UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1998 TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT For the transition period from to Commission file number 1-11151 U.S. PHYSICAL THERAPY, INC. (Name of registrant as specified in its charter) Nevada 76-0364866 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 3040 Post Oak Blvd., Suite 222, Houston, Texas 77056 (Address of principal executive offices) (Zip Code) Issuer's telephone number: (713) 297-7000 Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 3,610,734
PART I - FINANCIAL INFORMATION Item 1. Financial Statements U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Consolidated Balance Sheets as of June 30, 1998 and December 31, 1997 3 Consolidated Statements of Operations for the three months and six months ended June 30, 1998 and 1997 5 Consolidated Statements of Cash Flows for the six months ended June 30, 1998 and 1997 7 Notes to Consolidated Financial Statements 9
U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands) June 30, December 31, 1998 1997 (unaudited) ASSETS Current assets: Cash and cash equivalents $ 5,959 $ 5,556 Patient accounts receivable, less allowance for doubtful accounts of $1,623 and $1,595, respectively 8,061 7,707 Accounts receivable-other 243 187 Other current assets 524 504 Total current assets 14,787 13,954 Fixed assets: Furniture and equipment 8,761 8,111 Leasehold improvements 4,096 3,869 12,857 11,980 Less accumulated depreciation 6,884 5,951 5,973 6,029 Noncompete agreements, net of amortization of $548, and $501, respectively 92 124 Goodwill, net of amortization of $177, and $138, respectively 1,094 1,042 Other assets 1,281 1,399 $ 23,227 $ 22,548 See notes to consolidated financial statements. 3
U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except share amounts) June 30, December 31, 1998 1997 (unaudited) LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable - trade $ 192 $ 250 Accrued expenses 1,491 1,333 Estimated third-party payor (Medicare) settlements 597 1,095 Notes payable 72 72 Total current liabilities 2,352 2,750 Notes payable - long-term portion 163 189 Convertible subordinated notes payable 8,050 8,050 Minority interests in subsidiary limited partnerships 1,669 1,557 Commitments - - Shareholders' equity: Preferred stock, $.01 par value, 500,000 shares authorized, -0- shares outstanding - - Common stock, $.01 par value, 10,000,000 shares authorized, 3,615,634 shares outstanding at June 30, 1998 and December 31, 1997, respectively 36 36 Additional paid-in capital 11,689 11,689 Accumulated deficit (685) (1,676) Treasury stock at cost, 4,900 shares held at June 30, 1998 and December 31, 1997, respectively (47) (47) Total shareholders' equity 10,993 10,002 $ 23,227 $ 22,548 See notes to consolidated financial statements. 4
U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) Three Months Ended June 30, 1998 1997 (unaudited) Net patient revenues $ 10,689 $ 9,550 Other revenues 151 136 Net revenues 10,840 9,686 Clinic operating costs: Salaries and related costs 5,006 4,326 Rent, clinic supplies and other 2,685 2,596 Provision for doubtful accounts 269 288 7,960 7,210 Corporate office costs: General and administrative 1,025 952 Recruitment and development 324 272 1,349 1,224 Operating income before non- operating expenses 1,531 1,252 Interest expense 183 184 Minority interests in subsidiary limited partnerships 481 411 Income before income taxes 867 657 Provision for income taxes 345 35 Net income $ 522 $ 622 Basic earnings per common share $ .14 $ .17 Earnings per common share-assuming dilution $ .14 $ .17 See notes to consolidated financial statements. 5 U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) Six Months Ended June 30, 1998 1997 (unaudited) Net patient revenues $ 21,141 $ 18,177 Other revenues 289 201 Net revenues 21,430 18,378 Clinic operating costs: Salaries and related costs 9,973 8,453 Rent, clinic supplies and other 5,351 4,945 Provision for doubtful accounts 542 522 15,866 13,920 Corporate office costs: General and administrative 2,035 1,796 Recruitment and development 612 541 2,647 2,337 Operating income before non- operating expenses 2,917 2,121 Interest expense 365 367 Minority interests in subsidiary limited partnerships 911 687 Income before income taxes 1,641 1,067 Provision for income taxes 650 51 Net income $ 991 $ 1,016 Basic earnings per common share $ .27 $ .28 Earnings per common share-assuming dilution $ .26 $ .27 See notes to consolidated financial statements. 6 U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Six Months Ended June 30, 1998 1997 (unaudited) Operating activities Net income $ 991 $ 1,016 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,032 921 Minority interests in earnings of subsidiary limited partnerships 911 687 Provision for bad debts 542 522 Loss (gain) on sale of fixed assets 1 (3) Changes in operating assets and liabilities: Increase in patient accounts receivable (896) (1,160) Increase in accounts receivable- other (56) (60) Decrease (increase) in other assets 90 (233) Increase in accounts payable and accrued expenses 100 18 Decrease in estimated third- party payor (Medicare) settlements (498) (535) Net cash provided by operating activities 2,217 1,173 See notes to consolidated financial statements. 7
