Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(MARK ONE)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For The Quarterly Period Ended September 30, 2009

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 0-19946

 

 

LINCARE HOLDINGS INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		51-0331330
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
19387 US 19 North Clearwater, FL		33764
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code:

(727) 530-7700

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files). (Registrant is not subject to the requirements of Rule 405 of Regulation S-T at this time)    Yes  ¨    No  ¨

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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer		x		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  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class		Outstanding at October 31, 2009
Common Stock, $0.01 par value		68,121,822

 

 

 

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

FORM 10-Q

For The Quarterly Period Ended September 30, 2009

INDEX

 

				Page
PART I. FINANCIAL INFORMATION
Item 1.		Financial Statements (unaudited)		3
		Condensed consolidated balance sheets		3
		Condensed consolidated statements of operations		4
		Condensed consolidated statements of cash flows		5
		Notes to condensed consolidated financial statements (unaudited)		6
Item 2.		Management’s Discussion and Analysis of Results of Operations and Financial Condition		20
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		36
Item 4.		Controls and Procedures		36
PART II. OTHER INFORMATION
Item 1.		Legal Proceedings		37
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		38
Item 3.		Defaults Upon Senior Securities		38
Item 4.		Submission of Matters to a Vote of the Security Holders		38
Item 5.		Other Information		38
Item 6.		Exhibits		38
SIGNATURE				39
INDEX OF EXHIBITS				S-1

 

2

---

Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1.

Financial Statements (Unaudited)

LINCARE HOLDINGS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

 

		September 30, 2009			December 31, 2008
					(As adjusted Note 1)
ASSETS
Current assets:
Cash and cash equivalents		$	92,218		$	72,651
Short-term investments			59,100			0
Accounts receivable, net			169,159			176,797
Income tax receivable			0			2,863
Inventories			9,020			9,468
Prepaid and other current assets			3,613			3,057
Deferred income taxes			23,849			22,286
Total current assets			356,959			287,122
Property and equipment, net			343,055			347,860
Long-term investments			0			60,400
Goodwill			1,243,404			1,232,178
Other			10,015			11,249
Total assets		$	1,953,433		$	1,938,809
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current installments of long-term obligations		$	4,353		$	6,902
Accounts payable			51,103			60,472
Accrued expenses:
Compensation and benefits			39,113			27,989
Liability insurance			19,178			17,895
Other current liabilities			51,482			54,484
Income taxes payable			1,115			0
Total current liabilities			166,344			167,742
Long-term obligations, net, excluding current installments			472,648			454,045
Deferred income taxes and other taxes			319,778			288,696
Total liabilities			958,770			910,483
Commitments and contingencies:
Stockholders’ equity:
Common stock			680			744
Additional paid-in capital			581,112			560,444
Retained earnings			412,871			467,138
Total stockholders’ equity			994,663			1,028,326
Total liabilities and stockholders’ equity		$	1,953,433		$	1,938,809

See accompanying notes to condensed consolidated financial statements (unaudited).

 

3

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

		For The Three Months Ended								For The Nine Months Ended
		September 30, 2009				September 30, 2008				September 30, 2009				September 30, 2008
						(As adjusted Note 1)								(As adjusted Note 1)
Net revenues		$	392,644			$	405,677			$	1,144,677			$	1,249,488
Costs and expenses:
Cost of goods and services			109,810				94,969				317,874				302,362
Operating expenses			98,440				100,508				292,282				294,442
Selling, general and administrative expenses			82,090				82,165				247,360				243,708
Bad debt expense			5,890				6,085				17,170				18,742
Depreciation and amortization expense			30,303				29,015				89,353				88,618
			326,533				312,742				964,039				947,872
Operating income			66,111				92,935				180,638				301,616
Other income (expense):
Interest income			160				1,390				738				5,163
Interest expense			(8,773	)			(9,432	)			(26,106	)			(30,878	)
			(8,613	)			(8,042	)			(25,368	)			(25,715	)
Income before income taxes			57,498				84,893				155,270				275,901
Income tax expense			21,470				31,614				59,785				104,250
Net income		$	36,028			$	53,279			$	95,485			$	171,651
Basic earnings per common share		$	0.54			$	0.73			$	1.39			$	2.35
Diluted earnings per common share		$	0.53			$	0.73			$	1.38			$	2.28
Weighted average number of common shares outstanding			66,987				73,006				68,902				72,903
Weighted average number of common shares and common share equivalents outstanding			67,585				73,435				69,313				76,346

See accompanying notes to condensed consolidated financial statements (unaudited).

 

4

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

		For The Nine Months Ended
		September 30, 2009				September 30, 2008
						(As adjusted Note 1)
Cash flows from operating activities:
Net income		$	95,485			$	171,651
Adjustments to reconcile net income to net cash provided by operating activities:
Bad debt expense			17,170				18,742
Depreciation and amortization expense			89,353				88,618
Net gain on disposal of property and equipment			(21	)			(30	)
Amortization of debt issuance costs			1,327				1,943
Amortization of discount on bonds payable			12,821				11,956
Stock-based compensation expense			19,417				12,366
Deferred income taxes			26,662				17,931
Excess tax benefit from stock-based compensation			0				(19	)
Change in assets and liabilities net of effects of acquired businesses:
Accounts receivable			(9,520	)			(18,082	)
Inventories			448				(1,121	)
Prepaid and other assets			(641	)			2,274
Accounts payable			(9,082	)			757
Accrued expenses			6,966				15,502
Income taxes payable			4,128				(425	)
Net cash provided by operating activities			254,513				322,063
Cash flows from investing activities:
Proceeds from sale of property and equipment			82				19,745
Capital expenditures			(84,570	)			(114,773	)
Purchases of investments			0				(31,450	)
Sales and maturities of investments			1,300				36,800
Business acquisitions, net of cash acquired and purchase price adjustments			(5,067	)			(6,120	)
Net cash used in investing activities			(88,255	)			(95,798	)
Cash flows from financing activities:
Proceeds from revolving line of credit			0				70,000
Payments on revolving line of credit			0				(10,000	)
Payments of principal on debt			(3,227	)			(275,872	)
Payments of debt issuance costs			0				(128	)
Proceeds from exercise of stock options and issuance of common shares			6,812				6,136
Excess tax benefit from stock-based compensation			0				19
Payments to acquire treasury stock			(150,276	)			(35,211	)
Net cash used in financing activities			(146,691	)			(245,056	)
Net increase (decrease) in cash and cash equivalents			19,567				(18,791	)
Cash and cash equivalents, beginning of period			72,651				51,707
Cash and cash equivalents, end of period		$	92,218			$	32,916
Supplemental disclosure of cash flow information:
Cash paid for interest		$	7,585			$	13,016
Cash paid for income taxes		$	31,557			$	93,337

See accompanying notes to condensed consolidated financial statements (unaudited).

 

5

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Basis of Presentation, Summary of Significant Accounting Policies and Change in Accounting Principle

The accompanying condensed consolidated financial statements are unaudited and have been prepared in accordance with generally accepted accounting principles accepted in the United States for interim financial information and with the instructions to Form 10-Q. They should be read in conjunction with the consolidated financial statements and related notes to the financial statements of Lincare Holdings Inc. and Subsidiaries (“Lincare” or the “Company”) on Form 10-K for the fiscal year ended December 31, 2008. In the opinion of management, all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the results of operations for the interim periods presented have been reflected herein. Certain amounts in the prior years’ financial statements have been reclassified to conform to the current year presentation. The results of operations for interim periods are not necessarily indicative of the results to be expected for the entire year.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual amounts could differ from those estimates. It is at least reasonably possible that a change in those estimates will occur in the near term. The Company evaluated subsequent events after the balance sheet date of September 30, 2009 through the financial statement issuance date of November 4, 2009.

Investments: At September 30, 2009, the Company held $55.0 million of auction rate securities. These securities are variable-rate debt instruments with contractual maturities between the years 2020 and 2041 with interest rates that reset every seven or 35 days pursuant to a bidding process as determined by the underlying security indentures. The investments are classified as trading securities and are carried at fair value, with any realized and unrealized gains and losses included in other income and expense.

During the second quarter of 2009, the Company reclassified all of its investments in auction rate securities from long-term to short-term investments due to the put rights associated with the UBS Put Option becoming effective within one year of the June 30, 2009 balance sheet date.

At September 30, 2009, the Company held a $4.1 million put option from UBS Financial Services, Inc. The put option is carried at fair value, with any realized and unrealized gains and losses included in other income and expense.

Financial Instruments: The Company believes the book value of its cash equivalents, short-term and long-term investments, accounts receivable, income taxes receivable, accounts payable, accrued expenses, acquisition obligations and borrowings, if any, under its revolving credit agreement approximate fair value. The Company utilizes Level 3 fair value measurements to value its short-term and long-term investments due to the lack of significant observable valuation inputs (see Note 3, Investments). The fair value of the Company’s 2.75% Series A Debentures due 2037 and 2.75% Series B Debentures due 2037 are estimated based on several standard market variables including the Company’s stock price, yield to put/call through conversion and yield to maturity. The estimated fair values of the Series A and Series B Debentures at September 30, 2009, were $275,687,500 and $269,170,000, respectively, and $230,802,000 and $213,309,250, respectively, at December 31, 2008. The book value of these debentures are reported pursuant to the guidance in ASC 470-20, “Debt With Conversion and Other Options” (see Note 7, Long-Term Obligations).

Concentration of Credit Risk: The Company’s revenues are generated through locations in 48 states. The Company generally does not require collateral or other security in extending credit to customers; however, the Company routinely obtains assignment of (or is otherwise entitled to receive) benefits receivable under the health insurance programs, plans or policies of its customers. Included in the Company’s net revenues is reimbursement from government sources under Medicare, Medicaid and other federally funded programs, which represented approximately 60% of net revenues for the nine months ended September 30, 2009 and 2008. The exclusion of the Company from participating in federally funded programs would have a material adverse effect on the Company’s business, financial condition, operating results and cash flows.

 

6

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Revenue Recognition: The Company’s revenues are recognized on an accrual basis in the period in which services and related products are provided to customers and are recorded at net realizable amounts estimated to be paid by customers and third-party payors. The Company’s billing system contains payor-specific price tables that reflect the fee schedule amounts in effect or contractually agreed upon by various government and commercial payors for each item of equipment or supply provided to a customer. The Company has established an allowance to account for sales adjustments that result from differences between the expected realizable amount and the payment amount received. Actual adjustments that result from differences between the payment amount received and the expected realizable amount are recorded against the allowance for sales adjustments and are typically identified and ultimately recorded at the point of cash application or when otherwise determined pursuant to the Company’s collection procedures. The Company reports revenues in its financial statements net of such adjustments.

Certain items provided by the Company are reimbursed under rental arrangements that generally provide for fixed monthly payments established by fee schedules for as long as the patient is using the equipment and medical necessity continues (subject to capped rental arrangements that limit the rental payment periods in some instances and that may result in a transfer of title to the equipment at the end of the rental payment period). Once initial delivery of rental equipment is made to the patient, a monthly billing cycle is established based on the initial date of delivery. The Company recognizes rental arrangement revenues ratably over the monthly service period and defers revenue for the portion of the monthly bill that is unearned. No separate payment is earned from the initial equipment delivery and setup process. During the rental period, the Company is responsible for servicing the equipment and providing routine maintenance, if necessary.

The Company’s revenue recognition policy is consistent with the criteria set forth in Staff Accounting Bulletin 104, “Revenue Recognition” (“SAB 104”), for determining when revenue is realized or realizable and earned. The Company recognizes revenue in accordance with the requirements of SAB 104 that:

 

•

persuasive evidence of an arrangement exists;

 

•

delivery has occurred;

 

•

the seller’s price to the buyer is fixed or determinable; and

 

•

collectibility is reasonably assured.

Due to the nature of the industry and the reimbursement environment in which the Company operates, certain estimates are required to record net revenues and accounts receivable at their net realizable values at the time products or services are provided. Inherent in these estimates is the risk that they will have to be revised or updated as additional information becomes available. Specifically, the complexity of many third-party billing arrangements and the uncertainty of reimbursement amounts for certain services from certain payors may result in adjustments to amounts originally recorded. Such adjustments are typically identified and recorded by the Company at the point of cash application, claim denial or account review. Included in accounts receivable are earned but unbilled accounts receivable from earned revenues. Unbilled accounts receivable represent charges for equipment and supplies delivered to customers for which invoices have not yet been generated by the Company’s billing system. Prior to the delivery of equipment and supplies to customers, the Company performs certain certification and approval procedures to ensure collection is reasonably assured. Once the items are delivered, unbilled accounts receivable are recorded at net amounts expected to be paid by customers and third-party payors. Billing delays, generally ranging from several days to several weeks, can occur due to delays in obtaining certain required payor-specific documentation from internal and external sources as well as interim transactions occurring between cycle billing dates established for each customer within the billing system, and business acquisitions awaiting assignment of new provider enrollment identification numbers. In the event that a third-party payor does not accept the claim, the customer is ultimately responsible for payment of the products or services. Accounts receivable are reported net of allowances for sales adjustments and uncollectible accounts. Sales adjustments are recorded against revenues and result from differences between the payment amount received and the expected realizable amount. Bad debt is recorded as an operating expense and consists of billed charges that are ultimately deemed uncollectible due to the customer’s or third-party payor’s inability or refusal to pay.

