issue additional restricted securities or register additional shares of common stock under the Securities Act of 1933, as amended (the “Securities Act”), in the future. The issuance of a significant number of shares of common stock upon the exercise of stock options or the availability for sale, or sale, of a substantial number of the shares of common stock eligible for future sale under effective registration statements, under Rule 144 or otherwise, could adversely affect the market price of the common stock.

Provisions in our articles of incorporation and bylaws could delay or prevent a change in control of our company, even if that change would be beneficial to our stockholders.

Certain provisions of our articles of incorporation and bylaws may delay, discourage, prevent or render more difficult an attempt to obtain control of our company, whether through a tender offer, business combination, proxy contest or otherwise. These provisions include the charter authorization of “blank check” preferred stock and a restriction on the ability of stockholders to call a special meeting.

ITEM 1B.
UNRESOLVED STAFF COMMENTS.

We received comment letters from the SEC Staff regarding our historical accounting for mandatorily redeemable non-controlling interests.  We responded to the Staff’s letters and have had several discussions with them. The financial statements included in the Annual Report have been restated to reflect our interpretation and application of the technical accounting requirements associated with mandatorily redeemable non-controlling interests.

ITEM 2.
PROPERTIES.

We lease the properties used for our clinics under non-cancelable operating leases with terms ranging from one to five years, with the exception of the property for one clinic which we own. We intend to lease the premises for any new clinic locations except in rare instances where leasing is not a cost-effective alternative. Our typical clinic occupies 1,600 to 3,000 square feet.

We also lease our executive offices located in Houston, Texas, under a non-cancelable operating lease expiring in April 2022. We currently occupy approximately 39,452 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. On March 31, 2017, an alleged shareholder of the Company filed a putative class action lawsuit in the United States District Court for the Southern District of New York against the Company, chief executive officer Christopher J. Reading, chief financial officer Lawrance C. McAfee and corporate controller, Jon C. Bates, alleging, inter alia, that the defendants misstated or omitted to state material information concerning the Company’s historical accounting for redeemable non-controlling interests of acquired partnerships, in alleged violation of Sections 10(b) and 20(a) of the Exchange Act. The complaint seeks a declaration that the action is a proper class action under Rule 23 of the Federal Rules of Civil Procedure, unspecified compensatory damages in an amount to be determined at trial and interest, costs and expenses.  The proceeding is in its initial stages and the defendants have not yet answered, moved against or otherwise responded to the complaint, though they intend to defend themselves vigorously.

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 will have a material impact on our business, financial condition or results of operations.

ITEM 4.
MINE SAFETY DISCLOSURES.

Not Applicable.
 
PART II

ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

PRICE QUOTATIONS

Our common stock has traded on the New York Stock Exchange (“NYSE”) since August 14, 2012 under the symbol “USPH.” Prior to that, our common stock was traded on the Nasdaq Global Select Market under the symbol “USPH”. As of June 6, 2017, there were 68 holders of record of our outstanding common stock. The table below indicates the high and low sales prices of our common stock reported for the periods presented.

   
2016
   
2015
 
Quarter
 
High
   
Low
   
High
   
Low
 
                         
First
 
$
54.35
   
$
45.62
   
$
50.79
   
$
38.17
 
Second
   
61.31
     
46.39
     
55.22
     
43.13
 
Third
   
64.89
     
57.76
     
56.37
     
42.59
 
Fourth
   
72.65
     
51.96
     
55.75
     
43.18
 

On March 28, 2017, the Board of Directors declared a dividend of $0.20 per share on all shares of common stock issued and outstanding to those shareholders of record on April 17, 2017 and, on May 25, 2017, the Board of Directors declared a dividend of $0.20 per share on all shares of common stock issued and outstanding to those shareholders of record on June 16, 2017.  The dividend declared on March 28, 2017 was paid on May 5, 2017 and the one declared on May 25, 2017 will be paid on July 7, 2017.  During 2016, we paid a regular quarterly dividend of $0.17 per share totaling $0.68 per share, which amounted to a total of aggregate cash payments of dividends to holders of our common stock in 2016 of approximately $8.5 million. During 2015, we paid a quarterly dividend of $0.15 per share totaling $0.60 per share for 2015, which amounted to a total of aggregate cash payments of dividends to holders of our common stock in 2015 of approximately $7.4 million. We are currently restricted from paying dividends in excess of $15,000,000 in any fiscal year on our common stock under the Credit Agreement (as defined in ‘‘Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources’’).
 
FIVE YEAR PERFORMANCE GRAPH

The performance graph and related description shall not be deemed incorporated by reference into any filing under the Securities Act or under the Exchange Act, except to the extent that the Company specifically incorporates this information by reference. In addition, the performance graph and the related description shall not be deemed “soliciting material” or “filed” with the SEC or subject to Regulation 14A or 14C.

Prior to August 14, 2012, our common stock traded on the Nasdaq Global Select Market. On August 14, 2012, our common stock began trading on NYSE. The following performance graph compares the cumulative total stockholder return of our common stock to The NYSE Composite Index and the NYSE Health Care Index for the period from December 31, 2011 through December 31, 2016. The graph assumes that $100 was invested in our common stock and the common stock of each of the companies listed on The NYSE Composite Index and The NYSE Health Care Index on December 31, 2011 and that any dividends were reinvested.

Comparison of Five Years Cumulative Total Return for the Year Ended December 31, 2016
 
 
 
12/11
12/12
12/13
12/14
12/15
12/16
U. S. Physical Therapy, Inc.
 100
 140
 179
 213
 273
 357
NYSE Composite
 100
 113
 139
 145
 136
 148
NYSE Healthcare Index
 100
 112
 145
 170
 176
 169
 
ITEM 6.
SELECTED FINANCIAL DATA.

Prior to issuing the 2016 annual financial statements, the Company determined it had accounted for redeemable non-controlling interests incorrectly.  Accordingly, the Company has restated prior periods included in the selected financial data below to reflect the correction in the appropriate periods.  For more information on this matter, see Footnote 1 – Organization, Nature of Operations and Basis of Presentation – Restatement of Prior Financial Statements and Footnote 2 – Significant Accounting Policies – Mandatorily Redeemable Non-controlling interests – in the accompanying financial statements for a details of the restatement and a description of the accounting for redeemable non-controlling interests.

The following restated selected financial data from continuing operations should be read in conjunction with the description of our critical accounting policies set forth in “Management’s Discussion and Analysis of Results of Operations and Financial Condition” and the Consolidated Financial Statements and Notes included herein.

 
For the Years Ended December 31,
 
   
2016
   
2015
   
2014
   
2013
   
2012
 
         
(as restated)
   
(as restated)
   
(as restated)
   
(as restated)
 
   
($ in thousands, except per share data)
 
                               
Net revenues
 
$
356,546
   
$
331,302
   
$
305,074
   
$
264,058
   
$
249,651
 
Operating income
 
$
49,533
   
$
47,294
   
$
45,768
   
$
38,770
   
$
38,406
 
                                         
Interest expense
                                       
Mandatorily redeemable non-controlling interests - change in redemption value
 
$
6,169
   
$
2,670
   
$
2,978
   
$
1,222
   
$
4,171
 
Mandatorily redeemable non-controlling interests - earnings allocable
 
$
4,057
   
$
3,538
   
$
3,388
   
$
2,642
   
$
2,356
 
Debt and other
 
$
1,252
   
$
1,031
   
$
1,088
   
$
538
   
$
557
 
Total interest expense
 
$
11,478
   
$
7,239
   
$
7,454
   
$
4,402
   
$
7,084
 
                                         
Net income
 
$
26,268
   
$
26,489
   
$
25,314
   
$
22,981
   
$
21,690
 
Net income attributable to non-controlling interests
 
$
5,717
   
$
5,874
   
$
6,183
   
$
5,869
   
$
6,072
 
Net income attributable to USPH shareholders
 
$
20,551
   
$
20,615
   
$
19,131
   
$
17,112
   
$
15,618
 
                                         
Per share net income attributable to USPH shareholders:
                                       
Basic
 
$
1.64
   
$
1.66
   
$
1.57
   
$
1.42
   
$
1.32
 
Diluted
 
$
1.64
   
$
1.66
   
$
1.57
   
$
1.42
   
$
1.31
 
                                         
                                         
Dividends declared and paid per common share
 
$
0.68
   
$
0.60
   
$
0.48
   
$
0.40
   
$
0.76
 
                                         
 
On December 31,
 
    2016     2015     2014   2013    
2012
           
(as restated)
   
(as restated)
   
(as restated)
   
(as restated)
 
   
($ in thousands)
 
                                         
Total assets.
 