U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Six Months Ended June 30, 1998 1997 (unaudited) Investing activities Purchase of fixed assets (882) (896) Purchase of intangibles (107) - Proceeds on sale of fixed assets - 67 Net cash used in investing activities (989) (829) Financing activities Proceeds from notes payable - 40 Payment of notes payable (26) (37) Acquisition of treasury stock - (47) Proceeds from investment of minority investors in subsidiary limited partnerships 1 1 Distributions to minority investors in subsidiary limited partnerships (800) (487) Net cash used in financing activities (825) (530) Net increase (decrease) in cash and cash equivalents 403 (186) Cash and cash equivalents - beginning of period 5,556 4,912 Cash and cash equivalents - end of period $ 5,959 $ 4,726 Supplemental disclosures of cash flow information Cash paid during the period for: Income taxes $ 513 $ 390 Interest $ 326 $ 276 See notes to consolidated financial statements. 8
U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 1998 1. Basis of Presentation and Significant Accounting Policies The consolidated financial statements include the accounts of U.S. Physical Therapy, Inc. and its subsidiaries (the "Company"). All significant intercompany transactions and balances have been eliminated. As of June 30, 1998, the Company, through its wholly- owned subsidiaries, owns a 1% general partnership interest and limited partnership interests ranging from 59% to 99% in the clinics it operates (87% of the clinics were at 64% as of June 30, 1998). For the majority of the clinics, the managing therapist of each such clinic, along with other therapists at the clinic in several of the partnerships, own the remaining limited partnership interest in the clinic which ranges from 0% to 40%. The minority interest in the equity and earnings of the subsidiary clinic limited partnerships are presented separately in the consolidated financial statements. The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and in accordance with the instructions for Form 10-Q. Accordingly, the statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the accompanying unaudited financial statements contain all necessary adjustments (consisting only of normal recurring adjustments) to present fairly the Company's financial position, results of operations and cash flows for the interim periods presented. For further information regarding the Company's accounting policies, refer to the audited financial statements included in the Company's Form 10-KSB for the year ended December 31, 1997. Operating results for the three and six months ended June 30, 1998 are not necessarily indicative of the results expected for the entire year. 9 Use of Estimates Management is required to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Reclassifications The accompanying financial statements for 1997 have been reclassified to conform with the presentation used for 1998. 2. Earnings per Share The following table sets forth the computation of basic and diluted earnings per share: Three Months Ended Six Months Ended June 30, June 30, 1998 1997 1998 1997 Numerator: Net income $ 522,000 $ 622,000 $ 991,000 $1,016,000 Numerator for basic earnings per share and diluted earnings per share $ 522,000 $ 622,000 $ 991,000 $1,016,000 Denominator: Denominator for basic earnings per share--weighted-average shares 3,611,000 3,598,000 3,611,000 3,594,000 Effect of dilutive securities: Stock Options 166,000 83,000 166,000 84,000 Warrants - - - 21,000 Dilutive potential common shares 166,000 83,000 166,000 105,000 Denominator for diluted earnings per share--adjusted weighted-average shares and assumed conversions 3,777,000 3,681,000 3,777,000 3,699,000 Basic earnings per share $ 0.14 $ 0.17 $ 0.27 $ 0.28 Diluted earnings per share $ 0.14 $ 0.17 $ 0.26 $ 0.27 During the three and six months ending June 30, 1998 and 1997, the Company had outstanding the following notes payable: 8% Convertible Subordinated Notes due June 30, 2003, for an aggregate principal amount of $3,050,000; 8% Convertible Subordinated Notes, Series B, due June 30, 2004, for an aggregate principal amount of $2,000,000; 10 and 8% Convertible Subordinated Notes, Series C, due June 30, 2004, for an aggregate principal amount of $3,000,000 (collectively "the Notes"). The Notes were not included in the computation of diluted earnings per share because the effect on the computation was anti- dilutive. 3. Income Taxes Significant components of the provision for income taxes were as follows: Three Months Ended Six Months Ended June 30, June 30, 1998 1997 1998 1997 Current: Federal $ 182,000 $ 140,000 $ 432,000 $ 234,000 State 64,000 77,000 119,000 122,000 Total current 246,000 217,000 551,000 356,000 Deferred: Federal 99,000 (182,000) 99,000 (305,000) State - - - - Total deferred 99,000 (182,000) 99,000 (305,000) Total income tax provision $ 345,000 $ 35,000 $ 650,000 $ 51,000 During 1997, the Company utilized all of its unused net operating loss carryforwards. Accordingly, during the three and six months ending June 30, 1998, the Company was taxed at the corporate level federal tax rate of 39.8% and 39.6%, respectively. 