The Company performs analyses to evaluate the net realizable value of accounts receivable. Specifically, the Company considers historical realization data, accounts receivable aging trends, other operating trends and relevant

 

7

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

business conditions. Because of continuing changes in the health care industry and third-party reimbursement, it is possible that the Company’s estimates could change, which could have a material impact on the Company’s results of operations and cash flows.

Sales and Certain Other Taxes: In its consolidated financial statements, the Company accounts for taxes imposed on revenue-producing transactions by government authorities on a net basis, and accordingly, excludes such taxes from net revenues. Such taxes include, but are not limited to, sales, use, privilege and excise taxes.

Cost of Goods and Services: Cost of goods and services includes the cost of equipment (excluding depreciation of $22.8 million and $65.0 million for the three and nine-month periods in 2009 and $20.9 million and $62.7 million for the three and nine-month periods in 2008, respectively), drugs and supplies sold to patients and certain operating costs related to the Company’s respiratory drug product line. These costs include an allocation of customer service, distribution and administrative costs relating to the respiratory drug product line of approximately $12.8 million and $38.1 million for the three and nine-month periods ended September 30, 2009, respectively. For the three and nine-month periods of 2008, such costs amounted to $10.2 million and $35.8 million, respectively. Included in cost of goods and services in the three and nine-month periods ended September 30, 2009 are salary and related expenses of pharmacists and pharmacy technicians of approximately $2.9 million and $8.6 million, respectively. Such salary and related expenses for the three and nine-month periods ended September 30, 2008, were $2.8 million and $8.5 million, respectively.

Operating Expenses: The Company manages 1,056 operating centers from which customers are provided equipment, supplies and services. An operating center averages approximately seven to eight employees and is typically comprised of a center manager, two customer service representatives (referred to as “CSR’s” – telephone intake, scheduling, documentation), two or three service representatives (referred to as “Service Reps” – delivery, maintenance and retrieval of equipment and delivery of disposables), a respiratory therapist (non-reimbursable and discretionary clinical follow-up with the customer and communication to the prescribing physician) and a sales representative (marketing calls to local physicians and other referral sources).

The Company includes in operating expenses the costs incurred at the Company’s operating centers for certain service personnel (center manager, CSR’s and Service Reps), facilities (rent, utilities, communications, property taxes, etc.), vehicles (vehicle leases, gasoline, repair and maintenance), and general business supplies and miscellaneous expenses. Operating expenses for the interim periods of 2009 and 2008 within these major categories were as follows:

 

Operating Expenses (in thousands)		For The Three Months Ended September 30,						For the Nine Months Ended September 30,
		2009			2008			2009			2008
Salary and related		$	65,503		$	63,156		$	194,000		$	186,559
Facilities			14,432			14,404			43,797			43,056
Vehicles			10,854			14,127			31,419			39,896
General supplies/miscellaneous			7,651			8,821			23,066			24,931
Total		$	98,440		$	100,508		$	292,282		$	294,442

Included in operating expenses during the three and nine months ended September 30, 2009 are salary and related expenses for Service Reps in the amount of $26.1 million and $78.3 million, respectively. Such salary and related expenses for the three and nine months ended September 30, 2008 were $27.1 million and $81.0 million, respectively.

Selling, General and Administrative Expenses: Selling, general and administrative expenses (“SG&A”) include costs related to sales and marketing activities, corporate overhead and other business support functions. Included in SG&A during the three and nine months ended September 30, 2009 are salary and related expenses of $63.1 million and $192.9 million, respectively. These salary and related expenses include the cost of the Company’s respiratory therapists for the three and nine months ended September 30, 2009 of $16.5 million and $48.9 million, respectively. Included in SG&A during the three and nine months ended September 30, 2008 are salary and related expenses of $58.5 million and

 

8

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

$176.2 million, respectively. These salary and related expenses include the cost of the Company’s respiratory therapists in the amount of $16.2 million and $49.2 million, respectively. The Company’s respiratory therapists generally provide non-reimbursable and discretionary clinical follow-up with the customer and communication, as appropriate, to the prescribing physician with respect to the customer’s plan of care. The Company includes the salaries and related expenses of its respiratory therapist personnel (licensed respiratory therapists or, in some cases, registered nurses) in SG&A because it believes that these personnel enhance the Company’s business relative to its competitors who do not employ respiratory therapists.

Change in Accounting Principle: In May 2008, the Financial Accounting Standards Board (“FASB”) issued updated guidance for the accounting of convertible debt included in the Codification in ASC 470-20, “Debt with Conversion and Other Options,” which specifies that issuers of convertible debt instruments that may be settled in cash upon conversion should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. Upon adoption, the debt component of such instrument would be recognized by measuring the fair value of a similar liability that does not have an associated equity component. The equity component of such instrument would be recognized as the difference between the proceeds from the issuance of the note and the fair value of the liability component. The resulting debt discount (equal to the proceeds allocated to the equity component) is accreted over the expected life of the debt. The guidance was effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company adopted ASC 470-20 effective January 1, 2009 on a retrospective basis to October 31, 2007, the issuance date of the convertible debt. Refer to Note 1 to the consolidated financial statements for the fiscal year ended December 31, 2008, for further discussion of the implementation of ASC 470-20 and the convertible debentures to which the guidance applies.

The change in accounting principle has been applied retrospectively by adjusting the financial statement amounts for the prior periods presented to reflect liability and equity components in a manner that reflects Lincare’s nonconvertible debt borrowing rate when interest cost is recognized in periods subsequent to the issuance date of the convertible instruments. The cumulative effect of this change in accounting principle was a $1.6 million reduction to retained earnings at January 1, 2008.

The following table details the retrospective application impact on previously reported amounts:

CONSOLIDATED BALANCE SHEETS:

 

		December 31, 2008
		As reported			As adjusted
		(In thousands)
Other assets, noncurrent		$	12,980		$	11,249
Long-term obligations, excluding current installments			550,013			454,045
Deferred income taxes and other taxes			253,267			288,696
Additional paid-in capital			490,109			560,444
Retained earnings			478,665			467,138

CONSOLIDATED STATEMENT OF OPERATIONS:

 

		For the three months ended						For the nine months ended
		September 30, 2008 As reported			September 30, 2008 As adjusted			September 30, 2008 As reported			September 30, 2008 As adjusted
		(In thousands, except per share data)
Interest expense		$	5,466		$	9,432		$	19,190		$	30,878
Income before income taxes			88,859			84,893			287,589			275,901
Income tax expense			33,073			31,614			108,550			104,250
Net income			55,786			53,279			179,039			171,651
Basic – earnings per common share			0.76			0.73			2.46			2.35
Diluted – earnings per common share			0.76			0.73			2.38			2.28

 

9

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Cash flows from operating activities were not impacted by the retrospective application of ASC 470-20.

Note 2. Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e. “the exit price”) in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various valuation approaches, including quoted market prices and discounted cash flows. A hierarchy for inputs is used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from independent sources. Unobservable inputs are inputs that reflect a company’s judgment concerning the assumptions that market participants would use in pricing the asset or liability developed based on the best information available under the circumstances. The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:

 

•

Level 1 — Valuations based on quoted prices in active markets for identical instruments that the Company is able to access. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.

 

•

Level 2 — Valuations based on quoted prices in active markets for instruments that are similar, or quoted prices in markets that are not active for identical or similar instruments, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.

 

•

Level 3 — Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

The Company utilizes Level 3 fair value measurements to value its investments in auction rate securities (“ARS”) consisting of securities collateralized by student loans, a related put option (see Note 3, Investments) and acquisition-related contingent consideration.

To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the Company’s degree of judgment exercised in determining fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases an asset or liability is classified in its entirety based on the lowest level of input that is significant to the measurement of fair value.

Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, the Company’s own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date. The Company uses prices and inputs that are current as of the measurement date, including during periods of market dislocation, such as the recent illiquidity in the auction rate securities market. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition has caused, and in the future may cause, the Company’s financial instruments to be reclassified from Level 1 to Level 2 or from Level 2 to Level 3.

Valuation techniques used by the Company must be consistent with at least one of the three possible approaches: the market approach, income approach and/or cost approach. The Company’s Level 3 valuations of auction rate securities and acquisition-related contingent consideration are based on the income approach, specifically, discounted cash flow analyses which utilize significant inputs based on the Company’s estimates and assumptions. Inputs include current coupon rates and expected maturity dates. The Company valued the UBS Put Option using a discounted cash flow approach that takes into account certain estimates for interest rates and the timing and amount of expected future cash flows, adjusted for any bearer risk associated with UBS’s financial ability to repurchase the ARS beginning June 30, 2010. These assumptions are volatile and subject to change as the underlying sources of these assumptions and market conditions change.

During the three months ended September 30, 2009, the Company recognized a $0.1 million unrealized loss on the ARS recorded to other expense, and recorded a corresponding decrease to short-term investments. This was offset by recognizing a $0.1 million unrealized gain on the UBS Put Option recorded to other income, and recorded a corresponding increase to short-term investments.

 

10

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

During the nine months ended September 30, 2009, the Company recognized a $6.7 million unrealized gain on the ARS recorded to other income, and recorded a corresponding increase to short-term investments. This was offset by recognizing a $6.7 million unrealized loss on the UBS Put Option recorded to other expense, and recorded a corresponding decrease to short-term investments.

The following table presents the valuation of the Company’s financial assets and liabilities as of September 30, 2009, measured at fair value on a recurring basis by input level.

 

		Significant Unobservable Inputs (Level 3)						Total
		(In thousands)
Assets
Short-term investments – trading securities		$	55,010					$	55,010
Short-term investments – UBS Put Option			4,090						4,090
Total		$	59,100					$	59,100
		Significant Unobservable Inputs (Level 3)						Total
		(In thousands)
Liabilities
Acquisition-related contingent consideration – short-term		$	276		(1	)		$	276
Acquisition-related contingent consideration – long-term			5,794		(2	)			5,794
Total		$	6,070					$	6,070

 

(1)	Included in current installments of long-term obligations on the accompanying condensed consolidated balance sheets.

(2)	Included in long-term obligations, net, excluding current installments on the accompanying condensed consolidated balance sheets.

 

11

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table presents the changes in the Company’s financial assets and liabilities that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3):

 

		Significant Unobservable Inputs (Level 3)
		(In thousands)
		Assets				Liabilities
Balance on December 31, 2008		$	60,400			$	0
Unrealized gain – ARS			6,736				0
Unrealized loss – UBS Put Option			(6,736	)			0
Redemptions at par			(1,300	)			0
Contingent consideration			0				6,070
Balance on September 30, 2009		$	59,100			$	6,070

Note 3. Investments

At September 30, 2009, the Company held $55.0 million of auction rate securities. These securities are variable-rate debt instruments with contractual maturities between the years 2020 and 2041 with interest rates that reset every seven or 35 days pursuant to a bidding process as determined by the underlying security indentures. The investments are classified as trading securities and are carried at fair value, with any realized and unrealized gains and losses included in other income and expense.

All of the auction rate securities held as of September 30, 2009, are secured by pools of student loans guaranteed by state-designated guaranty agencies or monoline insurers or reinsured by the United States government. The auction rate securities held by the Company are senior obligations under the applicable indentures authorizing the issuance of such securities. Recent turmoil in the credit markets has resulted in widespread failures to attract demand for such securities at the periodic auction dates occurring subsequent to December 31, 2007. As of September 30, 2009, all of the securities held by the Company continued to experience auction failures, resulting in the Company continuing to hold such securities.

The auction rate securities owned by the Company were purchased from UBS Financial Services, Inc., a subsidiary of UBS AG (“UBS”), and are held by UBS for the benefit of the Company. On August 8, 2008, UBS announced a settlement in principle with the Securities and Exchange Commission, the New York Attorney General and other state regulatory agencies to restore liquidity to remaining clients who hold auction rate securities. In November 2008, the Company accepted an offer (the “UBS Put Option”) from UBS to sell to it at par value all of the Company’s remaining auction rate securities in accordance with the terms of the settlement agreement. Under the settlement agreement, the Company will be able to redeem all of its auction rate securities at par during a two-year time period beginning June 30, 2010, while UBS may purchase all or some of the auction rate securities at par from the Company at any time through July 2, 2012. The Company elected to measure the UBS Put Option under the fair value option using a discounted cash flow approach that takes into account certain estimates for interest rates and the timing and amount of expected future cash flows, adjusted for any bearer risk associated with UBS’s financial ability to repurchase the ARS beginning June 30, 2010. These assumptions are volatile and subject to change as the underlying sources of these assumptions and market conditions change. The Company anticipates that any future changes in the fair value of the UBS Put Option will be offset by the changes in the fair value of the related auction rate securities with no material net impact to the consolidated statements of operations. The fair value option enables some companies to reduce the volatility in reported earnings caused by measuring related assets and liabilities differently without applying complex hedge accounting to achieve similar results. The UBS Put Option will continue to be measured at fair value until the earlier of its maturity or exercise, with any realized and unrealized gains and losses included in other income and expense. At September 30, 2009, the estimated fair value of the UBS Put Option was $4.1 million.