$
351,231
   
$
303,757
   
$
268,377
   
$
247,436
   
$
195,015
 
Mandatorily redeemable non-controlling interests
 
$
69,190
   
$
45,974
   
$
40,371
   
$
38,004
   
$
26,572
 
Long-term debt, less current portion
 
$
50,596
   
$
48,335
   
$
34,734
   
$
40,650
   
$
17,575
 
Working capital
 
$
41,347
   
$
41,193
   
$
29,347
   
$
26,488
   
$
29,015
 
Current ratio
   
2.68
     
3.17
     
2.15
     
2.14
     
2.78
 
 
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

EXECUTIVE SUMMARY

Our Business. We operate outpatient physical therapy clinics that provide pre- and post-operative care and treatment for a variety of orthopedic-related disorders and sports-related injuries, neurologically-related injuries and rehabilitation of injured workers. At December 31, 2016, we operated 540 clinics in 42 states. The average age of our clinics at December 31, 2016 was 9.3 years.

During 2016, 2015 and 2014, we completed the following multi-clinic acquisitions:
 
Acquisition  
 Date 
 
% Interest
Acquired
   
Number of
Clinics
 
 
 2016
           
February 2016 Acquisition
 
February  29
   
55
%
   
8
 
November 2016 Acquisition
 
November 30
   
60
%
   
12
 
                     
 
 2015
               
January 2015 Acquisition
 
January 31
   
60
%
   
9
 
April 2015 Acquisition
 
April 30
   
70
%
   
3
 
June 2015 Acquisition
 
June 30
   
70
%
   
4
 
December 2015 Acquisition
 
December 31
   
59
%
   
4
 
                     
 
 2014
               
April 2014 Acquisition
 
April 30
   
70
%
   
13
 
August 2014 Acquisition
 
August 1
   
100
%    
3
 
 
In addition to the multi-clinic acquisitions, we acquired two single clinic practices in separate transactions during 2016.  During 2015, we acquired a 60% interest in a single clinic practice and, during 2014, we acquired four individual clinics in separate transactions.

The results of operations of the clinics we acquired have been included in our consolidated financial statements since the date of the respective acquisition.

In addition to our owned clinics, we also manage physical therapy facilities for third parties. As of December 31, 2016, we had 20 physician or hospital owned facilities under management.

Recent Restatement of Our Historical Financial Statements.  In connection with the preparation of our 2016 annual financial statements, we determined that our historical accounting for redeemable non-controlling interests of acquired partnerships was incorrect.  This error was the result of an incorrect interpretation of technical accounting guidance concerning the classification of instruments as liabilities or equity.  Specifically, we recently determined that, under applicable accounting guidance, the redemption feature included in the partnership agreements should be considered a mandatorily redeemable financial instrument.  Accordingly, such interests should be accounted for as a liability, and not as temporary equity.  This error did not affect any of our partnership agreements for de novo clinics as those agreements do not contain a redemption feature.

As a result of the restatement, we determined that a material weakness existed in our internal control over financial reporting.  We have taken steps to remediate the material weakness, which relates to our accounting for, and reporting of, non-controlling interests, by engaging in a further analysis of the applicable technical accounting requirements and developing specific policies and procedures to evaluate our compliance with such requirements when we acquire future partnerships.  See Item 9A. – Controls and Procedures – for further discussion.

Although, the accounting error caused us to be in technical violation of our Amended Credit Agreement dated December 5, 2013, we were able to obtain the necessary waivers and amendments, as applicable.  As of the date of the filing of this Annual Report, we are in compliance with all our covenants thereunder.
 
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. Revenues are recognized in the period in which services are rendered. Net patient revenues (patient revenues less estimated contractual adjustments) 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 contracted amounts different from its established rates. The allowance for estimated contractual adjustments is based on terms of payor contracts and historical collection and write-off experience.

Contractual Allowances. Contractual allowances result from the differences between the rates charged for services performed and expected reimbursements by both insurance companies and government sponsored healthcare programs for such services. Medicare regulations and the various third party payors and managed care contracts are often complex and may include multiple reimbursement mechanisms payable for the services provided in our clinics. We estimate contractual allowances based on our interpretation of the applicable regulations, payor contracts and historical calculations. Each month the Company estimates its contractual allowance for each clinic based on payor contracts and the historical collection experience of the clinic and applies an appropriate contractual allowance reserve percentage to the gross accounts receivable balances for each payor of the clinic. Based on our historical experience, calculating the contractual allowance reserve percentage at the payor level is sufficient to allow us to provide the necessary detail and accuracy with our collectability estimates. However, the services authorized and provided and related reimbursement are subject to interpretation that could result in payments that differ from our estimates. Payor terms are periodically revised necessitating continual review and assessment of the estimates made by management. Our billing system may not capture the exact change in our contractual allowance reserve estimate from period to period. Therefore, in order to assess the accuracy of our revenues and hence our contractual allowance reserves, our management regularly compares its cash collections to corresponding net revenues measured both in the aggregate and on a clinic-by-clinic basis. In the aggregate, the historical difference between net revenues and corresponding cash collections has generally reflected a difference within approximately 1% of net revenues. Additionally, analysis of subsequent period’s contractual write-offs on a payor basis reflects a difference within approximately 1% between the actual aggregate contractual reserve percentage as compared to the estimated contractual allowance reserve percentage associated with the same period end balance. As a result, we believe that a reasonable likely change in the contractual allowance reserve estimate would not be more than 1% at December 31, 2016. For purposes of demonstrating the sensitivity of this estimate on the Company’s financial condition, a one percent increase or decrease in our aggregate contractual allowance reserve percentage would decrease or increase, respectively, net patient revenue by approximately $901,450 for the year ended December 31, 2016. Management believes the changes in the estimate of the contractual allowance reserve for the periods ended December 31, 2016, 2015 and 2014 have not been material to the statement of operations.

The following table sets forth information regarding our patient accounts receivable as of the dates indicated (in thousands):

   
December 31,
 
   
2016
   
2015
 
Gross patient accounts receivable
 
$
90,145
   
$
84,584
 
Less contractual allowances
   
49,513
     
46,909
 
Subtotal - accounts receivable
   
40,632
     
37,675
 
Less allowance for doubtful accounts
   
1,792
     
1,444
 
Net patient accounts receivable
 
$
38,840
   
$
36,231
 

The following table presents our patient accounts receivable aging by payor class as of the dates indicated (in thousands):

   
December 31, 2016
   
December 31, 2015
 
Payor
 
Current to
120 Days
   
120+ Days
   
Total
   
Current to
120 Days
   
120+ Days
   
Total
 
Managed Care/ Commercial Plans
 
$
13,906
   
$
1,939
   
$
15,845
   
$
12,936
   
$
1,381
   
$
14,317
 
Medicare/Medicaid
   
8,252
     
1,201
     
9,453
     
7,380
     
1,107
     
8,487
 
Workers Compensation*
   
7,550
     
1,107
     
8,657
     
7,945
     
1,144
     
9,089
 
Self-pay
   
2,709
     
2,469
     
5,178
     
2,296
     
1,504
     
3,800
 
Other**
   
1,212
     
287
     
1,499
     
1,165
     
817
     
1,982
 
Totals
 
$
33,629
   
$
7,003
   
$
40,632
   
$
31,722
   
$
5,953
   
$
37,675
 
 

*
Workers compensation is paid by state administrators or their designated agents.