4. Subsequent Event In August 1998, the Company decided to close its clinic located in Corpus Christi, Texas due to adverse local market conditions and economic performance. The Company anticipates that the loss which will be recognized relating to this closure, which is expected to occur on August 15, 1998, will approximate $230,000. This clinic, which opened during 1992, accounted for net patient revenues for the three and six months ended June 30, 1998 of $67,000 and $172,000, respectively, compared to $124,000 and $231,000 in the corresponding periods in 1997. Operating losses before income taxes from the clinic were ($113,000) and ($175,000) for the three and six month periods endedJune 30, 1998 compared to ($25,000) and ($65,000) for the three and six month periods ended June 30, 1997. 11 Item 2. Management's Discussion and Analysis or Plan of Operation. Overview The Company operates outpatient physical and occupational therapy clinics which provide post-operative care and treatment for a variety of orthopedic-related disorders and sports-related injuries. At June 30, 1998, the Company operated 87 outpatient physical and occupational therapy clinics in 25 states. The average age of the 87 clinics in operation at June 30, 1998 is 3.2 years old. Since inception of the Company, 88 clinics have been developed and six clinics have been acquired by the Company. To date, the Company has closed two facilities, due to adverse clinic performance, consolidated the operations of three of its clinics with other existing clinics to more efficiently serve various geographic markets and sold certain fixed assets at two of the Company's clinics and then closed such facilities. The sale of fixed assets and the concurrent closure of the two clinics occurred during the three months ended March 31, 1997 ("1997 First Quarter"). No loss was recognized relating to these 1997 First Quarter closures. These two clinics combined accounted for net patient revenues and clinic operating costs for the six months ended June 30, 1997 of $(1,000) and $54,000, respectively. Results of Operations Three Months Ended June 30, 1998 ("1998 Second Quarter") Compared to the Three Months Ended June 30, 1997 ("1997 Second Quarter") Net Patient Revenues Net patient revenues increased to $10,689,000 for the 1998 Second Quarter from $9,550,000 for the 1997 Second Quarter, an increase of $1,139,000, or 12 percent. Net patient revenues from the 12 clinics developed since the 1997 Second Quarter (the "New Clinics") accounted for 30 percent of the increase or $347,000. The remaining increase of $792,000 in net patient revenues comes from those 75 clinics opened more than one year as of June 30, 1998 (the "Pre-June 1997 Clinics"). Of the $792,000 increase in net patient revenues from these clinics, a six percent increase in the number of patient visits increased net patient revenues by $592,000, which was coupled with an increase in the average net revenue per visit of two percent. Net patient revenues are based on established billing rates less allowances and discounts for patients covered by worker's compensation programs and other contractual programs. Payments received under these programs are based on predetermined rates and are generally less than the established billing rates of the 12 clinics. Net patient revenues reflect reserves, which are evaluated quarterly by management, for contractual and other adjustments relating to patient discounts from certain payors. Net patient revenues also are reported net of estimated retrospective adjustments under Medicare. Medicare reimbursement for outpatient physical or occupational therapy services furnished by clinics or rehabilitation agencies is paid based on a cost reimbursement methodology. The Company is initially reimbursed at a tentative rate with final settlement determined after submission of an annual cost report by the Company and audits thereof by the Medicare fiscal intermediary. Beginning in 1998, certain changes were imposed in the method in which the Company is reimbursed for its services by Medicare as defined in the Balanced Budget Act of 1997 ("BBA"). See "Factors Affecting Future Results". Other Revenues Other revenues, consisting of interest, management fees and sublease income, increased by $15,000, or 11 percent, to $151,000 for the 1998 Second Quarter from $136,000 for the 1997 Second Quarter. This increase was due primarily to an increase in interest income as a result of the higher average amount of cash and cash equivalents available for investment during the 1998 Second Quarter. Clinic Operating Costs Clinic operating costs as a percent of net patient revenues declined slightly to 74% for the 1998 Second Quarter from 75% for the 1997 Second Quarter. Clinic Operating Costs - Salaries and Related Costs Salaries and related costs increased to $5,006,000 for the 1998 Second Quarter from $4,326,000 for the 1997 Second Quarter, an increase of $680,000 or 16 percent. Approximately 43 percent of the increase, or $293,000, was due to the New Clinics. The remaining 57 percent increase or $387,000 is due principally to increased staffing to meet the increase in patient visits for the clinics opened prior to the 1997 Second Quarter, coupled with an increase in bonuses earned by