 

12

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

During the second quarter of 2009, the Company reclassified all of its investments in auction rate securities from long-term to short-term investments due to the put rights associated with the UBS Put Option becoming effective within one year of the June 30, 2009 balance sheet date.

During the three months ended September 30, 2009, the Company recognized a $0.1 million unrealized loss on the ARS recorded to other expense, and recorded a corresponding decrease to short-term investments. This was offset by recognizing a $0.1 million unrealized gain on the UBS Put Option recorded to other income, and recorded a corresponding increase to short-term investments.

During the nine months ended September 30, 2009, the Company recognized a $6.7 million unrealized gain on the ARS recorded to other income, and recorded a corresponding increase to short-term investments. This was offset by recognizing a $6.7 million unrealized loss on the UBS Put Option recorded to other expense, and recorded a corresponding decrease to short-term investments.

The Company will continue to monitor credit market conditions to assess the liquidity of its investments. Due to the Company’s ability to access its cash and cash equivalents, amounts available under its revolving credit facility, and its expected operating cash flows, the Company believes that it has adequate liquidity available to meet its obligations.

Note 4. Business Combinations

Lincare acquires the business and related assets of local and regional companies as an ongoing strategy to increase revenue within its respective markets. Lincare arrives at a negotiated purchase price taking into account such factors including, but not limited to, the acquired company’s historical and projected revenue growth, operating cash flow, product mix, payor mix, service reputation and geographical location.

During the nine-month period ended September 30, 2009, the Company acquired certain assets of two companies. During the nine-month period ended September 30, 2008, the Company acquired certain assets of three companies.

The acquisition date fair value of the total consideration transferred for the 2009 acquisitions was $11.7 million, which consisted of the following:

 

		(In thousands)
Cash		$	5,067
Contingent consideration			6,070
Acquisition obligations			563
Assumption of liabilities			34
		$	11,734

The following table summarizes the estimated fair values of the assets acquired at the acquisition date for the 2009 acquisitions:

 

		(In thousands)
Current assets		$	2
Property and equipment			73
Intangible assets			260
Goodwill			11,399
		$	11,734

The results of the 2009 acquisitions have been included in the Company’s financial statements from the acquisition dates forward and were immaterial for the first nine months of 2009. Pro forma information for the comparable period of 2008 would not be materially different from amounts reported.

 

13

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Note 5. Accounts Receivable, Net

Accounts receivable, net at September 30, 2009 and December 31, 2008 consist of:

 

		September 30, 2009				December 31, 2008
		(In thousands)
Trade accounts receivable		$	208,593			$	223,868
Less allowance for sales adjustments and uncollectible accounts			(39,434	)			(47,071	)
Accounts receivable, net		$	169,159			$	176,797

Note 6. Property and Equipment, Net

Property and equipment, net at September 30, 2009 and December 31, 2008 consist of:

 

		September 30, 2009				December 31, 2008
		(In thousands)
Property and equipment at cost		$	1,063,963			$	1,002,503
Less accumulated depreciation			(720,908	)			(654,643	)
Property and equipment, net		$	343,055			$	347,860

Note 7. Long-Term Obligations

Long-term obligations at September 30, 2009 and December 31, 2008 consist of:

 

		September 30, 2009				December 31, 2008
		(In thousands)
						(As adjusted Note 1)
Convertible debt to mature in 2037, bearing fixed interest of 2.75%, with a put/call option in 2012		$	275,000			$	275,000
Original issue discount			(31,100	)			(37,728	)
Convertible debt to mature in 2037, bearing fixed interest of 2.75%, with a put/call option in 2014			275,000				275,000
Original issue discount			(52,047	)			(58,240	)
Capital lease obligations due through 2010			38				163
Unsecured acquisition obligations and contingent consideration, net of imputed interest, payable in various installments through 2011			10,110				6,752
Total long-term obligations			477,001				460,947
Less: current installments			4,353				6,902
Long-term debt, excluding current installments		$	472,648			$	454,045

The Company’s revolving credit agreement with several lenders and Bank of America N.A., as agent, dated December 1, 2006, permits the Company to borrow amounts up to $390.0 million under a five-year revolving credit facility. The revolving credit facility contains a $60.0 million letter of credit sub-facility, which reduces the principal amount available under the facility by the amount of outstanding letters of credit on the sub-facility. As of September 30, 2009 and December 31, 2008, no borrowings were outstanding under the credit facility and $27.0 million in standby letters of credit were issued as of those dates. The revolving credit agreement has a maturity date of December 1, 2011. The Company pays an annual administration agency fee along with a quarterly facility fee. The facility fee is based on the

 

14

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Company’s consolidated leverage ratio and ranges between 0.10% and 0.175% annually. The leverage ratio is calculated each quarter to determine the applicable interest rate on revolving loans, the letter of credit fee and the facility fee for the following quarter. The revolving credit agreement contains several financial and other negative and affirmative covenants customary in such agreements and is secured by a pledge of the stock of the wholly-owned subsidiaries of Lincare Holdings Inc. The financial covenants in the Company’s credit agreement include interest coverage and leverage ratios, as defined in the agreement. The Company’s credit agreement requires compliance with all covenants set forth in the agreement and the Company was in compliance with all covenants as of September 30, 2009 and December 31, 2008. The credit agreement defines the occurrence of certain specified events as events of default which, if not waived by or cured to the satisfaction of the requisite lenders, allow the lenders to take actions against the Company, including termination of commitments under the agreement, acceleration of any unpaid principal and accrued interest in respect of outstanding borrowings, payment of additional cash collateral to be held in escrow for the benefit of the lenders and enforcement of any and all rights and interests created and existing under the credit agreement. Under certain conditions, an event of default may result in an increase in the interest rate (the “Default Rate”) payable by the Company on loans outstanding under the credit facility. The Default Rate is equal to the interest rate (including any applicable percentage as set forth in the agreement) otherwise applicable to such loans plus 2% per annum. In the case of a bankruptcy event (as defined in the credit agreement), all commitments automatically terminate and all amounts outstanding under the credit facility become immediately due and payable.

On October 31, 2007, the Company completed the sale of $275.0 million principal amount of convertible senior debentures due 2037 – Series A (the “Series A Debentures”) and $275.0 million principal amount of convertible senior debentures due 2037 – Series B (the “Series B Debentures” and together with the Series A Debentures, the “Series Debentures”) in a private placement. The Series Debentures pay interest semi-annually at a rate of 2.75% per annum. The Series Debentures are unsecured and unsubordinated obligations and will be convertible under specified circumstances based upon a base conversion rate, which, under certain circumstances, will be increased pursuant to a formula that is subject to a maximum conversion rate. Upon conversion, holders of the Series Debentures will receive cash up to the principal amount, and any excess conversion value will be delivered in shares of the Company’s common stock or in a combination of cash and shares of common stock, at the Company’s option. The initial base conversion rate for the Debentures is 19.5044 shares of common stock per $1,000 principal amount of Series Debentures, equivalent to an initial base conversion price of approximately $51.27 per share. In addition, if at the time of conversion the applicable price of the Company’s common stock exceeds the base conversion price, holders of the Series A Debentures and Series B Debentures will receive an additional number of shares of common stock per $1,000 principal amount of the Debentures, as determined pursuant to a specified formula. The Company will have the right to redeem the Series A Debentures and the Series B Debentures at any time after November 1, 2012 and November 1, 2014, respectively. Holders of the Series Debentures will have the right to require the Company to repurchase for cash all or some of their Series Debentures upon the occurrence of certain fundamental change transactions or on November 1, 2012, 2017, 2022, 2027 and 2032 in the case of the Series A Debentures and November 1, 2014, 2017, 2022, 2027 and 2032 in the case of the Series B Debentures.

The Company has estimated the fair value of the liability components of the Series Debentures by calculating the present value of the cash flows of similar liabilities without associated equity components. In performing those calculations, the Company estimated that instruments similar to the Series A and B Debentures without a conversion feature as of the date of issuance would have had 7.0% and 7.4% rates of return (respectively) and expected lives of five and seven years (respectively). These estimated rates of return were based on the Company’s nonconvertible debt borrowing rate at the time of issuance and the expected lives were based on the holder’s put option features embedded in the notes. The initial proceeds from the instruments exceeded the estimated fair value of the liability components, and as a result, the Company reclassified $47.4 million and $67.2 million, respectively, of the carrying value of the Series A and B convertible debentures to equity as of the October 31, 2007 issuance date. These amounts represent the equity components of the proceeds from the debentures. The Company also recognized debt discounts equal to the equity components which will be accreted to interest expense over the respective 5 and 7-year terms of the first put option dates specified in the indentures underlying the debentures. The accreted interest plus the cash interest payments based on the stated coupon rates results in interest cost being recognized in the income statement that reflect the interest rates on similar instruments without a conversion feature.

 

15

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The debt and equity components recognized for our Series A and Series B convertible debentures were as follows (in thousands):

 

		September 30, 2009						December 31, 2008
		Series A			Series B			Series A			Series B
Principal amount of convertible debentures		$	275,000		$	275,000		$	275,000		$	275,000
Unamortized discount			31,100			52,047			37,728			58,240
Net carrying amount			243,900			222,953			237,272			216,760
Additional paid-in capital			29,065			41,238			29,065			41,238

At September 30, 2009, the remaining period over which the discount on the liability components will be amortized is 37 months and 61 months for the Series A and Series B convertible debentures, respectively.

The amount of interest expense recognized for the three months ended September 30, 2009 and 2008 was as follows (in thousands):

 

		September 30, 2009						September 30, 2008
		Series A			Series B			Series A			Series B
Contractual coupon interest		$	1,891		$	1,891		$	1,891		$	1,891
Amortization of discount on convertible debentures			2,247			2,101			2,099			1,956
Interest expense		$	4,138		$	3,992		$	3,990		$	3,847

The amount of interest expense recognized for the nine months ended September 30, 2009 and 2008 was as follows (in thousands):

 

		September 30, 2009						September 30, 2008
		Series A			Series B			Series A			Series B
Contractual coupon interest		$	5,672		$	5,672		$	5,672		$	5,672
Amortization of discount on convertible debentures			6,628			6,193			6,192			5,764
Interest expense		$	12,300		$	11,865		$	11,864		$	11,436

In June 2003, the Company completed the sale of $275.0 million aggregate principal amount of 3.0% Convertible Senior Debentures due 2033 (the “Debentures”) in a private placement. The Debentures were convertible into shares of our common stock based on a conversion rate of 18.7515 shares for each $1,000 principal amount of Debentures. Interest on the Debentures was payable at the rate of 3.0% per annum. On June 15, 2008, the Company redeemed all of the outstanding Debentures at par pursuant to a notice of redemption.

Note 8. Income Taxes

The Company conducts business nationally and, as a result, files U.S. federal income tax returns as well as tax returns in various state and local jurisdictions. In the normal course of business the Company is subject to examination by taxing authorities throughout the United States. With few exceptions, the Company is no longer subject to U.S. federal, state and local income tax examinations for years before 2004.

The Company does not expect that the total amount of unrecognized tax positions will significantly increase or decrease in the next twelve months. The Company continues to recognize accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense.

The Internal Revenue Service (“IRS”) has completed its examination of the Company’s federal income tax returns through 2007. The federal statute of limitations remains open for the year 2006 and onward. There are no material disputes for the open tax years.

The Company was invited to participate in the IRS’s Compliance Assurance Program, or CAP, for the years 2008 and 2009. The years 2008 and 2009 are currently under examination under the CAP program. The objective of CAP is to reduce taxpayer burden and uncertainty while assuring the IRS of the tax return’s accuracy prior to filing, thereby reducing or eliminating the need for post-filing examination.

 

16

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Note 9. Earnings Per Common Share

Basic earnings per common share is computed by dividing earnings available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per common share reflects the potential dilution of securities that could share in the Company’s earnings, including securities that may be issued upon conversion of convertible debentures and exercise of outstanding stock options and non-vested restricted stock using the treasury stock method. When the exercise of stock options or the inclusion of awards would be anti-dilutive, they are excluded from the earnings per common share calculation. For the three and nine months ended September 30, 2009, the number of excluded shares underlying anti-dilutive stock options and awards was 5,798,750 and 7,168,041, respectively. For the three and nine months ended September 30, 2008, the number of excluded shares underlying anti-dilutive stock options and awards was 4,990,500 and 6,785,166, respectively.

A reconciliation of the numerators and the denominators of the basic and diluted earnings per common share computations is as follows:

 

		For The Three Months Ended September 30,						For The Nine Months Ended September 30,
		2009			2008			2009			2008
		(In thousands, except per share data)
					(As adjusted Note 1)						(As adjusted Note 1)
Numerator:
Basic – Income available to common stockholders		$	36,028		$	53,279		$	95,485		$	171,651
Adjustment for assumed dilution:
Interest on convertible debt, net of tax			0			0			0			2,343	(1)
Diluted – Income available to common stockholders and holders of dilutive securities		$	36,028		$	53,279		$	95,485		$	173,994
Denominator:
Weighted average shares			66,987			73,006			68,902			72,903
Effect of dilutive securities:
Incremental shares under stock compensation plans			598			429			411			300
Incremental shares from assumed conversion of convertible debt			0			0			0			3,143
Adjusted weighted average shares			67,585			73,435			69,313			76,346
Per share amount:
Basic		$	0.54		$	0.73		$	1.39		$	2.35
Diluted		$	0.53		$	0.73		$	1.38		$	2.28	(1)

 

(1)

Figures reflect the application of the “if converted” method of accounting for the Company’s 3.0% Convertible Senior Debentures due 2033 (see “Liquidity and Capital Resources”) in accordance with ASC 260-10-45-44. The debentures were redeemed in full on June 15, 2008, pursuant to a notice of redemption.