**
Other includes primarily litigation claims and, to a lesser extent, vehicular insurance claims.
 
Reimbursement for Medicare beneficiaries is based upon a fee schedule published by HHS. For a more complete description of our third party revenue sources, see “Business—Sources of Revenue” in Item 1.

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

Accounting for Income Taxes. We account for income taxes 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 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. The Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount to be recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority.

We do not believe that we have any significant uncertain tax positions at December 31, 2016, nor is this expected to change within the next twelve months due to the settlement and expiration of statutes of limitation.

We did not have any accrued interest or penalties associated with any unrecognized tax benefits nor was any interest expense recognized during the twelve months ended December 31, 2016 and 2015.

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. The accounting standards require that we periodically, and upon the occurrence of certain events, assess the recoverability of our long-lived assets. If the carrying value of our property and equipment exceeds their undiscounted cash flows, we are required to write the carrying value down to estimated fair value.

Goodwill. The fair value of goodwill and other intangible assets with indefinite lives are tested for impairment annually and upon the occurrence of certain events, and are written down to fair value if considered impaired. We evaluate goodwill for impairment on at least an annual basis (in the third quarter) by comparing the fair value of its reporting units to the carrying value of each reporting unit including related goodwill. We operate a one segment business which is made up of various clinics within partnerships. The partnerships are components of regions and are aggregated to that operating segment level for the purpose of determining reporting units when performing the annual goodwill impairment test. In 2016 and 2015, we had six regions.

An impairment loss generally would be recognized when the carrying amount of the net assets of a reporting unit, inclusive of goodwill and other intangible assets, exceeds the estimated fair value of the reporting unit. The estimated fair value of a reporting unit is determined using two factors: (i) earnings prior to taxes, depreciation and amortization for the reporting unit multiplied by a price/earnings ratio used in the industry and (ii) a discounted cash flow analysis. A weight is assigned to each factor and the sum of each weight times the factor is considered the estimated fair value. For 2016, the factors (i.e., price/earnings ratio, discount rate and residual capitalization rate) were updated to reflect current market conditions. The evaluation of goodwill in 2016, 2015 and 2014 did not result in any goodwill amounts that were deemed impaired.

Mandatorily Redeemable Non-Controlling Interests –  The non-controlling interests that are reflected as mandatorily redeemable non-controlling interests in the consolidated financial statements are subject to Required Redemption (as defined in Footnote 5 – Mandatorily Redeemable Non-Controlling Interest), whether currently exercisable or not, and which currently, or in the future, require that the Company purchase the non-controlling interest of those owners at a predetermined formula based on a multiple of trailing twelve months earnings performance as defined in the respective limited partnership agreements.  The Required Redemption is triggered at such time as both of the following events have occurred: 1) termination of the holder’s employment with NewCo (as defined in Footnote 5 – Mandatorily Redeemable Non-Controlling Interest), regardless of the reason for such termination, and 2) the passage of specified number of years after the closing of the transaction, typically three to five years, as defined in the applicable limited partnership agreement.

On the date the Company acquires a controlling interest in a partnership and the limited partnership agreement contains a Required Redemption, the fair value of the non-controlling interest is recorded in the long-term liabilities section of the consolidated balance sheet under the caption – Mandatorily redeemable non-controlling interests.  Then, in each reporting period thereafter until purchased by the Company, the redeemable non-controlling interest is adjusted to its current Redemption Amount (as defined in Footnote 5 – Mandatorily Redeemable Non-Controlling Interest).  The Company reflects any adjustment in the Redemption Amount of the mandatorily redeemable non-controlling interest in its consolidated financial statements of net income by recording the change in the redemption value and any earnings to other income and expense in the caption - Interest expense – mandatorily redeemable non-controlling interests – change in redemption value or Interest expense – mandatorily redeemable non-controlling interests – allocable earnings, respectively. See Note 5 – Mandatorily Redeemable Non-Controlling Interest for further details.
 
SELECTED OPERATING AND FINANCIAL DATA

The following table and discussion relates to continuing operations unless otherwise noted. The defined terms with their respective description used in the following discussion are listed below:

2016
Year ended December 31, 2016
2015
Year ended December 31, 2015
2014
Year ended December 31, 2014
New Clinics
Clinics opened or acquired during the year ended December 31, 2016
Mature Clinics
Clinics opened or acquired prior to January 1, 2016
2015 New Clinics
Clinics opened or acquired during the year ended December 31, 2015
2015 Mature Clinics
Clinics opened or acquired prior to January 1, 2015
2014 New Clinics.
Clinics opened or acquired during the year ended December 31, 2014
2014 Mature Clinics
Clinics opened or acquired prior to January 1, 2014
2013 New Clinics
Clinics opened or acquired during the year ended December 31, 2013
 
The following table presents selected operating and financial data, used by management as key indicators of our operating performance:

   
For the Years Ended December 31,
 
   
2016
   
2015
   
2014
 
Number of clinics, at the end of period
   
540
     
508
     
489
 
Working Days
   
255
     
255
     
255
 
Average visits per day per clinic
   
25.0
     
24.1
     
22.9
 
Total patient visits
   
3,316,729
     
3,080,166
     
2,818,815
 
Net patient revenue per visit
 
$
105.18
   
$
105.28
   
$
106.08
 

RESULTS OF OPERATIONS

FISCAL YEAR 2016 COMPARED TO FISCAL 2015
 
Net revenues rose 7.6 % to $356.5 million for 2016 from $331.3 million for 2015 primarily due to increases in net patient revenues which are discussed in detail below.
 
Net income attributable to USPH shareholders prior to interest expense – mandatorily redeemable non-controlling interest – change in redemption value (“operating results”) was $24.3 million in 2016, or $1.94 per diluted share, and $22.2 million in 2015, or $1.79 per diluted share.  The following table details this computation:

   
For the Year Ended
 
   
December 31, 2016
   
December 31, 2015
 
         
(as restated)
 
Net income attributable to USPH shareholders
 
$
20,551
   
$
20,615
 
                 
Adjustments:
               
Interest expense MRNCI * - change in redemption value, net of tax
   
3,748
     
1,622
 
Operating results
 
$
24,299
   
$
22,237
 

* Mandatorily redeemable non-controlling interest
 
The above table reconciles net income attributable to USPH shareholders calculated in accordance with GAAP to operating results.  Operating results is defined as USPH’s net income attributable to common shareholders prior to interest expense – mandatorily redeemable non-controlling interests – change in redemption value, net of tax.  Management uses operating results, which eliminates this non-cash item that can be subject to volatility, as one of the principal measures to evaluate and monitor financial performance period over period.  Management believes that operating results is useful information for investors to use in comparing the Company's period-to-period results as well as for comparing with other similar businesses since most do not have mandatorily redeemable instruments and therefore have different liability and equity structures. Operating results is not a measure of financial performance under GAAP and should not be considered in isolation or as an alternative to, or substitute for, net income attributable to USPH shareholders presented in the consolidated financial statements.

Net Patient Revenues

Net patient revenues increased to $348.8 million for 2016 from $324.3 million for 2015, an increase of $24.5 million, or 7.6%. The increase in net patient revenues of $24.5 million consisted of an increase of $12.8 million from New Clinics and $11.7 million from Mature Clinics of which $15.1 million was related to 2015 New Clinics offset by a decrease of $3.4 million related to 2015 Mature Clinics. During 2016, we acquired two multi-clinic groups for a total of 20 clinics. The net patient revenues from these multi-clinic groups are included in our results of operations since the respective date of their acquisition. See above table under “—Executive Summary” detailing our multi-clinic acquisitions.
 
Total patient visits increased to 3,316,800 for 2016 from 3,080,200 for 2015. The growth in patient visits was attributable to 102,800 visits in New Clinics primarily due to the acquisitions in 2016 and an increase of 133,800 visits for Mature Clinics primarily due to 2015 New Clinics.
 
The average net patient revenue per visit slightly decreased to $105.18 in 2016 from $105.28 in 2015.