the managing therapists at the clinics opened prior to the 1998 Second Quarter. Such bonuses are based on the net revenues or operating profit generated by the individual clinics. Salaries and related costs as a percent of net patient revenues increased to 47 percent for the 1998 Second Quarter from 45 percent for the 1997 Second Quarter. Clinic Operating Costs - Rent, Clinic Supplies and Other Rent, clinic supplies and other costs increased to $2,685,000 for the 1998 Second Quarter from $2,596,000 for the 1997 Second Quarter, an increase 13 of $89,000, or three percent. This net increase was the result of a $189,000 increase due to the New Clinics, which was offset, in part, by a decrease of $100,000 for clinics opened prior to the 1997 Second Quarter. Rent, clinic supplies and other costs as a percent of net patient revenues declined to 25 percent for the 1998 Second Quarter from 27 percent for the 1997 Second Quarter. Clinic Operating Costs - Provision for Doubtful Accounts The provision for doubtful accounts decreased to $269,000 for the 1998 Second Quarter from $288,000 for the 1997 Second Quarter, a decrease of seven percent or $19,000. Approximately 32 percent of the decrease, or $6,000, was due to the New Clinics, while 68 percent, or $13,000, of the decrease relates to the clinics opened prior to the 1997 Second Quarter. The provision as a percent of net patient revenues declined to 2.5 percent for the 1998 Second Quarter compared to 3.0 percent for the 1997 Second Quarter. Corporate Office Costs - General & Administrative General and administrative costs, consisting primarily of salaries and benefits of corporate office personnel, recruiting fees associated with hiring personnel at both the corporate office and at the seasoned clinics, insurance costs, depreciation and amortization, travel and legal and professional fees increased to $1,025,000 for the 1998 Second Quarter from $952,000 for the 1997 Second Quarter, an increase of $73,000, or eight percent. General and administrative costs increased primarily as a result of additional personnel hired to oversee the operations of an increasing number of clinics in operation. General and administrative costs, as a percent of net patient revenues, was 10 percent for the 1998 Second Quarter and for the 1997 Second Quarter. Corporate Office Costs - Recruitment & Development Recruitment and development costs primarily represent salaries and benefits of recruitment and development personnel, rent, travel, marketing and recruiting fees attributed directly to the Company's activities in the development and acquisition of new clinics. All recruitment and development personnel are located at the corporate office in Houston, Texas. Once a clinic has opened, these personnel are not involved with the clinic. Recruitment and development costs increased $52,000 or 19 percent to $324,000 for the 1998 Second Quarter from $272,000 for the 1997 Second Quarter. The majority of this increase relates to an increase in salaries and benefits of recruitment and development personnel which were added in response to management's intention to accelerate the pace of new 14 clinic openings during 1998 from the level of 13 new clinics developed and opened during 1997. Recruitment and development costs, as a percent of net patient revenues was three percent for the 1998 Second Quarter and the 1997 Second Quarter. Interest Expense Interest expense of $183,000 for the 1998 Second Quarter relates primarily to $65,000 of interest expense on the $3,050,000 aggregate principal amount of 8% Convertible Subordinated Notes issued by the Company in June 1993 and $99,000 of interest expense on the $5,000,000 aggregate principal amount of 8% Series B and Series C Notes issued by the Company in May 1994. In addition, $18,000 of interest expense was recorded in the 1998 Second Quarter relating to the Contingent Interest Enhancement feature of the Series B Notes. This feature allowed Series B Note holders to receive an interest enhancement payable in shares of Company Common Stock based upon the market value of the Company's shares for the month of June 1996, which corresponded to two years from the date of issuance of the Series B Notes (the "Contingent Interest Enhancement"). A total of 70,965 shares of Company Common Stock were issued in connection with the Contingent Interest Enhancement feature. Minority Interests in Subsidiary Limited Partnerships Minority interests in subsidiary limited partnerships increased $70,000, or 17 percent, to $481,000 for the 1998 Second Quarter from $411,000 for the 1997 Second Quarter due to the increase in aggregate profitability of those clinics in which partners have achieved positive retained earnings and are accruing partnership income. Provision for Income Taxes The provision for income taxes increased to $345,000 for the 1998 Second Quarter from $35,000 for the 1997 Second Quarter, an increase of $310,000. This increase relates primarily to the increase in profitability of the clinics, coupled with the fact that during 1997, the Company utilized all of its unused net operating loss carryforwards. Accordingly, during the 1998 Second Quarter, the Company was taxed at the corporate level federal tax rate of 39.8%. Net