Note 10. Stock-Based Compensation

For the three months ended September 30, 2009 and 2008, the Company recognized total stock-based compensation expenses of $4.5 million and $4.2 million, respectively, as well as related tax benefits of $33.0 thousand and $1.6 million, respectively. For the nine months ended September 30, 2009 and 2008, the Company recognized total stock-based compensation expenses of $19.4 million and $12.4 million, respectively, as well as related tax benefits of $4.4 million and $4.5 million, respectively. Substantially all stock-based compensation costs are classified within selling, general and administrative expenses on the accompanying condensed consolidated statements of operations.

 

17

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Stock Options

Stock option activity for the nine months ended September 30, 2009 is summarized below:

 

		Number of Options			Weighted Average Exercise Price			Weighted Average Remaining Contractual Life (Years)		Aggregate Intrinsic Value
Outstanding at December 31, 2008		8,324,266			$	34.68
Options granted in 2009		0				—
Exercised in 2009		(224,000	)		$	26.42
Cancelled in 2009		(1,954,996	)		$	33.74
Outstanding at September 30, 2009		6,145,270			$	35.28		2.79		$	5,277,743
Exercisable at September 30, 2009		5,848,798			$	34.97		2.73		$	5,277,743
Vested or expected to vest in the future as of September 30, 2009		6,134,088			$	35.27		2.79		$	5,277,743

Stock options outstanding at September 30, 2009, were 6,145,270. Of the stock options outstanding at September 30, 2009, options for 5,848,798 shares were exercisable and options for 296,472 shares were unvested. Of the total stock options outstanding at September 30, 2009, 6,134,088 were vested or expected to vest in the future, net of expected cancellations and forfeitures of 11,182. The intrinsic value of options exercised during the nine months ended September 30, 2009 and 2008 amounted to $0.4 million and $1.6 million, respectively.

During the first quarter of 2009, the Company’s executive officers, directors and certain of its employees surrendered a total of approximately 1.1 million unvested, out-of-the money stock options for no compensation in return. The cancellation of these stock options resulted in acceleration of future stock option compensation expense (included in selling, general and administrative expenses) of $4.7 million before taxes, or a non-cash charge of $0.04 earnings per common share during the period.

As of September 30, 2009, the total remaining unrecognized compensation cost related to unvested stock options amounted to $0.6 million, which will be amortized over the weighted-average remaining requisite service period of one year.

 

18

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Restricted Stock

The following table summarizes information about restricted stock activity for the nine months ended September 30, 2009:

 

		Shares			Weighted- Average Grant Date Fair Value Per Share
Unvested at December 31, 2008		911,850			$	33.72
Granted		0				—
Vested		0				—
Forfeited		(8,500	)			39.02
Unvested at September 30, 2009		903,350			$	33.67

As of September 30, 2009, the total remaining unrecognized compensation cost related to restricted stock amounted to $8.0 million, which will be amortized over the weighted-average remaining requisite service period of two years.

Note 11. Comprehensive Income

The objective for the reporting and display of comprehensive income and its components in the Company’s condensed consolidated financial statements is to report a measure (comprehensive income (loss)) of all changes in equity of an enterprise that result from transactions and other economic events in a period other than transactions with owners.

The Company’s comprehensive income is the same as reported net income for the three and nine-month periods ended September 30, 2009 and 2008.

 

19

---

Table of Contents

LINCARE HOLDINGS INC. AND SUBSIDIARIES

 

Item 2.

Management’s Discussion and Analysis of Results of Operations and Financial Condition

This “Management’s Discussion and Analysis of Results of Operations and Financial Condition” is intended to assist in understanding and assessing the trends and significant changes in our results of operations and financial condition. Historical results may not indicate future performance. As used in this “Management’s Discussion and Analysis of Results of Operations and Financial Condition,” the words “we,” “our,” “us” and the “Company” refer to Lincare Holdings Inc. and its consolidated subsidiaries.

Medicare Reimbursement

As a provider of home oxygen and other respiratory therapy services to the home health care market, we participate in Medicare Part B, the Supplementary Medical Insurance Program, which was established by the Social Security Act of 1965. Providers of home oxygen and other respiratory therapy services have historically been heavily dependent on Medicare reimbursement due to the high proportion of elderly persons suffering from respiratory disease. Durable medical equipment (“DME”), including oxygen equipment, is traditionally reimbursed by Medicare based on fixed fee schedules.

Recent legislation, including the Medicare Improvements for Patients and Providers Act of 2008 (“MIPPA”), the Medicare, Medicaid and SCHIP Extension Act of 2007 (“SCHIP Extension Act”), the Deficit Reduction Act of 2005 (“DRA”) and the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (“MMA”), contain provisions that directly impact reimbursement for the primary respiratory and other DME products provided by Lincare. MIPPA delayed until 2010 the implementation of a Medicare competitive bidding program for oxygen equipment and certain other DME items that was scheduled to begin on July 1, 2008 and instituted a 9.5% price reduction nationwide for these items as of January 1, 2009. The SCHIP Extension Act reduced Medicare reimbursement amounts for covered Part B drugs, including inhalation drugs that we provide, beginning April 1, 2008. DRA provisions negatively impacted reimbursement for oxygen equipment beginning in 2009 and negatively impacted reimbursement for DME items subject to capped rental payments beginning in 2007. MMA significantly reduced reimbursement for inhalation drug therapies beginning in 2005, reduced payment amounts for five categories of DME, including oxygen, beginning in 2005, froze payment amounts for other covered DME items through 2007, established a competitive acquisition program for DME and implemented quality standards and accreditation requirements for DME suppliers. These legislative provisions, now and when fully implemented, have had a material adverse effect on our business, financial condition, operating results and cash flows.

The SCHIP Extension Act, which became law on December 29, 2007, required the Centers for Medicare and Medicaid Services (“CMS”) to adjust the methodology used to determine Medicare payment amounts for inhalation drugs by using volume-weighted average selling prices (“ASP”) based on actual sales volumes rather than average sales prices. The SCHIP Extension Act also specifically lowered reimbursement for the inhalation drug albuterol. We estimate that these lower payment amounts for inhalation drugs reduced our net revenues by approximately $1.8 million and $31.5 million, respectively, in the three and nine months ended September 30, 2009 compared with the comparable prior year periods. We can not determine whether quarterly updates in ASP pricing data will continue to result in ongoing reductions in payment rates for inhalation drugs, or what impact such payment reductions could have on our business in the future.

On February 1, 2006, Congress passed the DRA legislation which changed the reimbursement methodology for oxygen equipment from continuous monthly payment for as long as the equipment is in use by a Medicare beneficiary, which includes payment for oxygen contents, related disposable supplies and accessories and maintenance of equipment, to a capped rental arrangement whereby payment for oxygen equipment may not extend over a period of continuous use of longer than 36 months. Separate payments for oxygen contents continue to be made for the period of medical need beyond the 36^th month. Additionally, payment for routine maintenance and service of the oxygen equipment, limited to 30 minutes of labor, is made following each six-month period after the 36-month rental period ends. The oxygen provisions contained in DRA became effective on January 1, 2006. In the case of beneficiaries receiving oxygen equipment prior to the effective date, the 36-month period of continuous use began on January 1, 2006. Accordingly, the first month in which the new payment methodology impacted our net revenues was January 2009.

The ultimate financial impact to the Company of the oxygen capped rental regulations will be dependent upon a number of variables, including (i) the number of Medicare oxygen customers reaching 36 months of continuous service, (ii) the number of customers receiving reimbursable oxygen contents beyond the 36-month rental period, (iii) the ultimate duration of therapy for customers on service beyond 36 months, (iv) the incidence of customers with equipment deemed to be beyond its useful life that may be eligible for new equipment and therefore a new rental period, (v) payment amounts and coverage guidelines established by CMS to reimburse suppliers for maintenance of oxygen equipment, and (vi) the

 

20

---

Table of Contents

extent to which other government and private payors attempt to adopt new oxygen payment rules similar to those now in effect under Medicare. We continue to evaluate these factors in order to determine the expected impact of the regulations, which we believe will have a material adverse effect on our revenues, operating income, cash flows and financial position in 2009 and beyond. We estimate that these regulations reduced our net revenues in the three and nine months ended September 30, 2009 by approximately $33.1 million and $99.7 million, respectively. The assumptions used to develop these estimates are highly dependent upon the variables listed above, as well as other factors that we may be unable to anticipate. These estimates may be unreliable and subject to change as more information becomes available to the Company.

DRA also changed the reimbursement methodology for items of DME in the capped rental payment category, including but not limited to such items as continuous positive airway pressure (“CPAP”) devices, certain respiratory assist devices, nebulizers, hospital beds and wheelchairs. For such items of DME, payment may not extend over a period of continuous use of longer than 13 months. On the first day that begins after the 13^th continuous month during which payment is made for the item, the supplier must transfer title of the item to the beneficiary. Additional payments for maintenance and service of the item are made for parts and labor not covered by a supplier’s or manufacturer’s warranty. The DME capped rental provisions contained in DRA applied to items furnished for which the first rental month occurred on or after January 1, 2006. Accordingly, the first month in which the new payment methodology impacted our net revenues was February 2007.

On December 8, 2003, MMA was signed into law. The MMA legislation contains provisions that directly impact reimbursement for the primary respiratory and other DME products provided by Lincare. Among other things, MMA:

 

(1)

Significantly reduced reimbursement for inhalation drug therapies. Historically, prescription drug coverage under Medicare has been limited to drugs furnished incident to a physician’s services and certain self-administered drugs, including inhalation drug therapies. Prior to MMA, Medicare reimbursement for covered drugs, including the inhalation drugs that we provide, was limited to 95% of the published average wholesale price (“AWP”) for the drug. MMA established new payment limits and procedures for drugs reimbursed under Medicare Part B. Beginning in 2005, inhalation drugs furnished to Medicare beneficiaries are reimbursed at 106% of the volume-weighted average selling price (“ASP”) of the drug, as determined from data provided each quarter by drug manufacturers under a specific formula described in MMA. Implementation of the ASP-based reimbursement formula has resulted in dramatic reductions in payment rates for inhalation drugs since 2005.

 

(2)

Established a competitive acquisition program for DME that was expected to commence in 2008, but was subsequently delayed by further legislation. MMA instructs CMS to establish and implement programs under which competitive acquisition areas will be established throughout the United States for contract award purposes for the furnishing of competitively priced items of DME, including oxygen equipment. The program was initially intended to be implemented in phases such that competition under the program would occur in ten of the largest metropolitan statistical areas (“MSAs”) in the first year, 80 of the largest MSAs in the following year, and additional areas thereafter.

For each competitive acquisition area, CMS is to conduct a competition under which providers will submit bids to supply certain covered items of DME. Successful bidders will be expected to meet certain program quality standards in order to be awarded a contract and only successful bidders can supply the covered items to Medicare beneficiaries in the acquisition area. The applicable contract award prices are expected to be less than would be paid under current Medicare fee schedules and contracts will be re-bid at least every three years. CMS will be required to award contracts to multiple entities submitting bids in each area for an item or service, but will have the authority to limit the number of contractors in a competitive acquisition area to the number needed to meet projected demand. CMS may use competitive bid pricing information to adjust the payment amounts otherwise in effect for an area that is not a competitive acquisition area.

CMS concluded the bidding process for the first round of MSAs in September 2007. On March 20, 2008, CMS completed the bid evaluation process and announced the payment amounts that would have taken effect in the ten competitive bidding areas beginning July 1, 2008. Contracts to provide products within the competitive bid areas were awarded to selected suppliers, including the Company, and took effect on July 1, 2008. On July 15, 2008, Congress enacted the MIPPA legislation which retroactively delayed the implementation of competitive bidding for up to 18 months and reduced Medicare prices nationwide by 9.5% beginning in 2009 for the product categories, including oxygen, that were initially included in competitive bidding. As a result of the delay, CMS cancelled all contract awards retroactively to June 30, 2008.

 

21

---

Table of Contents

On April 18, 2009, the interim final rule (“IFR”) for competitive bidding became effective. The IFR outlines the process for rebidding the first round of competitive bidding in 2009. The bidding will apply to nine of the original ten MSAs in round one and will be expanded to additional MSAs thereafter. A competition for a national mail order competitive bidding program may occur after 2010. It is unclear at this time when contracts would be awarded under the program and the respective effective dates of the contracts. We will continue to monitor developments regarding the implementation of the competitive bidding program. We can not predict the outcome of the competitive bidding program on our business when fully implemented nor the Medicare payment rates that will be in effect in future years for the items subjected to competitive bidding.

The 9.5% reduction in Medicare payment rates imposed by the MIPPA legislation for the product categories, including oxygen, that were initially included in competitive bidding took effect on January 1, 2009. In addition to the 9.5% reduction, CMS subjected the monthly payment amount for stationary oxygen equipment to additional cuts of 2.3%, thereby reducing the monthly payment rate from $199.28 in 2008 to $175.79 in 2009. We estimate that these price reductions, in aggregate, reduced our net revenues in the three and nine months ended September 30, 2009 by approximately $27.6 million and $82.2 million, respectively.