Net patient revenues are based on established billing rates less allowances and discounts for patients covered by contractual programs and workers’ compensation. Net patient revenues reflect contractual and other adjustments, which we evaluate monthly, 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.

Other Revenues

Other revenues, consisting primarily of management fees, increased by $0.7 million, from $7.0 million in 2015 to $7.7 million in 2016.

Clinic Operating Costs

Clinic operating costs were $274.5 million, or 77.0% of net revenues, for 2016 and $252.9 million, or 76.3% of net revenues, for 2015. The increase was attributable to $10.9 million in operating costs for New Clinics, an increase in operating costs of $11.2 million for 2015 New Clinics, due to a full year of activity (see table detailing acquisition dates above under – “Executive Summary”), and an decrease of $0.5 million for 2014 Mature Clinics. Each component of clinic operating costs is discussed below:

Clinic Operating Costs—Salaries and Related Costs

Salaries and related costs increased to $198.5 million for 2016 from $180.5 million for 2015, an increase of $18.0 million, or 10.0%. Approximately $7.6 million of the increase was attributable to New Clinics, $8.0 million of the increase was due to a higher costs at various 2015 New Clinics due to a full year of activity and higher costs of $2.4 million at 2014 Mature Clinics. Salaries and related costs as a percentage of net revenues was 55.7% for 2016 and 54.5% for 2015.

Clinic Operating Costs—Rent, Clinic Supplies, Contract Labor and Other

Rent, clinic supplies, contract labor and other costs increased to $71.9 million for 2016 from $68.0 million for 2015, an increase of $3.9 million, or 5.6%. For 2016, New Clinics accounted for approximately $3.1 million of the increase and 2015 New Clinics accounted for approximately $3.2 million of the increase due to a full year of activity. Rent, clinic supplies, contract labor and other costs for 2015 Mature Clinics decreased $2.4 million in 2016 as compared to 2015. Rent, clinic supplies, contract labor and other costs as a percent of net revenues was 20.2% for 2016 and 20.5% for 2015.

Clinic Operating Costs—Provision for Doubtful Accounts

The provision for doubtful accounts for net patient receivables was $4.0 million for 2016 and $4.2 million for 2015. As a percentage of net patient revenues, the provision for doubtful accounts was 1.1% for 2016 and 1.3% for 2015.

Our provision for doubtful accounts as a percentage of total patient accounts receivable was 4.4% at December 31, 2016 and 3.8% at December 31, 2015. The provision for doubtful accounts at the end of each period is based on a detailed, clinic-by-clinic review of overdue accounts and is regularly reviewed in the aggregate in light of historical experience.

The average accounts receivable days outstanding were 36 days for December 31, 2016 and for December 31, 2015. Net patient receivables in the amount of $3.6 million and $4.4 million were written-off in 2016 and 2015, respectively.
 
Closure Costs

For 2016 and 2015, closure costs amounted to $131,000 and $211,000, respectively.

Gross Margin

In 2016, the gross margin (net revenues less total clinic operating costs) increased by 4.7% to $82.0 million from $78.4 million in 2015. The gross margin percentage for 2016 was 23.0% as compared to 23.7% for 2015.

Corporate Office Costs

Corporate office costs, consisting primarily of salaries, benefits and equity based compensation of corporate office personnel and directors, rent, insurance costs, depreciation and amortization, travel, legal, compliance, professional, marketing and recruiting fees, were $32.5 million for 2016 and $31.1 million for 2015. The dollar increase is primarily due to increases in salaries, benefits and equity based compensation. Corporate office costs as a percentage of net revenues were 9.1% for 2016 and 9.4% in 2015.

Interest Expense – mandatorily redeemable non-controlling interest – change in redemption value.

Interest Expense – mandatorily redeemable non-controlling interest – change in redemption value increased to $6.2 million for the year 2016 from $2.7 million in 2015.  This increase is due to the increased earnings performance of the underlying businesses.  The change in redemption value is based on the redemption amount (which is derived from a formula based on a specified multiple times the underlying business’ trailing twelve months of earnings before interest, taxes, depreciation, amortization and our internal management fee) at the end of the reporting period compared to the end of the previous period.

 Interest Expense – mandatorily redeemable non-controlling interest – earnings allocable.

Interest Expense – mandatorily redeemable non-controlling interest – earnings allocable represent the portion of earnings allocable to the holders of the mandatorily redeemable non-controlling interest.  This expense increased to $4.1 million in 2016 as compared to $3.5 million in 2015.  The increase is the result of new business acquisitions and increased performance of existing businesses.

Interest Expense – debt and other

Interest expense – debt and other was $1.3 million for 2016 and $1.0 million for 2015. At December 31, 2016, $46.0 million was outstanding under our Credit Agreement. See “—Liquidity and Capital Resources” below for a discussion of the terms of our Amended Credit Agreement (as defined below under “—Liquidity and Capital Resources”).

Provision for Income Taxes

The provision for income taxes was $11.9 million for 2016 and $13.7 million for 2015. We accrued state and federal income taxes at an effective tax rate (provision for taxes divided by the difference between income before taxes and net income attributable to non-controlling interest) of 36.6% for 2016 and 39.8% for 2015. The 2016 provision for taxes includes a reduction of $1.0 million due to the adoption of new Financial Accounting Standards Board guidance relevant to stock compensation accounting provisions.  This guidance amends how excess tax benefits should be classified.  Under the guidance, excess tax benefits will be a component of the income tax provision/benefit in the period in which they occur.  The reconciliation of the 2015 federal and state returns to our book provision was $34,000 which is included in the 2016 provision.  The 2015 tax provision includes an additional $147,000 due to reconciliation of the 2014 federal and state returns to our book provision.

Net Income Attributable to Non-controlling Interests

Net income attributable to non-controlling interests was $5.7 million in 2016 and $5.9 million in 2015.
 
FISCAL YEAR 2015 COMPARED TO FISCAL 2014

Net revenues rose 8.6 % to $331.3 million for 2015 from $305.1 million for 2014 primarily due to increases in net patient revenues which are discussed in detail below.
 
Net income attributable to USPH shareholders prior to interest expense – mandatorily redeemable non-controlling interest – increase in redemption value was $22.2 million in 2015, or $1.79 per diluted share, and $20.9 million in 2014, or $1.69 per diluted share.  The following table details this computation:
 
 
 
For the Year Ended
 
 
 
December 31, 2015
   
December 31, 2014
 
 
 
(as restated)
   
(as restated)
 
Net income attributable to USPH shareholders
 
$
20,615
   
$
19,131
 
 
               
Adjustments:
               
Interest expense MRNCI * - change in redemption value, net of tax
   
1,622
     
1,809
 
Operating results
 
$
22,237
   
$
20,940
 
 
* Mandatorily redeemable non-controlling interest
 
The above table reconciles net income attributable to USPH shareholders calculated in accordance with GAAP to operating results.  Operating results is defined as USPH’s net income attributable to common shareholders prior to interest expense – mandatorily redeemable non-controlling interests – change in redemption value, net of tax.  Management uses operating results, which eliminates this non-cash item that can be subject to volatility, as one of the principal measures to evaluate and monitor financial performance period over period.  Management believes that operating results is useful information for investors to use in comparing the Company's period-to-period results as well as for comparing with other similar businesses since most do not have mandatorily redeemable instruments and therefore have different liability and equity structures. Operating results is not a measure of financial performance under GAAP and should not be considered in isolation or as an alternative to, or substitute for, net income attributable to USPH shareholders presented in the consolidated financial statements.

Net Patient Revenues

Net patient revenues increased to $324.3 million for 2015 from $299.0 million for 2014, an increase of $25.3 million, or 8.5%. The increase in net patient revenues of $25.3 million consisted of an increase of $15.2 million from New Clinics and $10.1 million from Mature Clinics of which $10.3 million was related to 2014 New Clinics offset by a small decrease of $0.2 million related to 2014 Mature Clinics. During 2015, we acquired four multi-clinic groups for a total of 20 clinics. The net patient revenues from these multi-clinic groups are included in our results of operations since the respective date of their acquisition. See above table under ‘‘—Executive Summary’’ detailing our multi-clinic acquisitions.
 