Income The Company's net income for the 1998 Second Quarter of $522,000 was less than the 1997 Second Quarter's net income of $622,000 principally due to the fact that during 1997, the Company utilized 15 all of its remaining tax operating loss carryforwards and, therefore, incurred corporate income tax at an effective rate of 39.8% in the 1998 Second Quarter. The Company's income before income taxes for the 1998 Second Quarter of $867,000 exceeded the 1997 Second Quarter's income before income taxes of $657,000 principally due to the $1,154,000 increase in net revenues, which more than offset the $750,000 increase in clinic operating costs, the $125,000 increase in corporate office costs and the $70,000 increase in minority interests in subsidiary limited partnerships. Six Months Ended June 30, 1998 ("1998 Six Months") Compared to the Six Months Ended June 30, 1997 ("1997 Six Months") Net Patient Revenues Net patient revenues increased to $21,141,000 for the 1998 Six Months from $18,177,000 for the 1997 Six Months, an increase of $2,964,000, or 16 percent. Net patient revenues from the 12 clinics developed since the 1997 Six Months (the "New Clinics") accounted for 21 percent of the increase or $624,000. The remaining increase of $2,340,000 in net patient revenues comes from those 75 clinics opened more than one year as of June 30, 1998 (the "Pre-June 1997 Clinics"). Of the $2,340,000 increase in net patient revenues from these clinics, an 11 percent increase in the number of patient visits increased net patient revenues by $1,956,000, which was coupled with an increase in the average net revenue per visit of two percent. Net patient revenues are based on established billing rates less allowances and discounts for patients covered by worker's compensation programs and other contractual programs. Payments received under these programs are based on predetermined rates and are generally less than the established billing rates of the clinics. Net patient revenues reflect reserves, which are evaluated quarterly by management, for contractual and other adjustments relating to patient discounts from certain payors. Net patient revenues also are reported net of estimated retrospective adjustments under Medicare. Medicare reimbursement for outpatient physical or occupational therapy services furnished by clinics or rehabilitation agencies is paid based on a cost reimbursement methodology. The Company is initially reimbursed at a tentative rate with final settlement determined after submission of an annual cost report by the Company and audits thereof by the Medicare fiscal intermediary. Beginning in 1998, certain changes were imposed in the method in which the Company is reimbursed for its services by Medicare as defined in the BBA. See "Factors Affecting Future Results". 16 Other Revenues Other revenues, consisting of interest, management fees and sublease income, increased by $88,000, or 44 percent, to $289,000 for the 1998 Six Months from $201,000 for the 1997 Six Months. This increase was due primarily to an increase in interest income as a result of the higher average amount of cash and cash equivalents available for investment and management fees earned in connection with a contract the Company entered into during the 1997 First Quarter to manage a third-party physical therapy clinic. Clinic Operating Costs Clinic operating costs as a percent of net patient revenues declined to 75% for the 1998 Six Months from 77% for the 1997 Six Months. Clinic Operating Costs - Salaries and Related Costs Salaries and related costs increased to $9,973,000 for the 1998 Six Months from $8,453,000 for the 1997 Six Months, an increase of $1,520,000, or 18 percent. Approximately 34 percent of the increase, or $518,000, was due to the New Clinics. The remaining 66 percent increase or $1,002,000 is due principally to increased staffing to meet the increase in patient visits for the clinics opened prior to the 1997 Six Months, coupled with an increase in bonuses earned by the managing therapists at the clinics opened prior to the 1998 Six Months. Such bonuses are based on the net revenues or operating profit generated by the individual clinics. Salaries and related costs as a percent of net patient revenues was 47 percent for the 1998 Six Months and the 1997 Six Months. Clinic Operating Costs - Rent, Clinic Supplies and Other Rent, clinic supplies and other costs increased to $5,351,000 for the 1998 Six Months from $4,945,000 for the 1997 Six Months, an increase of $406,000, or eight percent. Approximately 88 percent of the increase, or $356,000, was due to the New Clinics, while 12 percent, or $50,000, of the increase was due to clinics opened prior to the 1997 Six Months. Rent, clinic supplies and other costs as a percent of net patient revenues declined to 25 percent for the 1998 Six Months from 27 percent for the 1997 Six Months. Clinic Operating Costs - Provision for Doubtful Accounts The provision for doubtful accounts increased to $542,000 for the 1998 Six Months from $522,000 for the 1997 Six Months, an increase of four percent or $20,000. Approximately 60 percent of the increase, or $12,000, was due to the New Clinics, while 40 percent, or $8,000, of the increase relates to the clinics opened prior to the 1997 Six Months. The provision for doubtful accounts as a percent of net patient revenues declined slightly to 2.6 percent for the 1998 Six Months compared to 2.9 percent for the 1997 Six Months. 