Federal and state budgetary and other cost-containment pressures will continue to impact the home respiratory care industry. We can not predict whether new federal and state budgetary proposals will be adopted or the effect, if any, such proposals would have on our business.

Government Regulation

The federal government and all states in which we currently operate regulate various aspects of our business. In particular, our operating centers are subject to federal laws that regulate the repackaging of drugs (including oxygen) and interstate motor-carrier transportation. Our operations also are subject to state laws governing, among other things, pharmacies, nursing services, distribution of medical equipment and certain types of home health activities. Certain of our employees are subject to state laws and regulations governing the ethics and professional practice of respiratory therapy, pharmacy and nursing.

As a health care supplier, we are subject to extensive government regulation, including numerous laws directed at preventing fraud and abuse and laws regulating reimbursement under various government programs. The marketing, billing, documenting and other practices of health care companies are all subject to government scrutiny. To ensure compliance with Medicare and other regulations, regional health insurance carriers often conduct audits and request customer records and other documents to support our claims submitted for payment of services rendered to customers. Similarly, government agencies periodically open investigations and obtain information from health care providers pursuant to the legal process. Violations of federal and state regulations can result in severe criminal, civil and administrative penalties and sanctions, including disqualification from Medicare and other reimbursement programs, which could have a material adverse effect on our business.

Numerous federal and state laws and regulations, including the Federal Health Insurance Portability And Accountability Act of 1996 (“HIPAA”) and the Health Information Technology For Economic And Clinical Health Act (“HITECH Act”), govern the collection, dissemination, security, use and confidentiality of patient-identifiable health information. As part of our provision of, and billing for, health care equipment and services, we are required to collect and maintain patient-identifiable health information. New health information standards, whether implemented pursuant to HIPAA, the HITECH Act, congressional action or otherwise, could have a significant effect on the manner in which we handle health care related data and communicate with payors, and the cost of complying with these standards could be significant. If we do not comply with existing or new laws and regulations related to patient health information, we could be subject to criminal or civil sanctions.

Health care is an area of rapid regulatory change. Changes in the laws and regulations and new interpretations of existing laws and regulations may affect permissible activities, the relative costs associated with doing business, and reimbursement amounts paid by federal, state and other third-party payors. We can not predict the future of federal, state and local regulation or legislation, including Medicare and Medicaid statutes and regulations, or possible changes in national health care policies. Future legislative and regulatory changes could have a material adverse effect on our business.

 

22

---

Table of Contents

Operating Results

The following table sets forth for the periods indicated a summary of the Company’s net revenues by product category:

 

		For The Three Months Ended September 30,						For The Nine Months Ended September 30,
		2009			2008			2009			2008
		(In thousands)						(In thousands)
Oxygen and other respiratory therapy		$	353,938		$	370,713		$	1,033,463		$	1,147,310
Home medical equipment and other			38,706			34,964			111,214			102,178
Total		$	392,644		$	405,677		$	1,144,677		$	1,249,488

Net revenues for the three months ended September 30, 2009, decreased by $13.0 million (or 3.2%), compared with the three months ended September 30, 2008, and for the nine months ended September 30, 2009, decreased by $104.8 million (or 8.4%) compared with the nine months ended September 30, 2008. The Company estimates that the 3.2% decrease in net revenues in the third quarter of 2009 was comprised of approximately 12.2% internal and acquisition growth offset by approximately 15.4% negative impact from $62.6 million of Medicare price reductions taking effect in 2009 (see “Medicare Reimbursement” above). The Company estimates that the 8.4% decrease in net revenues in the first nine months of 2009 was comprised of approximately 8.7% internal and acquisition growth offset by approximately 17.1% negative impact from Medicare price reductions of $213.5 million taking effect in 2009. The internal growth in net revenues is attributable to underlying demographic growth in the markets for our products and gains in customer counts resulting primarily from our sales and marketing efforts that emphasize high-quality equipment and customer service. Growth in net revenues from acquisitions is attributable to the effects of acquisitions of local and regional companies and is based on the estimated contribution to net revenues for the four quarters following such acquisitions.

The contribution of oxygen and other respiratory therapy products to our net revenues was 90.1% and 90.3%, respectively, during the three and nine months ended September 30, 2009. Our strategy is to focus on the provision of oxygen and other respiratory therapy services to patients in the home and to provide home medical equipment and other services where we believe such services will enhance our core respiratory business.

Cost of goods and services, as a percentage of net revenues, was 28.0% and 27.8%, respectively, for the three and nine months ended September 30, 2009, compared with 23.4% and 24.2% for the comparable prior year periods. Cost of goods and services for the three months ended September 30, 2009, increased $14.8 million, or 15.6%, when compared with the prior year period. Cost of goods and services for the nine months ended September 30, 2009, increased $15.5 million, or 5.1%, when compared with the prior year period. The increase in cost of goods and services in the three and nine month periods of 2009 is attributable to an increase in the number of oxygen customers served and higher volumes in our inhalation drug and sleep therapy product lines.

Cost of goods and services for the three and nine-month periods includes the cost of equipment (excluding depreciation of $22.8 million and $65.0 million in 2009 and $20.9 million and $62.7 million in 2008, respectively), drugs and supplies sold to patients and certain costs related to the Company’s respiratory drug product line. These costs include an allocation of customer service, distribution and administrative costs relating to the respiratory drug product line of approximately $12.8 million and $38.1 million for the three and nine-month periods of 2009, respectively, and approximately $10.2 million and $35.8 million for the three and nine-month periods of 2008, respectively. Included in cost of goods and services in the three and nine months ended September 30, 2009 are salary and related expenses of pharmacists and pharmacy technicians of $2.9 million and $8.6 million, respectively. Such salary and related expenses for the three and nine months ended September 30, 2008, were $2.8 million and $8.5 million, respectively.

Operating expenses, as a percentage of net revenues, were 25.1% and 25.5%, respectively, for the three and nine months ended September 30, 2009, compared with 24.8% and 23.6% respectively, for the comparable prior year periods. Operating expenses for the three and nine months ended September 30, 2009, decreased by $2.1 million, or 2.1%, and $2.2 million, or 0.7%, respectively, over the prior year periods. Contributing to the containment of growth in operating expenses during the first nine months of 2009 were lower fuel and other vehicle related expenses, lower purchases of supply items and controls over salary and related expenses, partially offset by higher employee health benefits costs.

 

23

---

Table of Contents

The Company manages 1,056 operating centers from which customers are provided equipment, supplies and services. An operating center averages approximately seven to eight employees and is typically comprised of a center manager, two customer service representatives (referred to as “CSR’s” – telephone intake, scheduling, documentation), two or three service representatives (referred to as “Service Reps” – delivery, maintenance and retrieval of equipment and delivery of disposables), a respiratory therapist (non-reimbursable and discretionary clinical follow-up with the customer and communication to the prescribing physician) and a sales representative (marketing calls to local physicians and other referral sources).

The Company includes in operating expenses the costs incurred at the Company’s operating centers for certain service personnel (center manager, CSR’s and Service Reps), facilities (rent, utilities, communications, property taxes, etc.), vehicles (vehicle leases, gasoline, repair and maintenance), and general business supplies and miscellaneous expenses. Operating expenses for the interim periods of 2009 and 2008 within these major categories were as follows:

 

Operating Expenses (in thousands)		For The Three Months Ended September 30,						For the Nine Months Ended September 30,
		2009			2008			2009			2008
Salary and related		$	65,503		$	63,156		$	194,000		$	186,559
Facilities			14,432			14,404			43,797			43,056
Vehicles			10,854			14,127			31,419			39,896
General supplies/miscellaneous			7,651			8,821			23,066			24,931
Total		$	98,440		$	100,508		$	292,282		$	294,442

Included in operating expenses during the three and nine months ended September 30, 2009 are salary and related expenses for Service Reps in the amount of $26.1 million and $78.3 million, respectively. Such salary and related expenses for the three and nine months ended September 30, 2008 were $27.1 million and $81.0 million, respectively.

Selling, general and administrative (“SG&A”) expenses, as a percentage of net revenues, were 20.9% and 21.6%, respectively, for the three and nine months ended September 30, 2009, compared with 20.3% and 19.5% for the comparable prior year periods. SG&A expenses for the three months ended September 30, 2009 decreased by $0.1 million, or 0.1%, compared to the prior year period. SG&A expenses for the nine months ended September 30, 2009 increased by $3.7 million, or 1.5% over the prior year period. Contributing to the increase in SG&A expenses during the nine months ended September 30, 2009 was $4.7 million of stock option compensation expense attributable to the surrender and cancellation in the first quarter of 2009 of approximately 1.1 million unvested, out-of-the money stock options held by our executive officers, directors and certain other employees for no compensation in return. The $4.7 million charge represents acceleration of future non-cash compensation expense recognized during the period.

SG&A expenses include costs related to sales and marketing activities, corporate overhead and other business support functions. Included in SG&A during the three and nine months ended September 30, 2009 are salary and related expenses of $63.0 million and $192.9 million, respectively. These salary and related expenses include the cost of the Company’s respiratory therapists in the amount of $16.5 million and $48.9 million during the respective periods. Included in SG&A during the three and nine months ended September 30, 2008 are salary and related expenses of $58.5 million and $176.2 million, respectively. These salary and related expenses include the cost of the Company’s respiratory therapists in the amount of $16.2 million and $49.2 million during the respective periods. The Company’s respiratory therapists generally provide non-reimbursable and discretionary clinical follow-up with the customer and communication, as appropriate, to the prescribing physician with respect to the customer’s plan of care. The Company includes the salaries and related expenses of its respiratory therapist personnel (licensed respiratory therapists or, in some cases, registered nurses) in SG&A because it believes that these personnel enhance the Company’s business relative to its competitors who do not employ respiratory therapists.

Included in depreciation and amortization expense in the three and nine months ended September 30, 2009 is depreciation of patient service equipment of $22.8 million and $65.0 million, respectively, and depreciation of other

 

24

---

Table of Contents

property and equipment of $7.4 million and $24.1 million, respectively. Included in depreciation and amortization expense in the three and nine months ended September 30, 2008 is depreciation of patient service equipment of $20.9 million and $62.7 million, respectively, and depreciation of other property and equipment of $8.1 million and $25.8 million, respectively.

Operating income for the three and nine months ended September 30, 2009, was $66.1 million (16.8% of net revenues) and $180.6 million (15.8% of net revenues), respectively, compared with $92.9 million (22.9% of net revenues) and $301.6 million (24.1% of net revenues), respectively, for the comparable prior year periods. The decrease in operating income in 2009 is attributed to the dramatic reduction in Medicare reimbursement for the Company’s primary product lines that took effect this year (see “Medicare Reimbursement”).

Liquidity and Capital Resources

Our primary sources of liquidity have been internally generated funds from operations, borrowings under credit facilities and proceeds from equity and debt transactions. We have used these funds to meet our capital requirements, which consist primarily of operating costs, capital expenditures, acquisitions, debt service and share repurchases.

Net cash provided by operating activities decreased by 21.0% to $254.5 million for the nine months ended September 30, 2009, compared with $322.1 million for the nine months ended September 30, 2008. Net cash used in investing and financing activities was $234.9 million for the nine months ended September 30, 2009. Investing and financing activities during the nine-month period ended September 30, 2009 included our net investment in property and equipment of $84.5 million, $5.1 million of business acquisition expenditures, payments of principal on debt of $3.2 million and repurchases of our common stock of $150.3 million, and proceeds of $1.3 million from the sale of investments and $6.8 million in proceeds from the exercise of stock options.

As of September 30, 2009, our principal sources of liquidity consisted of approximately $151.3 million of cash and cash equivalents and short-term investments and $363.0 million available under our revolving credit agreement. The revolving credit agreement, dated December 1, 2006, makes available to us up to $390.0 million over a five-year period, subject to certain terms and conditions set forth in the agreement. As of September 30, 2009, there were $27.0 million of standby letters of credit issued under the credit facility.

At September 30, 2009, the Company held $55.0 million of auction rate securities. These securities are variable-rate debt instruments with contractual maturities between the years 2020 and 2041 with interest rates that reset every seven or 35 days pursuant to a bidding process as determined by the underlying security indentures. The investments are classified as trading securities and are carried at fair value, with any realized and unrealized gains and losses included in other income and expense.

The auction rate securities owned by the Company were purchased from UBS Financial Services, Inc., a subsidiary of UBS AG (“UBS”), and are held by UBS for the benefit of the Company. On August 8, 2008, UBS announced a settlement in principle with the Securities and Exchange Commission, the New York Attorney General and other state regulatory agencies to restore liquidity to remaining clients who hold auction rate securities. In November 2008, the Company accepted an offer (the “UBS Put Option”) from UBS to sell to it at par value all of the Company’s remaining auction rate securities in accordance with the terms of the settlement agreement. Under the settlement agreement, the Company will be able to redeem all of its auction rate securities at par during a two-year time period beginning June 30, 2010, while UBS may purchase all or some of the auction rate securities at par from the Company at any time through July 2, 2012. At September 30, 2009, the estimated fair value of the UBS Put Option was $4.1 million.