Total patient visits increased to 3,080,200 for 2015 from 2,818,800 for 2014. The growth in patient visits was attributable to 150,200 visits in New Clinics primarily due to the acquisitions in 2015 and an increase of 111,200 visits for Mature Clinics primarily due to 2014 New Clinics.
 
The average net patient revenue per visit decreased to $105.28 in 2015 from $106.08 in 2014.

Net patient revenues are based on established billing rates less allowances and discounts for patients covered by contractual programs and workers’ compensation. Net patient revenues reflect contractual and other adjustments, which we evaluate monthly, 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.

Other Revenues

Other revenues, consisting primarily of management fees, increased by $0.9 million, from $6.1 million in 2014 to $7.0 million in 2015. On December 31, 2015, we managed 21 third-party physical therapy facilities versus 16 on December 31, 2014.

Clinic Operating Costs

Clinic operating costs were $252.9 million, or 76.3% of net revenues, for 2015 and $228.9 million, or 75.0% of net revenues, for 2014. The increase was attributable to $13.9 million in operating costs for 2015 New Clinics, an increase in operating costs of $8.1 million for 2014 New Clinics and an increase of $2.0 million for 2014 Mature Clinics primarily resulting from 2013 New Clinics. Each component of clinic operating costs is discussed below.
 
Clinic Operating Costs—Salaries and Related Costs

Salaries and related costs increased to $180.5 million for 2015 from $163.4 million for 2014, an increase of $17.1 million, or 10.5%. Approximately $9.9 million of the increase was attributable to 2015 New Clinics and $5.6 million of the increase was due to a higher costs at various 2014 New Clinics due to a full year of activity (see table detailing acquisition dates above under ‘‘-Executive Summary’’) and higher costs of $1.6 million at 2014 Mature Clinics. Salaries and related costs as a percentage of net revenues was 54.5% for 2015 and 53.6% for 2014.

Clinic Operating Costs—Rent, Clinic Supplies, Contract Labor and Other

Rent, clinic supplies, contract labor and other costs increased to $68.0 million for 2015 from $61.2 million for 2014, an increase of $6.8 million, or 11.2%. For 2015, 2015 New Clinics accounted for approximately $3.8 million of the increase and 2014 New Clinics accounted for approximately $2.5 million of the increase due to a full year of activity. Rent, clinic supplies, contract labor and other costs for 2014 Mature Clinics increased $0.5 million in 2015 as compared to 2014. Rent, clinic supplies, contract labor and other costs as a percent of net revenues was 20.5% for 2015 and 20.1% for 2014.

Clinic Operating Costs—Provision for Doubtful Accounts

The provision for doubtful accounts for net patient receivables was $4.2 million for 2015 and $4.1 million for 2014. As a percentage of net patient revenues, the provision for doubtful accounts was 1.3% for 2015 and 1.4% for 2014.

Our provision for doubtful accounts as a percentage of total patient accounts receivable was 3.8% at December 31, 2015 and 4.8% at December 31, 2014. The provision for doubtful accounts at the end of each period is based on a detailed, clinic-by-clinic review of overdue accounts and is regularly reviewed in the aggregate in light of historical experience..

The average accounts receivable days outstanding were 36 days for December 31, 2015 and 39 days for December 31, 2014. Net patient receivables in the amount of $3.9 million and $4.4 million were written-off in 2015 and 2014, respectively.

Closure Costs

For 2015 and 2014, closure costs amounted to $211,000 and $169,000, respectively.

Gross Margin

In 2015, the gross margin (net revenues less total clinic operating costs) increased by 2.9% to $78.4 million from $76.2 million in 2014. The gross margin percentage for 2015 was 23.7% as compared to 25.0% for 2014.

Corporate Office Costs

Corporate office costs, consisting primarily of salaries, benefits and equity based compensation of corporate office personnel and directors, rent, insurance costs, depreciation and amortization, travel, legal, compliance, professional, marketing and recruiting fees, were $31.1 million for 2015 and $30.4 million for 2014. The dollar increase is primarily due to increases in salaries, benefits and equity based compensation. Corporate office costs as a percentage of net revenues were 9.4% for 2015 and 10.0% in 2014.

Interest Expense – mandatorily redeemable non-controlling interest – change in redemption value.

Interest Expense – mandatorily redeemable non-controlling interest – change in redemption value was $2.7 million for the year 2015 and $3.0 million in 2014.  The change in redemption value is based on the redemption amount (which is derived from a formula based on a specified multiple of the underlying business’ trailing twelve months of earnings before interest, taxes, depreciation, amortization and our internal management fee) at the end of the reporting period compared to the end of the previous period.

 Interest Expense – mandatorily redeemable non-controlling interest – earnings allocable.

Interest Expense – mandatorily redeemable non-controlling interest – earnings allocable represent the portion of earnings allocable to the holders of the mandatorily redeemable non-controlling interest.  This expense increased to $3.5 million in 2015 as compared to $3.4 million in 2014.  The increase is the result of new business acquisitions and increased performance of existing businesses.
 
Interest Expense – debt and other

Interest expense on debt remained relatively the same in 2015 and 2014. Interest expense was $1.0 million for 2015 and $1.1 million for 2014. At December 31, 2015, $44.0 million was outstanding under our Credit Agreement. See ‘‘—Liquidity and Capital Resources’’ below for a discussion of the terms of our Amended Credit Agreement (as defined below under ‘‘—Liquidity and Capital Resources’’).

Provision for Income Taxes

The provision for income taxes was $13.6 million for 2015 and $13.0 million for 2014. We accrued state and federal income taxes at an effective tax rate (provision for taxes divided by the difference between income before taxes and net income attributable to non-controlling interest) of 39.8% for 2015 and 40.5% for 2014. The 2015 provision for taxes includes an additional $147,000 due to reconciliation of the 2014 federal and state returns to our book provision and an additional $223,000 in 2014 for the 2013 reconciliation.

Net Income Attributable to Non-controlling Interests

Net income attributable to non-controlling interests was $5.9 million in 2015 and $6.2 million in 2014.

LIQUIDITY AND CAPITAL RESOURCES

We believe that our business is generating sufficient cash flow from operating activities to allow us to meet our short-term and long-term cash requirements, other than those with respect to future significant acquisitions. At December 31, 2016, we had $20.0 million in cash and cash equivalents compared to $15.8 million at December 31, 2015. 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 and availability under our Amended Credit Agreement are sufficient to fund the working capital needs of our operating subsidiaries, future clinic development and acquisitions and investments through at least December 2017. Significant acquisitions would likely require financing under our Amended Credit Agreement.

Effective December 5, 2013, we entered into an Amended and Restated Credit Agreement with a commitment for a $125.0 million revolving credit facility with a maturity date of November 30, 2018. This agreement was amended in August 2015, January 2016 and March 2017 (hereafter referred to as “Amended Credit Agreement”). The Amended Credit Agreement is unsecured and has loan covenants, including requirements that the Company comply with a consolidated fixed charge coverage ratio and consolidated leverage ratio. Proceeds from the Amended Credit Agreement may be used for working capital, acquisitions, purchases of the Company’s common stock, dividend payments to the Company’s common stockholders, capital expenditures and other corporate purposes. The pricing grid which is based on the Company’s consolidated leverage ratio with the applicable spread over LIBOR ranging from 1.5% to 2.5% or the applicable spread over the Base Rate ranging from 0.1% to 1%. Fees under the Amended Credit Agreement include an unused commitment fee ranging from 0.1% to 0.25% depending on the Company’s consolidated leverage ratio and the amount of funds outstanding under the Amended Credit Agreement. On December 31, 2016, $46.0 million was outstanding under our Amended Credit Agreement resulting in $79.0 million of availability.  As of the date of the filing of this Annual Report, we were in compliance with all of the covenants thereunder.