17 Corporate Office Costs - General & Administrative General and administrative costs, consisting primarily of salaries and benefits of corporate office personnel, insurance costs, depreciation and amortization, travel and legal and professional fees increased to $2,035,000 for the 1998 Six Months from $1,796,000 for the 1997 Six Months, an increase of $239,000, or 13 percent. General and administrative costs increased primarily as a result of additional personnel hired to oversee the operations of an increasing number of clinics in operation and increased legal and professional fees relating to operating these additional clinics. General and administrative costs, as a percent of net patient revenues, was 10 percent for the 1998 Six Months and the 1997 Six Months. Corporate Office Costs - Recruitment & Development Recruitment and development costs primarily represent salaries and benefits of recruitment and development personnel, rent, travel, marketing and recruiting fees attributed directly to the Company's activities in the development and acquisition of new clinics. All recruitment and development personnel are located at the corporate office in Houston, Texas. Once a clinic has opened, these personnel are not involved with the clinic. Recruitment and development costs increased $71,000, or 13 percent, to $612,000 for the 1998 Six Months from $541,000 for the 1997 Six Months. The majority of this increase relates to an increase in salaries and related costs of recruitment and development personnel which were added in response to management's intention to accelerate the pace of new clinic openings during 1998 from the level of 13 new clinics developed and opened during 1997. Recruitment and development costs, as a percent of net patient revenues, was three percent for the 1998 Six Months and the 1997 Six Months. Interest Expense Interest expense of $365,000 for the 1998 Six Months relates primarily to $121,000 of interest expense on the $3,050,000 aggregate principal amount of 8% Convertible Subordinated Notes issued by the Company in June 1993 and $198,000 of interest expense on the $5,000,000 aggregate principal amount of 8% Series B and Series C Notes issued by the Company in May 1994. In addition, $37,000 of interest expense was recorded in the 1998 Second Quarter relating to the Contingent Interest Enhancement feature of the Series B Notes. This feature allowed Series B Note holders to receive an interest enhancement payable in shares of Company Common Stock based upon the market value of the Company's shares for the 18 month of June 1996, which corresponded to two years from the date of issuance of the Series B Notes (the "Contingent Interest Enhancement"). A total of 70,965 shares of Company Common Stock were issued in connection with the Contingent Interest Enhancement feature. Minority Interests in Subsidiary Limited Partnerships Minority interests in subsidiary limited partnerships increased $224,000, or 33 percent, to $911,000 for the 1998 Six Months from $687,000 for the 1997 Six Months due to the increase in aggregate profitability of those clinics in which partners have achieved positive retained earnings and are accruing partnership income. Provision for Income Taxes The provision for income taxes increased to $650,000 for the 1998 Six Months from $51,000 for the 1997 Six Months, an increase of $599,000. This increase relates primarily to the increase in profitablity of the clinics, coupled with the fact that during 1997, the Company utilized all of its unused net operating loss carryforwards. Accordingly, during the 1998 Six Months, the Company was taxed at the corporate level federal tax rate of 39.6%. Net Income The Company's net income for the 1998 Six Months of $991,000 was less than the 1997 Six Month's net income of $1,016,000 principally due to the fact that during 1997, the Company utilized all of its remaining tax operating loss carryforwards and, therefore, incurred corporate income tax at an effective rate of 39.6% during the 1998 Six Months. The Company's income before income taxes for the 1998 Six Months of $1,641,000 exceeded the 1997 Six Month's income before income taxes of $1,067,000 principally due to the $3,052,000 increase in net revenues, which more than offset the $1,946,000 increase in clinic operating costs, the $310,000 increase in corporate office costs and the $224,000 increase in minority interests in subsidiary limited partnerships. Liquidity and Capital Resources At June 30, 1998, the Company had $5,959,000 in cash and cash equivalents, which is available to fund the working capital needs of its operating subsidiaries, future clinic developments and acquisitions and the Company's repurchase of shares of its common stock. Included in cash and cash equivalents at June 30, 1998 is $4,300,000 of short-term United States government agency 19 securities and $625,000 of short-term United States government money market funds. The market value of the short-term United States government agency securities and the United States