During the second quarter of 2009, the Company reclassified all of its investments in auction rate securities from long-term to short-term investments due to the put rights associated with the UBS Put Option becoming effective within one year of the June 30, 2009 balance sheet date. All of the auction rate securities held as of September 30, 2009, are secured by pools of student loans guaranteed by state-designated guaranty agencies or monoline insurers or reinsured by the United States government. The auction rate securities held by the Company are senior obligations under the applicable indentures authorizing the issuance of such securities. Recent turmoil in the credit markets has resulted in widespread failures to attract demand for such securities at the periodic auction dates occurring subsequent to December 31, 2007. As of September 30, 2009, all of the securities held by the Company continued to experience auction failures, resulting in our continuing to hold such securities. The Company received partial redemptions of these securities, at par, in the amount of $0.5 million in February 2009, $0.5 million in July 2009 and $0.3 million in August 2009.

 

25

---

Table of Contents

We will continue to monitor credit market conditions to assess the liquidity of our investments and access to external sources of capital. Due to our ability to access our cash and cash equivalents, amounts available under our revolving credit facility, and our expected operating cash flows, we believe that we have adequate liquidity available to meet our obligations.

Our Board of Directors has authorized a share repurchase plan whereby the Company may repurchase from time to time, on the open market or in privately negotiated transactions, shares of the Company’s common stock in amounts determined pursuant to a formula (the “share repurchase formula”) that takes into account both the ratio of the Company’s net debt to cash flow and its available cash resources and borrowing availability. During the nine months ended September 30, 2009, the Company repurchased and retired 6,621,264 shares for $150.3 million pursuant to the repurchase plan. As of September 30, 2009, $324.0 million of the Company’s common stock was eligible for repurchase in accordance with the plan’s formula.

On October 31, 2007, we completed the sale of $275.0 million principal amount of convertible senior debentures, due 2037 – Series A (the “Series A Debentures”) and $275.0 million principal amount of convertible senior debentures due 2037 – Series B (the “Series B Debentures” and together with the Series A Debentures, the “Series Debentures”) in a private placement. The Series Debentures pay interest semi-annually at a rate of 2.75% per annum. The Series Debentures are unsecured and unsubordinated obligations and are convertible under specified circumstances based upon a base conversion rate, which, under certain circumstances, will be increased pursuant to a formula that is subject to a maximum conversion rate. Upon conversion, holders of the Series Debentures will receive cash up to the principal amount, and any excess conversion value will be delivered in shares of our common stock or in a combination of cash and shares of common stock, at our option. The initial base conversion rate for the Debentures is 19.5044 shares of common stock per $1,000 principal amount of Series Debentures, equivalent to an initial base conversion price of approximately $51.27 per share. In addition, if at the time of conversion the applicable price of our common stock exceeds the base conversion price, holders of the Series Debentures will receive an additional number of shares of common stock per $1,000 principal amount as determined pursuant to a specified formula. We have the right to redeem the Series A Debentures and the Series B Debentures at any time after November 1, 2012 and November 1, 2014, respectively. Holders of the Series Debentures will have the right to require us to repurchase for cash all or some of their Series Debentures upon the occurrence of certain fundamental change transactions or on November 1, 2012, 2017, 2022, 2027 and 2032 in the case of the Series A Debentures and November 1, 2014, 2017, 2022, 2027 and 2032 in the case of the Series B Debentures.

On June 15, 2008, we redeemed $275.0 million of 3.0% Convertible Senior Debentures due 2033 (the “Debentures”) pursuant to a redemption notice. The Debentures were convertible into shares of our common stock based on a conversion rate of 18.7515 shares for each $1,000 principal amount of Debentures. Interest on the Debentures was payable at the rate of 3.0% per annum.

Our future liquidity will continue to be dependent upon our operating cash flow and management of accounts receivable. We anticipate that funds generated from operations, together with our current cash on hand and funds available under our revolving credit facility, will be sufficient to finance our working capital requirements, fund anticipated acquisitions and capital expenditures, and meet our contractual obligations for at least the next 12 months.

Accounts Receivable: The Company maintains payor-specific price tables in its billing system that reflect the fee schedule amounts statutorily in effect or contractually agreed upon by various government and commercial payors for each item of equipment or supply provided to a customer. Due to the nature of the health care industry and the reimbursement environment in which Lincare operates, situations can occur where expected payment amounts are not established by fee schedules or contracted rates, and estimates are required to record revenues and accounts receivable at their net realizable values. Inherent in these estimates is the risk that revenues and accounts receivable will have to be revised or updated as additional information becomes available. Contractual adjustments to revenues and accounts receivable can result from price differences between allowed charges and amounts initially recognized as revenue due to incorrect price tables or subsequently negotiated payment rates. Actual adjustments that result from differences between the payment amount received and the expected realizable amount are recorded against the allowance for sales adjustments and are typically identified and ultimately recorded at the point of cash application or account review. We report revenues in our financial statements net of such adjustments. Accounts receivable are reported net of allowances for sales adjustments and uncollectible accounts. Bad debt is recorded as an operating expense and consists of billed charges that are ultimately deemed uncollectible due to the customer’s or third-party payor’s inability or refusal to pay.

 

26

---

Table of Contents

The Company’s payor mix is highly concentrated among Medicare, Medicaid and other government third-party payors and contracted private insurance or commercial payors. Government payment rates are determined according to published fee schedules established pursuant to statute, law or other regulatory processes and commercial payment rates are based on contractual line item pricing as reflected in the respective contracts. Fee schedule updates have historically occurred on a prospective basis and have been made available to the Company in advance of the effective date of a change in reimbursement rates. The Company’s proprietary billing system has features that allow the Company to timely update payor price tables within the system as changes occur in order to accurately record revenues and accounts receivable at their expected realizable values. Additional systems and manual controls and processes are used by management to evaluate the accuracy of these recorded amounts. Based on the Company’s experience, it is unlikely that a change in estimate of unsettled amounts from third party payors would have a material adverse impact on its financial position or results of operations.

Accounts receivable balance concentrations by major payor category as of September 30, 2009 and December 31, 2008 were as follows:

 

Percentage of Accounts Receivable Outstanding:		September 30, 2009			December 31, 2008
Medicare		35.1	%		35.5	%
Medicaid/Other Government		15.2	%		16.2	%
Private Insurance		38.7	%		39.0	%
Customer Pay		11.0	%		9.3	%
Total		100.0	%		100.0	%

Aged accounts receivable balances by major payor category as of September 30, 2009 and December 31, 2008 were as follows:

 

		September 30, 2009
Percentage of Accounts Aged in Days:		0-60			61-120			Over 120
Medicare		81.8	%		9.3	%		8.9	%
Medicaid/Other Government		61.9	%		16.5	%		21.6	%
Private Insurance		62.9	%		13.7	%		23.4	%
Customer Pay		47.9	%		23.7	%		28.4	%
All Payors		67.7	%		13.7	%		18.6	%

 

		December 31, 2008
Percentage of Accounts Aged in Days:		0-60			61-120			Over 120
Medicare		82.5	%		8.8	%		8.7	%
Medicaid/Other Government		53.1	%		17.4	%		29.5	%
Private Insurance		59.7	%		14.3	%		26.0	%
Customer Pay		50.3	%		26.6	%		23.1	%
All Payors		65.9	%		14.0	%		20.1	%

We operate 34 regional billing and collection offices (“RBCOs”) that are responsible for the billing and collection of accounts receivable. The RBCOs are aligned geographically to support the accounts receivable activity of the operating centers within their assigned territories. As of September 30, 2009, there were 1,343 full-time employees in the RBCOs. Accounts receivable collections are performed by designated collectors within each of the RBCOs. The collectors use

 

27

---

Table of Contents

various reporting tools available within our proprietary billing system to identify claims that have been denied or partially paid by the responsible party and claims that have not been processed by the third-party payor in a timely manner. Collections of accounts receivable are typically pursued using direct phone contact to determine the reason for non-payment and, if necessary, corrected claims are prepared for resubmission and further follow-up with the responsible party. In some cases, third-party payors have developed electronic inquiry methods that we can access to determine the status of individual claims. We have benefited from the increasing availability of electronic funds transfers from payors, which now account for approximately 68.9% of all payments received. We believe that our collection procedures contribute to our accounts receivable days sales outstanding (“DSO”) of 39 days and bad debt expense of 1.5% being among the lowest in the industry, according to published industry data and public filings of some of our competitors.

The ultimate collection of accounts receivable may not be known for several months. We record bad debt expense based on a percentage of revenue using historical Company-specific data. The percentage and amounts used to record bad debt expense and the allowance for doubtful accounts are supported by various methods and analyses including current and historical cash collections, bad debt write-offs, aged accounts receivable and consideration of any payor-specific concerns. The ultimate write-off of an accounts receivable occurs once collection procedures are determined to have been exhausted by the collector and after appropriate review of the specific account and approval by supervisory and/or management employees within the RBCOs. Management and RBCO supervisory and management employees also review accounts receivable write-off reports, correspondence from payors and individual account information to evaluate and correct processes that might have contributed to an unsuccessful collection effort.

We do not use an aging threshold for account receivable write-offs. However, the age of an account balance may provide an indication that collection procedures have been exhausted, and would be considered in the review and approval of an account balance write-off.

Future Minimum Obligations

In the normal course of business, we enter into obligations and commitments that require future contractual payments. The commitments primarily result from repayment obligations for borrowings under our revolving credit facility and Series Debentures as well as contractual lease payments for facility, vehicle, and equipment leases, deferred taxes and acquisition obligations.

New Accounting Standards

In June 2009, the Financial Accounting Standards Board (“FASB”) issued “Accounting Standards Codification” (“ASC”) 105-10, “Generally Accepted Accounting Principles – Overall” (“ASC 105-10”). ASC 105-10 establishes the FASB Accounting Standards Codification (the “Codification”) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles (“GAAP”). Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority. The Codification superseded all existing non-SEC accounting and reporting standards. All other non-grandfathered, non-SEC accounting literature not included in the Codification is non-authoritative. The FASB will not issue new standards in the form of Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standards Updates (“ASUs”). The FASB will not consider ASUs as authoritative in their own right. ASUs will serve only to update the Codification, provide background information about the guidance and provide the bases for conclusions on the change(s) in the Codification. References made to FASB guidance throughout this document have been updated for the Codification. The Codification is effective for all reporting periods that end after September 15, 2009. The adoption of ASC 105-10 did not have an impact on our financial condition, results of operations or cash flows.

In December 2007, the FASB issued FASB ASC 805, “Business Combinations,” (“ASC 805”), which requires an acquirer in a business combination to recognize the assets acquired, liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. It also requires the recognition of assets acquired and liabilities assumed arising from certain contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. The provisions of ASC 805 are effective as of the beginning of the 2009 calendar year. The adoption of ASC 805 did not have a material impact on our financial condition, results of operations or cash flows.

 

28

---

Table of Contents

In February 2008, the FASB issued updated guidance related to fair value measurements, which is included in the Codification in ASC 820-10-55, “Fair Value Measurements and Disclosures – Overall – Implementation Guidance and Illustrations.” The updated guidance provided a one year deferral of the effective date of ASC 820-10 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. Therefore, the Company adopted the provisions of ASC 820-10 for non-financial assets and non-financial liabilities effective January 1, 2009, and such adoption did not have a material impact on our financial condition, results of operations or cash flows.

In May 2008, the FASB issued updated guidance for the accounting for convertible debt included in the Codification in ASC 470-20, “Debt with Conversion and Other Options,” which specifies that issuers of convertible debt instruments that may be settled in cash upon conversion should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. Upon adoption, the debt component of such instrument would be recognized by measuring the fair value of a similar liability that does not have an associated equity component. The equity component of such instrument would be recognized as the difference between the proceeds from the issuance of the note and the fair value of the liability component. ASC 470-20 requires accretion of the resultant debt discount (equal to the proceeds allocated to the equity component) over the expected life of the debt. The guidance is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company adopted ASC 470-20 effective January 1, 2009, applied on a retrospective basis. For a full discussion of the impact to the Company’s condensed consolidated financial statements, refer to Note 1.

In April 2009, the FASB issued updated guidance related to business combinations, which is included in the Codification in ASC 805-20, “Business Combinations – Identifiable Assets, Liabilities and Any Noncontrolling Interest” (“ASC 805-20”). ASC 805-20 amends and clarifies ASC 805 to address application issues regarding initial recognition and measurement, subsequent measurement and accounting and disclosure of assets and liabilities arising from contingencies in a business combination. In circumstances where the acquisition-date fair value for a contingency cannot be determined during the measurement period and it is concluded that it is probable that as asset or liability exists as of the acquisition date and the amount can be reasonably estimated, a contingency is recognized as of the acquisition date based on the estimated amount. The provisions of ASC 805-20 were effective for assets or liabilities arising from contingencies in business combinations for which the acquisition date is on or after January 1, 2009 and did not have an impact on our financial condition, results of operations or cash flows.