The increase in cash and cash equivalents of $4.3 million from December 31, 2016 to December 31, 2015 was due primarily to $51.1 million provided by operations and $2.0 million net proceeds from our Amended Credit Agreement. The major uses of cash for investing and financing activities included: purchase of businesses ($23.6 million), distributions to non-controlling interests ($10.3 million), payments of cash dividends to our shareholders ($8.5 million), purchases of fixed assets ($8.3 million), acquisitions of non-controlling interests ($1.9 million) and payments on notes payable ($0.8 million).

On November 30, 2016, we acquired a 60% interest in a 12 clinic physical therapy practice.  The purchase price for the 60% interest was $11.0 million in cash and $0.5 million in a seller note that is payable in two principal installments of $250,000 each, plus accrued interest, in November 2017 and 2018.  On February 29, 2016, we acquired a 55% interest in an eight-clinic physical therapy practice.  The purchase price for the 55% interest was $13.2 million in cash and $0.5 million in a seller note that was payable in two principal installments totaling $250,000 each, plus accrued interest.  The first installment was paid in February 2017 and the next installment is due February 2018.

On December 31, 2015, we acquired a 59% interest in a four-clinic practice for $4.6 million in cash and $400,000 in seller notes that were payable in two principal installments of an aggregate of $200,000 each, plus accrued interest.  The first installment was paid in December 2016 and the next installment is due in December 2017. On June 30, 2015, we acquired a 70% interest in a four-clinic physical therapy practice. The purchase price was $3.6 million in cash and $0.7 million in seller notes that are payable plus accrued interest, in June 2018. On April 30, 2015, we acquired a 70% interest in a three-clinic physical therapy practice. The purchase price was $4.7 million in cash and $150,000 in a seller note that was payable in two principal installments of $75,000 each, plus accrued interest.  The first installment was paid in April 2016 and the next installment is due in April 2017. On January 31, 2015, we acquired a 60% interest in a nine-clinic physical therapy practice. The purchase price for the 60% interest was $6.7 million in cash and $0.5 million in a seller note that is payable in two principal installments of $250,000 each, plus accrued interest.  The installments were paid in January 2016 and 2017. In addition to the multi-clinic acquisitions, on August 31, 2015, we acquired a 60% interest in a single physical therapy clinic for $150,000 in cash and $50,000 in a seller note that was paid plus accrued interest in August 2016.
 
Historically, we have generated sufficient cash from operations to fund our development activities and to cover operational needs. We plan to continue developing new clinics and making additional acquisitions in selected markets. We have from time to time purchased the non-controlling interests of limited partners in our Clinic Partnerships. We may purchase additional non-controlling interests in the future. Generally, any acquisition or purchase of non-controlling interests is expected to be accomplished using a combination of cash and financing. Any large acquisition would likely require financing.

We make reasonable and appropriate efforts to collect accounts receivable, including applicable deductible and co-payment amounts. Claims are submitted to payors daily, weekly or monthly in accordance with our policy or payor’s requirements. When possible, we submit our claims electronically. The collection process is time consuming and typically involves the submission of claims to multiple payors whose payment of claims may be dependent upon the payment of another payor. Claims under litigation and vehicular incidents can take a year or longer to collect. Medicare and other payor claims relating to new clinics awaiting CMS approval initially may not be submitted for six months or more. When all reasonable internal collection efforts have been exhausted, accounts are written off prior to sending them to outside collection firms. With managed care, commercial health plans and self-pay payor type receivables, the write-off generally occurs after the account receivable has been outstanding for 120 days or longer.

We have future obligations for debt repayments, employment agreements and future minimum rentals under operating leases. The obligations as of December 31, 2016 are summarized as follows (in thousands):

   
Total
   
2017
   
2018
   
2019
   
2020
   
2021
   
Thereafter
 
Credit Agreement
 
$
46,000
   
$
-
   
$
46,000
   
$
-
   
$
-
   
$
-
   
$
-
 
Notes Payable
   
5,823
     
1,227
     
2,750
     
1,846
     
-
     
-
     
-
 
Interest Payable
   
288,298
     
162,465
     
120,739
     
5,094
     
-
     
-
     
-
 
Employee Agreements
   
40,827
     
24,601
     
11,070
     
2,430
     
1,548
     
1,178
     
-
 
Operating Leases
   
96,433
     
30,376
     
23,907
     
17,041
     
15,164
     
6,850
     
3,095
 
   
$
477,381
   
$
218,669
   
$
204,466
   
$
26,411
   
$
16,712
   
$
8,028
   
$
3,095
 

In addition to the above obligations, as of December 31, 2016, we have mandatorily redeemable non-controlling interests in the consolidated financial statements which consist of those owners who have certain redemption rights, whether currently exercisable or not, and which currently, or in the future, require that the Company purchase the non-controlling interest of those owners at a predetermined formula based on a multiple of trailing twelve months earnings performance as defined in the respective limited partnership agreements amounting to $69.2 million.  The redemption rights are triggered at such time as both of the following events have occurred: 1) termination of the owner’s employment, regardless of the reason for such termination, and 2) the passage of specified number of years after the closing of the transaction, typically three to five years, as defined in the limited partnership agreement.
 
We generally enter into various notes payable as a means of financing our acquisitions. Our present outstanding notes payable relate only to certain of the acquisitions of businesses and non-controlling interests and settlement of mandatorily redeemable non-controlling interests. At December 31, 2016, our remaining outstanding balance on these notes aggregated $5.8 million.  Generally, the notes are payable in equal annual installments of principal over two years plus any accrued and unpaid interest. See above table for a detail of future principal payments. Interest accrues at various interest rates ranging from 3.25% to 4.0% per annum, subject to adjustment. In addition, we assumed leases with remaining terms of 1 month to 6 years for the operating facilities.

In conjunction with the above mentioned acquisitions, in the event that a limited minority partner’s employment ceases, typically after three to five years, from the original date the interest was acquired, we have agreed to repurchase that individual’s non-controlling interest (mandatorily redeemable non-controlling interests) at a predetermined multiple of earnings before interest, taxes, depreciation, amortization and certain intercompany charges.

As of December 31, 2016, we have accrued $3.9 million related to credit balances and overpayments due to patients and payors. This amount is expected to be paid in 2017.

From September 2001 through December 31, 2008, our Board of Directors (“Board”) authorized us to purchase, in the open market or in privately negotiated transactions, up to 2,250,000 shares of our common stock. In March 2009, the Board authorized the repurchase of up to 10% or approximately 1,200,000 shares of our common stock (“March 2009 Authorization”). Our Amended Credit Agreement permits share repurchases of up to $15,000,000, subject to compliance with covenants. We are required to retire shares purchased under the March 2009 Authorization.

There is no expiration date for the share repurchase program. As of December 31, 2016, there are currently an additional estimated 213,675 shares (based on the closing price of $70.20 on December 31, 2016)  that may be purchased from time to time in the open market or private transactions depending on price, availability and our cash position. We did not purchase any shares of our common stock during the year ended December 31, 2016.
 
Off Balance Sheet Arrangements

With the exception of operating leases for our executive offices and clinic facilities discussed in Note 15 to our consolidated financial statements included in Item 8, we have no off-balance sheet debt or other off-balance sheet financing arrangements.

FACTORS AFFECTING FUTURE RESULTS

The risks related to our business and operations include:

·
the risk that the restatement of prior financial statements due to the correction in the accounting method for redeemable non-controlling interests could adversely affect the Company’s ability to make timely filings with the Securities and Exchange Commission;

·
cost, risks and uncertainties associated with the Company’s recent restatement of its prior financial statements due to the correction of its  accounting methodology for redeemable non-controlling partnership interests, and including any pending and future claims or proceedings relating to such matters;

·
changes in Medicare rules and guidelines and reimbursement or failure of our clinics to maintain their Medicare certification or enrollment status;
 
·
revenue we receive from Medicare and Medicaid being subject to potential retroactive reduction;
 
·
business and regulatory conditions including federal and state regulations;
 
·
governmental and other third party payor inspections, reviews, investigations and audits;
 
·
compliance with federal and state laws and regulations relating to the privacy of individually identifiable patient information, and associated fines and penalties for failure to comply;
 
·
legal actions, which could subject us to increased operating costs and uninsured liabilities;
 
·
changes in reimbursement rates or payment methods from third party payors including government agencies and deductibles and co-pays owed by patients;
 
·
revenue and earnings expectations;
 
·
general economic conditions;
 
·
availability and cost of qualified physical therapists;
 
·
personnel productivity and retaining key personnel;
 
·
competitive, economic or reimbursement conditions in our markets which may require us to reorganize or close certain clinics and thereby incur losses and/or closure costs including the possible write-down or write-off of goodwill and other intangible assets;
 
·
acquisitions, purchase of non-controlling interests (minority interests) and the successful integration of the operations of the acquired businesses;
 
·
our ability to design and maintain effective internal control over financial reporting and remediate the material weakness in internal control over financial reporting related to our accounting for redeemable non-controlling partnership interests;
 
·
maintaining necessary insurance coverage;
 
·
availability, terms, and use of capital; and
 
·
weather and other seasonal factors.