government money market funds approximated the carrying value of such securities as of June 30, 1998. The increase in cash of $403,000 from December 31, 1997 to June 30, 1998 is due to cash provided by operating activities of $2,217,000, offset, in part, by the Company's use of cash to fund capital expenditures, primarily for physical therapy equipment, leasehold improvements and intangibles in the amount of $989,000, distributions to minority partners in subsidiary limited partnerships of $800,000 and payment on notes payable of $26,000. The Company's current ratio increased to 6.29 to 1.00 at June 30, 1998 from 5.07 to 1.00 at December 31, 1997. The increase in the current ratio is due primarily to a decrease in estimated third- party payor (Medicare) settlements, offset, in part, by an increase in patient accounts receivable resulting from increased patient revenues. At June 30, 1998, the Company had a debt-to-equity ratio of 0.75 to 1.00 compared to 0.83 to 1.00 at December 31, 1997. The improvement in the debt-to-equity ratio from December 31, 1997 to June 30, 1998 relates primarily to the increase in equity as a result of the net income of $991,000 for the 1998 Six Months. The quarterly interest obligation on the outstanding 8% Convertible Subordinated Notes, the 8% Convertible Subordinated Notes, Series B and the 8% Convertible Subordinated Notes, Series C is $61,000, $40,000 and $60,000, respectively, through June 30, 2003, June 30, 2004 and June 30, 2004, respectively. In January 1997, the Company's Board of Directors authorized it to repurchase up to 200,000 shares of its common stock. The timing and the actual number of shares purchased will depend on market conditions. The repurchased shares, which will be financed with available cash, will be held as treasury shares and be available for general corporate purposes. As of June 30, 1998, 4,900 shares have been repurchased at a cost of $47,000. Management believes that existing funds, supplemented by cash flows from existing operations, will be sufficient to meet its current operating needs and its development plans through at least 1998. Recently Promulgated Accounting Standards In February 1997, the Financial Accounting Standards Board issued Statement No. 128, Earnings per Share, which required the Company to change the method presently used to compute earnings per share and 20 to restate all prior period amounts. Statement 128 replaced primary and fully diluted earnings per share with basic and diluted earnings per share. Under the new requirements for calculating earnings per share, the dilutive effect of stock options is excluded from basic earnings per share but included in the computation of diluted earnings per share. The new standard did not have a material impact on the basic or fully diluted earnings per share computations for 1997. Factors Affecting Future Results Clinic Closure In August 1998, the Company decided to close its clinic located in Corpus Christi, Texas due to adverse local market conditions and economic performance. The Company anticipates that the loss which will be recognized relating to this closure, which is expected to occur on August 15, 1998, will approximate $230,000. This clinic, which opened during 1992, accounted for net patient revenues for the three and six months ended June 30, 1998 of $67,000 and $172,000, respectively, compared to $124,000 and $231,000 in the corresponding periods in 1997. The Company's future results should be positively impacted by the reduction in net loss, before income taxes, incurred by this clinic. Such losses incurred were ($113,000) and ($175,000) for the three and six month periods ended June 30, 1998 compared to ($25,000) and ($65,000) for the three and six month periods ended June 30, 1997. Clinic Development As of June 30, 1998, the Company has opened 87 clinics, three of which occurred in the 1998 Second Quarter. The Company expects to accelerate new clinic openings in the third and fourth quarters of 1998 with operating clinics reaching 100 by year-end from the 87 presently operating, subject to, among other things, the Company's ability to identify suitable geographic locations and physical therapy clinic partners. Accordingly, recruitment and development costs are expected to increase since new clinics traditionally involve a significant amount of start-up costs, such as travel and recruitment fees. In addition, the Company's operating results will be impacted by initial operating losses from the new clinics. During the initial period of operation, operating margins for newly opened clinics tend to be lower than more seasoned clinics due to the start-up costs of newly opened clinics (salaries and related costs of the physical therapist and other clinic personnel, rent and equipment and other supplies required to open the clinic) and the fact that patient revenues tend to be lower in the first year of a new clinic's operation and increase over the next several years. Based on the historical performance of the 21 Company's new clinics, new clinic openings in the third and fourth quarters of 1998 should favorably impact the Company's results of operations for 1999 and beyond. Growth in Physical Therapy Management In July 1998, the Company