In April 2009, the FASB issued FASB ASC 820-10-65, “Fair Value Measurements and Disclosures – Overall – Transition and Open Effective Date Information” (“ASC 820-10-65”). ASC 820-10-65 provides additional guidance for estimating fair value in accordance with ASC 820-10 when the volume and level of activity for the asset or liability have significantly decreased. The guidance indicates if the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability then transactions or quoted prices may not be determinative of fair value. In such a situation further analysis of the transactions or quoted prices is needed and a significant adjustment to the transactions or quoted prices may be necessary to estimate fair value in accordance with ASC 820. ASC 820-10-65 emphasizes that in identifying transactions that are not orderly an entity cannot assume that the observable transaction price is not orderly when the volume and level of activity for the asset or liability have significantly declined. Rather an entity must perform an analysis to determine whether the observable price is representative of a transaction that is not orderly. ASC 820-10-65 amends the disclosure provisions of ASC 820-10-50 to require entities to disclose in interim and annual periods the inputs and valuation technique(s) used to measure fair value. This requirement was previously limited to annual periods under ASC 820. Further, if an entity changes the valuation technique(s) or related assumptions in measuring fair value, the entity is required to qualitatively discuss the changes in valuation technique(s) and related assumptions in both interim and annual financial statements. Entities have alternatives for adopting ASC 820-10-65 including to not early adopt in which case adoption is required no later than periods ending after June 15, 2009 or to early adopt for periods ending after March 15, 2009. We adopted ASC 820-10-65 for the period ended June 30, 2009. The adoption of ASC 820-10-65 did not have a material impact on our financial condition, results of operations or cash flows.

In April 2009, the FASB issued FASB ASC 825-10-65, “Financial Instruments – Overall – Transition and Open Effective Date Information” (“ASC 825-10-65”), which increases the frequency of fair value disclosures from annual only to quarterly to provide financial statement users with more timely information about the effects of current market conditions on financial instruments. ASC 825-10-65 requires public entities to disclose in their interim financial statements the fair value of all financial instruments within the scope of ASC 825-10 as well as the method(s) and

 

29

---

Table of Contents

significant assumptions used to estimate the fair value of those financial instruments. Entities have alternatives for adopting the ASC 825-10-65 including to not early adopt in which case adoption is required no later than periods ending after June 15, 2009 or to early adopt for periods ending after March 15, 2009. We adopted ASC 825-10-65 for the period ended June 30, 2009. The adoption of ASC 825-10-65 did not have an impact on our financial condition, results of operations or cash flows.

In May 2009, the FASB issued FASB ASC 855-10, “Subsequent Events - Overall” (“ASC 855-10”), which provides guidance on management’s assessment of subsequent events. ASC 855-10 defines subsequent events as “events or transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued.” Financial statements are considered “issued” when they are widely distributed to shareholders and other financial statement users for general use and reliance in a form and format that complies with generally accepted accounting principles. Financial statements are considered “available to be issued” when they are complete in a form and format that complies with GAAP and all approvals necessary for issuance have been obtained. Entities that have a current expectation of widely distributing their financial statements, such as public companies, are required to assess subsequent events through the date of issuance. All other entities are required to consider subsequent events until financial statements are available to be issued. ASC 855-10 requires the disclosure of the date through which subsequent events have been evaluated, as well as whether that date is the date the financial statements were issued. ASC 855-10 is effective for interim or annual financial periods ending after June 15, 2009 and should be applied prospectively. We adopted the provisions of ASC 855-10 for the period ended June 30, 2009. The adoption of ASC 855-10 did not have an impact on our financial condition, results of operations or cash flows.

In August 2009, the FASB issued Accounting Standards Update 2009-05, “Measuring Liabilities at Fair Value,” which provides guidance on measuring the fair value of liabilities under FASB ASC 820, “Fair Value Measurements.” ASU 2009-05 reaffirms that fair value measurement of a liability assumes the transfer of a liability to a market participant as of the measurement date; that is, the liability is presumed to continue and is not settled with the counterparty. In addition, ASU 2009-05 reemphasizes that a fair value measurement of a liability includes nonperformance risk and that such risk does not change after transfer of the liability. In a manner consistent with this underlying premise (i.e., a transfer notion), the ASU requires that an entity should first determine whether a quoted price of an identical liability traded in an active market exists (i.e., a Level 1 fair value measurement). The ASU clarifies that the quoted price for the identical liability, when traded as an asset in an active market, is also a Level 1 measurement for that liability when no adjustment to the quoted price is required. In the absence of a Level 1 measurement, an entity must use one or more of the following valuation techniques to estimate fair value (in a manner consistent with the principles in ASC 820), which can be classified into two broad categories:

A valuation technique that uses a quoted price:

 

•

Quoted price of an identical liability when traded as an asset.

 

•

Quoted price of a similar liability or of a similar liability when traded as an asset.

Another valuation technique (e.g., a market approach or an income approach), including one of the following:

 

•

A technique based on the amount an entity would pay to transfer the identical liability.

 

•

A technique based on the amount an entity would receive to enter into an identical liability.

The ASU emphasizes that regardless of the technique(s) used, an entity should maximize the use of relevant observable inputs and minimize the use of unobservable inputs. The guidance in ASU 2009-05 is effective for the first reporting period (including interim periods) beginning after issuance. Entities may also elect to early adopt the ASU if financial statements have not been issued. In the period of adoption, an entity is required to disclose any change in valuation technique and related inputs and quantify the total effect, if practicable. We adopted this ASU effective October 1, 2009. We do not expect the adoption of ASU 2009-05 to have a material impact on our financial condition, results of operations or cash flows.

Forward Looking Statements

Statements in this report concerning future results, performance or expectations are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. All forward-looking statements included in this document are based upon information available to us as of the date hereof and we assume no obligation to

 

30

---

Table of Contents

update any such forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any results, levels of activity, performance or achievements expressed or implied by any forward-looking statements. In some cases, forward-looking statements that involve risks and uncertainties contain terminology such as “may,” “will,” “should,” “could,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or variations of these terms or other comparable terminology.

Key factors that have an impact on our ability to attain these estimates include potential reductions in reimbursement rates by government and other third-party payors, changes in reimbursement policies, the demand for our products and services, the availability of appropriate acquisition candidates and our ability to successfully complete and integrate acquisitions, efficient operations of our existing and future operating facilities, regulation and/or regulatory action affecting us or our business, economic and competitive conditions, access to borrowed and/or equity capital on favorable terms and other risks described below.

In developing our forward-looking statements, we have made certain assumptions relating to reimbursement rates and policies, internal growth and acquisitions and the outcome of various legal and regulatory proceedings. If the assumptions we use differ materially from what actually occurs, then actual results could vary significantly from the performance projected in the forward-looking statements. We are under no duty to update any of the forward-looking statements after the date of this report.

Certain Risk Factors Relating to the Company’s Business

We operate in a rapidly changing environment that involves a number of risks. The following discussion highlights some of these risks and others are discussed elsewhere in this report. These and other risks could materially and adversely affect our business, financial condition, operating results and cash flows.

A MAJORITY OF OUR CUSTOMERS HAVE PRIMARY HEALTH COVERAGE UNDER MEDICARE PART B, AND RECENTLY ENACTED AND FUTURE CHANGES IN THE REIMBURSEMENT RATES OR PAYMENT METHODOLOGIES UNDER THE MEDICARE PROGRAM COULD MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS.

As a provider of home oxygen and other respiratory therapy services for the home health care market, we have historically depended heavily on Medicare reimbursement as a result of the high proportion of elderly persons suffering from respiratory disease. Medicare Part B, the Supplementary Medical Insurance Program, provides coverage to eligible beneficiaries for DME, such as oxygen equipment, respiratory assistance devices, continuous positive airway pressure devices, nebulizers and associated inhalation medications, hospital beds and wheelchairs for the home setting. Approximately 68% of our customers have primary coverage under Medicare Part B. There are increasing pressures on Medicare to control health care costs and to reduce or limit reimbursement rates for home medical equipment and services. Medicare reimbursement is subject to statutory and regulatory changes, retroactive rate adjustments, administrative and executive orders and governmental funding restrictions, all of which could materially decrease payments to us for the services and equipment we provide.

Recent legislation, including the Medicare Improvements for Patients and Providers Act of 2008 (“MIPPA”), the Medicare, Medicaid and SCHIP Extension Act of 2007 (“SCHIP Extension Act”), the Deficit Reduction Act of 2005 (“DRA”) and the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (“MMA”), contain provisions that directly impact reimbursement for the primary respiratory and other DME products provided by Lincare. MIPPA delayed until 2010 the implementation of a Medicare competitive bidding program for oxygen equipment and certain other DME items that was scheduled to begin on July 1, 2008 and instituted a 9.5% price reduction nationwide for these items as of January 1, 2009. The SCHIP Extension Act reduced Medicare reimbursement amounts for covered Part B drugs, including inhalation drugs that we provide, beginning April 1, 2008. DRA provisions negatively impacted reimbursement for oxygen equipment beginning in 2009 and negatively impacted reimbursement for DME items subject to capped rental payments beginning in 2007. MMA significantly reduced reimbursement for inhalation drug therapies beginning in 2005, reduced payment amounts for five categories of DME, including oxygen, beginning in 2005, froze payment amounts for other covered DME items through 2007, established a competitive acquisition program for DME and implemented quality standards and accreditation requirements for DME suppliers. These legislative provisions, now and when fully implemented, have had a material adverse effect on our business, financial condition, operating results and cash flows. See “MEDICARE REIMBURSEMENT” for a full discussion of the MIPPA, SCHIP Extension Act, DRA and MMA provisions.

 

31

---

Table of Contents

A SIGNIFICANT PERCENTAGE OF OUR BUSINESS IS DERIVED FROM THE SALE AND RENTAL OF MEDICARE-COVERED OXYGEN AND DME ITEMS, AND RECENT LEGISLATIVE ACTS IMPOSE SUBSTANTIAL CHANGES IN THE MEDICARE PAYMENT METHODOLOGIES AND REDUCTIONS IN THE MEDICARE PAYMENT AMOUNTS FOR THESE ITEMS.

DRA changed the reimbursement methodology for oxygen equipment from continuous monthly payment for as long as the equipment is in use by a Medicare beneficiary, which includes payment for oxygen contents, related disposable supplies and accessories and maintenance of equipment, to a capped rental arrangement whereby payment for oxygen equipment may not extend over a period of continuous use of longer than 36 months. Separate payments for oxygen contents continue to be made for the period of medical need beyond the 36^th month. Additionally, payment for routine maintenance and service of the oxygen equipment is made following each six-month period after the 36-month rental period ends. The oxygen provisions contained in DRA became effective on January 1, 2006. In the case of beneficiaries receiving oxygen equipment prior to the effective date, the 36-month period of continuous use began on January 1, 2006. Accordingly, the first month in which the new payment methodology impacted our net revenues was January 2009.

The DRA oxygen provisions and related regulations represent a fundamental change in the Medicare payment system for oxygen. These provisions are complex, and are expected to result in profound changes in the provider-customer relationship for oxygen equipment and related services. The ultimate financial impact to the Company of the oxygen capped rental regulations will be dependent upon a number of variables, including (i) the number of Medicare oxygen customers reaching 36 months of continuous service, (ii) the number of customers receiving reimbursable oxygen contents beyond the 36-month rental period, (iii) the ultimate duration of therapy for customers on service beyond 36 months, (iv) the incidence of customers with equipment deemed to be beyond its useful life that may be eligible for new equipment and therefore a new rental episode, (v) payment amounts and coverage guidelines established by CMS to reimburse suppliers for maintenance of oxygen equipment, and (vi) the extent to which other government and private payors attempt to adopt new oxygen payment rules similar to those now in effect under Medicare. The Company continues to evaluate these factors in order to determine the expected impact of the regulations, which we believe will have a material adverse effect on our revenues, operating income, cash flows and financial position in 2009 and beyond. We estimate that these regulations reduced our net revenues in the three and nine months ended September 30, 2009 by approximately $33.1 million and $99.7 million, respectively. The assumptions used to develop this estimate are highly dependent upon the variables listed above, as well as other factors that we may be unable to anticipate. This estimate may be unreliable and subject to change as more information becomes available to the Company.

DRA also changed the reimbursement methodology for items of DME in the capped rental payment category, including but not limited to such items as continuous positive airway pressure (“CPAP”) devices, certain respiratory assist devices, nebulizers, hospital beds and wheelchairs. For such items of DME, payment may not extend over a period of continuous use of longer than 13 months. On the first day that begins after the 13^th continuous month during which payment is made for the item, the supplier must transfer title of the item to the beneficiary. Additional payments for maintenance and service of the item are made for parts and labor not covered by a supplier’s or manufacturer’s warranty. The DME capped rental provisions contained in DRA applied to items furnished for which the first rental month occurred on or after January 1, 2006. Accordingly, the first month in which the new payment methodology impacted our net revenues was February 2007.

On July 15, 2008, Congress enacted the MIPPA legislation which contains provisions that reduced Medicare payment rates nationwide for certain DME items, including oxygen equipment, by 9.5% beginning in 2009. In addition to the 9.5% reduction, CMS subjected the monthly payment amount for stationary oxygen equipment to additional cuts of 2.3%, thereby reducing the monthly payment rate from $199.28 in 2008 to $175.79 in 2009. We estimate that these price reductions, in aggregate, reduced our net revenues in the three and nine months ended September 30, 2009 by approximately $27.6 million and $82.2 million, respectively.