See also Risk Factors in Item 1A of this Annual Report on Form 10-K.

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

We do not maintain any derivative instruments such as interest rate swap arrangements, hedging contracts, futures contracts or the like. Our only indebtedness as of December 31, 2016 was the outstanding balance of seller notes of $5.8 million and an outstanding balance on our Amended Credit Agreement of $46.0 million. The outstanding balance under our Amended Credit Agreement is subject to fluctuating interest rates. A 1% change in the interest rate would yield an additional $460,000 of interest expense. See Note 9 to our consolidated financial statements included in Item 8.
 
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND RELATED INFORMATION
 
36
38
39
40
41
42
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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

We have audited the accompanying consolidated balance sheets of US Physical Therapy, Inc. (a Nevada corporation) and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of net income, equity, and cash flows for each of the three years in the period ended December 31, 2016. Our audits of the basic consolidated financial statements included the financial statement schedule listed in the index appearing under Item 15(a)(2). These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 US Physical Therapy, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

As discussed in Note 1, the 2015 and 2014 consolidated financial statements have been restated to correct an error.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated June 7, 2017 expressed an adverse opinion.

/s/ GRANT THORNTON LLP

Houston, Texas
June 7, 2017
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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

We have audited the internal control over financial reporting of US Physical Therapy, Inc. (a Nevada corporation) and subsidiaries (the “Company”) as of December 31, 2016, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting (“Management’s Report”). Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a deficiency, or combination of control deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management’s assessment. The Company identified a material weakness related to the accounting for redeemable non-controlling interests.  The Company’s business combination/purchase accounting controls related to the accounting for redeemable non-controlling interests were not designed effectively to ensure that the Company correctly interpreted and applied technical accounting requirements concerning the classification of such interests in the consolidated financial statements.

In our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control—Integrated Framework issued by COSO.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of the Company as of and for the year ended December 31, 2016. The material weakness identified above was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2016 consolidated financial statements, and this report does not affect our report dated June 7, 2017, which expressed an unqualified opinion on those financial statements.

/s/ GRANT THORNTON LLP

Houston, Texas
June 7, 2017
 
U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)

   
December 31, 2016
   
December 31, 2015
 
ASSETS
       
(as restated)
 
Current assets:
           
Cash and cash equivalents
 
$
20,047
   
$
15,778
 
Patient accounts receivable, less allowance for doubtful accounts of $1,792  and $1,444, respectively
   
38,840
     
36,231
 
Accounts receivable - other, less allowance for doubtful accounts of $-0- and $198, respectively
   
2,649
     
2,388
 
Other current assets
   
4,428
     
5,803
 
Total current assets
   
65,964
     
60,200
 
Fixed assets:
               
Furniture and equipment
   
48,426
     
44,749
 
Leasehold improvements
   
26,765
     
25,160
 
Fixed assets, gross
   
75,191
     
69,909
 
Less accumulated depreciation and amortization
   
56,018
     
53,255
 
Fixed assets, net
   
19,173
     
16,654
 
Goodwill
   
226,806
     
195,373
 
Other identifiable intangible assets, net
   
38,060
     
30,296
 
Other assets
   
1,228
     
1,234
 
Total assets
 
$
351,231
   
$
303,757
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable - trade
 
$
1,634
   
$
1,636
 
Accrued expenses
   
21,756
     
16,596
 
Current portion of notes payable
   
1,227
     
775
 
Total current liabilities
   
24,617
     
19,007
 
Notes payable
   
4,596
     
4,335
 
Revolving line of credit
   
46,000
     
44,000
 
Mandatorily redeemable non-controlling interests
   
69,190
     
45,974
 
Deferred taxes
   
15,736
     
15,508
 
Deferred rent
   
1,575
     
1,395
 
Other long-term liabilities
   
829
     
1,228
 
Total liabilities
   
162,543
     
131,447
 
Commitments and contingencies
               
U.S. Physical Therapy, Inc. ("USPH") shareholders’ equity:
               
Preferred stock, $.01 par value, 500,000 shares authorized, no shares issued and outstanding
   
-
     
-
 
Common stock, $.01 par value, 20,000,000 shares authorized, 14,732,699 and 14,635,874 shares issued, respectively
   
147
     
146
 
Additional paid-in capital
   
68,687
     
64,238
 
Retained earnings
   
150,342
     
138,301
 
Treasury stock at cost, 2,214,737 shares
   
(31,628
)
   
(31,628
)
Total USPH shareholders’ equity
   
187,548
     
171,057
 
Non-controlling interests
   
1,140
     
1,253
 
Total USPH shareholders' equity and non-controlling interests
   
188,688
     
172,310
 
Total liabilities, USPH shareholders' equity and non-controlling interests
 
$
351,231
   
$
303,757
 

See notes to consolidated financial statements.
 
U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF NET INCOME
(In thousands, except per share data)

   
Year Ended
 
   
December 31, 2016
   
December 31, 2015
   
December 31, 2014
 
         
(as restated)
   
(as restated)
 
Net patient revenues
 
$
348,839
   
$
324,293
   
$
299,009
 
Other revenues
   
7,707
     
7,009
     
6,065
 
Net revenues
   
356,546
     
331,302
     
305,074
 
Clinic operating costs:
                       
Salaries and related costs
   
198,495
     
180,514
     
163,417
 
Rent, clinic supplies, contract labor and other
   
71,868
     
68,046
     
61,209
 
Provision for doubtful accounts
   
4,040
     
4,170
     
4,112
 
Closure costs
   
131
     
211
     
169
 
Total clinic operating costs
   
274,534
     
252,941
     
228,907
 
                         
Gross margin
   
82,012
     
78,361
     
76,167
 
                         
Corporate office costs
   
32,479
     
31,067
     
30,399
 
Operating income
   
49,533
     
47,294
     
45,768
 
                         
Interest and other income, net
   
93
     
81
     
18
 
Interest expense
                       
Mandatorily redeemable non-controlling interests - change in redemption value
   
(6,169
)
   
(2,670
)
   
(2,978
)
Mandatorily redeemable non-controlling interests - earnings allocable
   
(4,057
)
   
(3,538
)
   
(3,388
)
Debt and other
   
(1,252
)
   
(1,031
)
   
(1,088
)
Total interest expense
   
(11,478
)
   
(7,239
)
   
(7,454
)
                         
Income before taxes
   
38,148
     
40,136
     
38,332
 
                         
Provision for income taxes
   
11,880
     
13,647
     
13,018
 
                         
Net income
   
26,268
     
26,489
     
25,314
 
                         
Less: net income attributable to non-controlling interests
   
(5,717
)
   
(5,874
)
   
(6,183
)
                         
Net income attributable to USPH shareholders
 
$
20,551
   
$
20,615
   
$
19,131
 
                         
Basic and diluted earnings per share attributable to USPH shareholders
 
$
1.64
   
$
1.66
   
$
1.57
 
                         
Shares used in computation - basic
   
12,500
     
12,392
     
12,217
 
                         
Shares used in computation - diluted
   
12,500
     
12,392
     
12,221
 
                         
Dividends declared per common share
 
$
0.68
   
$
0.60
   
$
0.48
 

See notes to consolidated financial statements.
 