entered into an agreement with an orthopedic group to manage a physical therapy facility in New England, bringing third-party facilities under management to three. Management believes that with physician groups facing declining incomes, the opportunity for enhancing the physicians' income through the ownership of in-house physical therapy facilities is becoming increasingly attractive. Since 1992, the Company has offered management and administrative services to its network of clinics owned with physical therapist partners. The Company is now offering that expertise to physician groups nationwide. The Company believes it has adequate internally generated funds to support its planned growth in this area. The Balanced Budget Act of 1997 Beginning in 1998, Medicare imposed new interim constraints on reimbursement for outpatient physical and/or occupational therapy services and will publish a fee schedule pursuant to which the Company's clinics will be paid for care provided Medicare patients in 1999. In 1998, Medicare reimbursement for outpatient physical and/or occupational therapy furnished by a Medicare-certified rehabilitation agency or clinic is equal to the lesser of the provider's "adjusted reasonable costs" as allowed under Medicare regulations and defined in the BBA or the provider's charges, in each case less 20% of the amount of the charge imposed for the services. For rehabilitation agencies and clinics, the "adjusted reasonable cost" of a service is the service's reasonable cost, as determined under Medicare regulations, less 10%. The 20% deduction represents the co-insurance amount that an individual beneficiary, or their "Medigap" insurance carrier if such coverage exists, is required to pay in addition to the beneficiary's annual deduction. Furthermore, the BBA also provides that after 1998, outpatient rehabilitation services will be paid based on a fee schedule, the amounts for which will be determined by the Secretary of HHS. Beginning in 1999, the total amount that may be paid by Medicare in any one year for outpatient physical or occupational therapy to any one patient will be limited to $1,500, except for services provided in hospitals. The effect of this payment change may be to encourage patients with extensive rehabilitation needs to seek treatment in a hospital setting. The Company will not be able to determine the impact the changes imposed by the BBA will have on its business in 1999 until the Secretary of HHS publishes its fee schedule. 22
Year 2000 Some of the Company's older computer programs were written using two digits rather than four to define the applicable year. As a result, those computer programs have time-sensitive software that recognize a date using "00" as the year 1900 rather than the year 2000. The Company has completed an assessment and will have to modify or replace portions of its software so that its computer systems will function properly with respect to dates in the year 2000 and thereafter. The Company does not anticipate that the cost of such modifications or replacements will be material to its operations. The Company believes that with modifications to existing software and conversions to new software, the Year 2000 issue will not pose significant operational problems for its computer systems. 23
U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES PART II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders (a) The Company held its 1998 annual meeting of shareholders ("Annual Meeting") on May 19, 1998. At the Annual Meeting, nine directors were elected for one-year terms. (b) The names of the nine directors elected at the Annual Meeting are as follows: J. Livingston Kosberg, Roy W. Spradlin, Mark J. Brookner, Daniel C. Arnold, George H. Hargrave, James B. Hoover, Marlin W. Johnston, Richard C.W. Mauran and Albert L. Rosen. (c) The following votes were cast in the election of directors: WITHHOLD Nominees For AUTHORITY J. Livingston Kosberg 2,545,698 1,000 Roy W. Spradlin 2,545,698 1,000 Mark J. Brookner 2,545,698 1,000 Daniel C. Arnold 2,545,698 1,000 George H. Hargrave 2,545,698 1,000 James B. Hoover 2,545,698 1,000 Marlin W. Johnston 2,545,698 1,000 Richard C.W. Mauran 2,545,598 1,100 Albert L. Rosen 2,484,388 62,310 There were a total of 2,546,698 shares represented by person or by proxy at the Annual Meeting. (d) Not applicable. Item 5. Other Information Effective August 3, 1998, Mark J. Brookner, the Company's Chief Financial Officer since April 1992 and a Director since 1990, was promoted to Vice Chairman. In this capacity, he will serve the Company on a part-time basis, focusing on strategic planning and corporate development. Also effective August 3, 1998, the Company named J. Michael Mullin, C.P.A., to the position of Chief Financial Officer. 24 Item 6. Exhibits and Reports on Form 8-K. (a) List of Exhibits 27. Financial Data Schedule (b) Reports of Form 8-K No reports on Form 8-K were filed with the Securities and Exchange Commission during the quarter ended June 30, 1998. 25
SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. U.S. PHYSICAL THERAPY, INC. Date: August 14, 1998 By: /s/ J. MICHAEL MULLIN J. Michael Mullin Chief Financial Officer (duly authorized officer and principal financial officer) 26