U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EQUITY
(In thousands)

   
U.S.Physical Therapy, Inc.
             
                                                       
   
Common Stock
   
Additional
   
Retained
   
Treasury Stock
   
Total Shareholders’
   
Non-Controlling
       
   
Shares
   
Amount
   
Paid-In Capital
   
Earnings
   
Shares
   
Amount
   
Equity
   
Interests
   
Total
 
   
(In thousands)
             
Balance January 1, 2014, as reported
   
14,316
   
$
143
   
$
40,569
   
$
119,206
     
(2,215
)
 
$
(31,628
)
 
$
128,290
   
$
22,727
   
$
151,017
 
Correction of prior years cumulative error
   
-
     
-
     
13,970
     
(7,329
)
   
-
     
-
     
6,641
     
(21,424
)
   
(14,783
)
Adjusted Balance January 1, 2014, as restated
   
14,316
   
$
143
   
$
54,539
   
$
111,877
     
(2,215
)
 
$
(31,628
)
 
$
134,931
   
$
1,303
   
$
136,234
 
Proceeds from exercise of stock options
   
21
     
1
     
43
     
-
     
-
     
-
     
44
     
-
     
44
 
Net tax benefit from exercise of stock options
   
-
     
-
     
948
     
-
     
-
     
-
     
948
     
-
     
948
 
Issuance of restricted stock
   
150
     
1
     
-
     
-
     
-
     
-
     
1
     
-
     
1
 
Compensation expense - restricted stock
   
-
     
-
     
3,363
     
-
     
-
     
-
     
3,363
     
-
     
3,363
 
Acquisitions of non-controlling interests, as restated
   
-
     
-
     
(94
)
   
-
     
-
     
-
     
(94
)
   
(35
)
   
(129
)
Distributions to non-controlling interest partners, as restated
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
(5,963
)
   
(5,963
)
Dividends payable to USPT shareholders
   
-
     
-
     
-
     
(5,873
)
   
-
             
(5,873
)
   
-
     
(5,873
)
Net income, as restated
   
-
     
-
     
-
     
19,131
     
-
     
-
     
19,131
     
6,183
     
25,314
 
Balance December 31, 2014, as restated
   
14,487
   
$
145
   
$
58,799
   
$
125,135
     
(2,215
)
 
$
(31,628
)
 
$
152,451
   
$
1,488
   
$
153,939
 
Proceeds from exercise of stock options
   
1
     
1
     
4
     
-
     
-
     
-
     
5
     
-
     
5
 
Net tax benefit from exercise of stock options
   
-
     
-
     
947
     
-
     
-
     
-
     
947
     
-
     
947
 
Issuance of restricted stock
   
148
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Compensation expense - restricted stock
   
-
     
-
     
4,491
     
-
     
-
     
-
     
4,491
     
-
     
4,491
 
Transfer of compensation liability for certain stock issued pursuant to long-term incentive plans
   
-
     
-
     
446
     
-
     
-
     
-
     
446
     
-
     
446
 
Acquisitions and sales of non-controlling interests, as restated
   
-
     
-
     
(449
)
   
-
     
-
     
-
     
(449
)
   
(217
)
   
(666
)
Distributions to non-controlling interest partners, as restated
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
(5,892
)
   
(5,892
)
Dividends payable to USPT shareholders
   
-
     
-
     
-
     
(7,449
)
   
-
     
-
     
(7,449
)
   
-
     
(7,449
)
Net income, as restated
   
-
     
-
     
-
     
20,615
     
-
     
-
     
20,615
     
5,874
     
26,489
 
Balance December 31, 2015, as restated
   
14,636
   
$
146
   
$
64,238
   
$
138,301
     
(2,215
)
 
$
(31,628
)
 
$
171,057
   
$
1,253
   
$
172,310
 
Issuance of restricted stock
   
97
     
1
     
-
     
-
     
-
     
-
     
1
     
-
     
1
 
Cancellation of restricted stock
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Compensation expense - equity-based awards
   
-
     
-
     
4,962
     
-
     
-
     
-
     
4,962
     
-
     
4,962
 
Transfer of compensation liability for certain stock issued pursuant to long-term incentive plans
   
-
     
-
     
211
     
-
     
-
     
-
     
211
     
-
     
211
 
Acquisitions of non-controlling interests, net
   
-
     
-
     
(533
)
   
-
     
-
     
-
     
(533
)
   
(112
)
   
(645
)
Adjustment for prior year acquisitions of non-controlling interest - tax true up
   
-
     
-
     
(191
)
   
-
     
-
     
-
     
(191
)
   
-
     
(191
)
Dividends payable to USPT shareholders
   
-
     
-
     
-
     
(8,510
)
   
-
     
-
     
(8,510
)
   
-
     
(8,510
)
Distributions to non-controlling interest partners, as restated
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
(5,718
)
   
(5,718
)
Net income
   
-
     
-
     
-
     
20,551
     
-
     
-
     
20,551
     
5,717
     
26,268
 
Balance December 31, 2016
   
14,733
   
$
147
   
$
68,687
   
$
150,342
     
(2,215
)
 
$
(31,628
)
 
$
187,548
   
$
1,140
   
$
188,688
 

See notes to consolidated financial statements.
 
U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
 (In thousands)

   
Year Ended
 
   
December 31, 2016
   
December 31, 2015
   
December 31, 2014
 
OPERATING ACTIVITIES
       
(as restated)
   
(as restated)
 
Net income including non-controlling interests
 
$
26,268
   
$
26,489
   
$
25,314
 
Adjustments to reconcile net income including non-controlling interests to net cash provided by operating activities:
                       
Depreciation and amortization
   
8,779
     
7,952
     
6,740
 
Provision for doubtful accounts
   
4,040
     
4,170
     
4,112
 
Equity-based awards compensation expense
   
4,962
     
4,491
     
3,363
 
Loss on sale of fixed assets
   
152
     
84
     
35
 
Excess tax benefit from equity-based awards
   
-
     
(947
)
   
(948
)
Deferred income tax
   
2,979
     
5,953
     
5,106
 
Other
   
-
     
180
     
135
 
Changes in operating assets and liabilities:
                       
Increase in patient accounts receivable
   
(3,275
)
   
(5,519
)
   
(5,388
)
(Increase) decrease in accounts receivable - other
   
(400
)
   
(852
)
   
341
 
(Increase) decrease in other assets
   
(1,399
)
   
(1,375
)
   
1,155
 
Increase (decrease) in accounts payable and accrued expenses
   
2,994
     
(7,011
)
   
1,868
 
Increase in mandatorily redeemable non-controlling interests
   
5,598
     
2,509
     
2,936
 
Increase (decrease) in other liabilities
   
352
     
1,396
     
(3,378
)
Net cash provided by operating activities
   
51,050
     
37,520
     
41,391
 
                         
INVESTING ACTIVITIES
                       
Purchase of fixed assets
   
(8,260
)
   
(6,263
)
   
(5,167
)
Purchase of businesses, net of cash acquired
   
(23,623
)
   
(18,965
)
   
(12,270
)
Acquisitions of non-controlling interests
   
(670
)
   
(968
)
   
(227
)
Proceeds on sale of fixed assets, net
   
61
     
71
     
47
 
Net cash used in investing activities
   
(32,492
)
   
(26,125
)
   
(17,617
)
                         
FINANCING ACTIVITIES
                       
Distributions to non-controlling interests
   
(5,718
)
   
(5,892
)
   
(5,963
)
Cash dividends to shareholders - funded
   
(8,510
)
   
(7,449
)
   
(5,873
)
Proceeds from revolving line of credit
   
168,000
     
103,000
     
134,300
 
Payments on revolving line of credit
   
(166,000
)
   
(93,500
)
   
(139,800
)
Payments to settle mandatorily redeemable non-controlling interests
   
(1,262
)
   
(6,115
)
   
(5,233
)
Principal payments on notes payable
   
(800
)
   
(884
)