A SIGNIFICANT PERCENTAGE OF OUR BUSINESS IS DERIVED FROM THE SALE OF MEDICARE-COVERED RESPIRATORY MEDICATIONS, AND RECENT LEGISLATION AND MEDICARE POLICY REVISIONS IMPOSED SIGNIFICANT REDUCTIONS IN MEDICARE REIMBURSEMENT FOR SUCH INHALATION DRUGS.

Recently enacted legislation negatively affected Medicare reimbursement amounts for covered Part B drugs, including inhalation drugs that we provide, beginning April 1, 2008 (See “MEDICARE REIMBURSEMENT”). The SCHIP Extension Act required CMS to adjust the average sales price (“ASP”) calculation methodology used to determine Medicare payment amounts for inhalation drugs by using volume-weighted ASPs based on actual sales volume rather than average sales price. The SCHIP Extension Act also specifically lowered reimbursement for the inhalation drug albuterol.

 

32

---

Table of Contents

We estimate that these lower payment amounts for inhalation drugs reduced our net revenues by approximately $1.8 million and $31.5 million, respectively, in the three and nine months ended September 30, 2009 compared with the comparable prior year periods. We can not determine whether quarterly updates in ASP pricing data will continue to result in ongoing reductions in payment rates for inhalation drugs, or what impact such payment reductions could have on our business in the future.

RECENT REGULATORY CHANGES SUBJECT THE MEDICARE REIMBURSEMENT RATES FOR OUR EQUIPMENT AND SERVICES TO ADDITIONAL REDUCTIONS AND TO POTENTIAL DISCRETIONARY ADJUSTMENT BY CMS, WHICH COULD REDUCE OUR REVENUES, NET INCOME AND CASH FLOWS.

In February 2006, a final rule governing CMS’ Inherent Reasonableness, or IR, authority became effective. The IR rule establishes a process for adjusting fee schedule amounts for Medicare Part B services when existing payment amounts are determined to be either grossly excessive or deficient. The rule describes the factors that CMS or its contractors will consider in making such determinations and the procedures that will be followed in establishing new payment amounts. To date, no payment adjustments have occurred or been proposed as a result of the IR rule.

The effectiveness of the IR rule itself does not trigger payment adjustments for any items or services. Nevertheless, the IR rule puts in place a process that could eventually have a significant impact on Medicare payments for our equipment and services. We can not predict whether or when CMS will exercise its IR authority with respect to payment for our equipment and services, or the effect that such payment adjustments would have on our financial position or operating results.

FUTURE IMPLEMENTATION OF A COMPETITIVE BIDDING PROCESS UNDER MEDICARE COULD REDUCE OUR REVENUES, NET INCOME AND CASH FLOWS.

CMS is required by law to establish and implement programs under which competitive acquisition areas will be established throughout the United States for contract award purposes for the furnishing of competitively priced items of DME, including oxygen equipment (See “MEDICARE REIMBURSEMENT”). The program was initially intended to be implemented in phases such that competition under the program would occur in ten of the largest MSAs in the first year, 80 of the largest MSAs in the following year, and additional areas thereafter.

For each competitive acquisition area, CMS is to conduct a competition under which providers will submit bids to supply certain covered items of DME. Successful bidders will be expected to meet certain program quality standards in order to be awarded a contract and only successful bidders can supply the covered items to Medicare beneficiaries in the acquisition area. The applicable contract award prices are expected to be less than would be paid under current Medicare fee schedules, and contracts will be re-bid at least every three years. CMS will be required to award contracts to multiple entities submitting bids in each area for an item or service, but will have the authority to limit the number of contractors in a competitive acquisition area to the number needed to meet projected demand. CMS may use competitive bid pricing information to adjust the payment amounts otherwise in effect for an area that is not a competitive acquisition area.

CMS concluded the bidding process for the first round of MSAs in September 2007. On March 20, 2008, CMS completed the bid evaluation process and announced the payment amounts that would have taken effect in the ten competitive bidding areas beginning July 1, 2008. Contracts to provide products within the competitive bid areas were awarded to selected suppliers, including the Company, and took effect on July 1, 2008. On July 15, 2008, Congress enacted the MIPPA legislation which retroactively delayed the implementation of competitive bidding for up to 18 months and reduced Medicare prices nationwide by 9.5% beginning in 2009 for the product categories, including oxygen, that were initially included in competitive bidding. As a result of the delay, CMS cancelled all contract awards retroactively to June 30, 2008.

On April 18, 2009, the interim final rule (“IFR”) for competitive bidding became effective. The IFR outlines the process for rebidding the first round of competitive bidding in 2009. The bidding will apply to nine of the original ten MSAs in round one and will be expanded to additional MSAs thereafter. A competition for a national mail order competitive bidding program may occur after 2010. It is unclear at this time when contracts would be awarded under the program and the respective effective dates of the contracts. We will continue to monitor developments regarding the implementation of the competitive bidding program. We can not predict the outcome of the competitive bidding program on our business when fully implemented nor the Medicare payment rates that will be in effect in future years for the items subjected to competitive bidding.

 

33

---

Table of Contents

FUTURE REDUCTIONS IN REIMBURSEMENT RATES UNDER MEDICAID COULD REDUCE OUR REVENUES, NET INCOME AND CASH FLOWS.

Due to budgetary shortfalls, many states are considering, or have enacted, cuts to their Medicaid programs, including funding for our equipment and services. These cuts have included, or may include, elimination or reduction of coverage for some or all of our equipment and services, amounts eligible for payment under co-insurance arrangements, or payment rates for covered items. Approximately 7% of our customers are eligible for primary Medicaid benefits, and State Medicaid programs fund approximately 11% of our payments from primary and secondary insurance benefits. Continued state budgetary pressures could lead to further reductions in funding for the reimbursement for our equipment and services which, in turn, could have a material adverse effect on our financial position and operating results.

FUTURE REDUCTIONS IN REIMBURSEMENT RATES FROM PRIVATE PAYORS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR FINANCIAL CONDITION AND OPERATING RESULTS.

Payors such as private insurance companies and employers are under pressure to increase profitability and reduce costs. In response, certain payors are limiting coverage or reducing reimbursement rates for the equipment and services we provide. Approximately 27% of our customers and approximately 33% of our primary and secondary payments are derived from private payors. Continued financial pressures on these entities could lead to further reimbursement reductions for our equipment and services that could have a material adverse effect on our financial condition and operating results.

WE DEPEND UPON REIMBURSEMENT FROM THIRD-PARTY PAYORS FOR A SIGNIFICANT MAJORITY OF OUR REVENUES, AND IF WE FAIL TO MANAGE THE COMPLEX AND LENGTHY REIMBURSEMENT PROCESS, OUR BUSINESS AND OPERATING RESULTS COULD SUFFER.

We derive a significant majority of our revenues from reimbursement by third-party payors. We accept assignment of insurance benefits from customers and, in most instances, invoice and collect payments directly from Medicare, Medicaid and private insurance carriers, as well as from customers under co-insurance provisions. Approximately 47% of our revenues are derived from Medicare, 33% from private insurance carriers, 13% from Medicaid and the balance directly from individual customers and commercial entities.

Our financial condition and results of operations may be affected by the reimbursement process, which in the health care industry is complex and can involve lengthy delays between the time that services are rendered and the time that the reimbursement amounts are settled. Depending on the payor, we may be required to obtain certain payor-specific documentation from physicians and other health care providers before submitting claims for reimbursement. Certain payors have filing deadlines and they will not pay claims submitted after such time. We can not ensure that we will be able to continue to effectively manage the reimbursement process and collect payments for our equipment and services promptly.

WE ARE SUBJECT TO EXTENSIVE FEDERAL AND STATE REGULATION, AND IF WE FAIL TO COMPLY WITH APPLICABLE REGULATIONS, WE COULD SUFFER SEVERE CRIMINAL OR CIVIL SANCTIONS OR BE REQUIRED TO MAKE SIGNIFICANT CHANGES TO OUR OPERATIONS THAT COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR RESULTS OF OPERATIONS.

The federal government and all states in which we currently operate regulate various aspects of our business. In particular, our operating centers are subject to federal laws that regulate the repackaging of drugs (including oxygen) and interstate motor-carrier transportation. Our operations also are subject to state laws governing, among other things, pharmacies, nursing services, distribution of medical equipment and certain types of home health activities. Certain of our employees are subject to state laws and regulations governing the ethics and professional practices of respiratory therapy, pharmacy and nursing.

As a health care supplier, we are subject to extensive government regulation, including numerous laws directed at preventing fraud and abuse and laws regulating reimbursement under various government programs. The marketing, billing, documenting and other practices of health care companies are all subject to government scrutiny. To ensure compliance with Medicare and other regulations, regional health insurance carriers often conduct audits and request customer records and other documents to support our claims submitted for payment of services rendered to customers. Similarly, government agencies periodically open investigations and obtain information from health care providers pursuant to the legal process. Violations of federal and state regulations can result in severe criminal, civil and administrative penalties and sanctions, including disqualification from Medicare and other reimbursement programs, which could have a material adverse effect on our business.

Health care is an area of rapid regulatory change. Changes in the laws and regulations and new interpretations of existing laws and regulations may affect permissible activities, the relative costs associated with doing business, and reimbursement amounts paid by federal, state and other third-party payors. We can not predict the future of federal, state and local regulation or legislation, including Medicare and Medicaid statutes and regulations, or possible changes in national health care policies. Future legislation and regulatory changes could have a material adverse effect on our business.

 

34

---

Table of Contents

WE ARE SUBJECT TO A CORPORATE INTEGRITY AGREEMENT WITH THE OFFICE OF INSPECTOR GENERAL, AND IF WE FAIL TO COMPLY WITH THE TERMS OF THE CORPORATE INTEGRITY AGREEMENT, WE COULD SUFFER SEVERE CRIMINAL, CIVIL OR ADMINISTRATIVE SANCTIONS.

We are subject to a five-year corporate integrity agreement with the Office of Inspector General that began in May 2006. Violations of the terms of the corporate integrity agreement could result in severe criminal, civil and administrative penalties and sanctions, including disqualification from Medicare and other reimbursement programs.

COMPLIANCE WITH REGULATIONS UNDER THE FEDERAL HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996 (HIPAA), THE HEALTH INFORMATION TECHNOLOGY FOR ECONOMIC AND CLINICAL HEALTH ACT (HITECH ACT) AND RELATED RULES, RELATING TO THE TRANSMISSION, SECURITY AND PRIVACY OF HEALTH INFORMATION COULD IMPOSE ADDITIONAL SIGNIFICANT COSTS ON OUR OPERATIONS.

Numerous federal and state laws and regulations, including HIPAA and the HITECH Act, govern the collection, dissemination, security, use and confidentiality of patient-identifiable health information. HIPAA and the HITECH Act require us to comply with standards for the use and disclosure of health information within our company and with third parties. HIPAA and the HITECH Act also include standards for common health care electronic transactions and code sets, such as claims information, plan eligibility, payment information and the use of electronic signatures, and privacy and electronic security of individually identifiable health information. HIPAA requires health care providers, including us, in addition to health plans and clearinghouses, to develop and maintain policies and procedures with respect to protected health information that is used or disclosed. The HITECH Act expands the notification requirement for breaches of patient-identifiable health information, restricts certain disclosures and sales of patient-identifiable health information and provides a tiered system for civil monetary penalties for HIPAA violations.

If we do not comply with existing or new laws and regulations related to patient health information, we could be subject to criminal or civil sanctions. New health information standards, whether implemented pursuant to HIPAA, the HITECH Act, congressional action or otherwise, could have a significant effect on the manner in which we handle health care related data and communicate with payors, and the cost of complying with these standards could be significant.

WE MAY UNDERTAKE ACQUISITIONS THAT COULD SUBJECT US TO UNANTICIPATED LIABILITIES AND THAT COULD FAIL TO ACHIEVE EXPECTED BENEFITS.

Our strategy is to increase our market share through internal growth and strategic acquisitions. Consideration for the acquisitions has generally consisted of cash, unsecured non-interest bearing obligations and the assumption of certain liabilities.

The implementation of an acquisition strategy entails certain risks, including inaccurate assessment of disclosed liabilities, the existence of undisclosed liabilities, regulatory compliance issues associated with the acquired business, entry into markets in which we may have limited or no experience, diversion of management’s attention and human resources from our underlying business, difficulties in integrating the operations of an acquired business or in realizing anticipated efficiencies and cost savings, failure to retain key management or operating personnel of the acquired business, and an increase in indebtedness and a limitation in the ability to access additional capital on favorable terms. The successful integration of an acquired business may be dependent on the size of the acquired business, condition of the customer billing records, and complexity of system conversions and execution of the integration plan by local management. If we do not successfully integrate the acquired business, the acquisition could fail to achieve its expected revenue contribution or there could be delays in the billing and collection of claims for services rendered to customers, which may have a material adverse effect on our financial position and operating results.

WE FACE INTENSE NATIONAL, REGIONAL AND LOCAL COMPETITION AND IF WE ARE UNABLE TO COMPETE SUCCESSFULLY, WE WILL LOSE REVENUES AND OUR BUSINESS WILL SUFFER.

The home respiratory market is a fragmented and highly competitive industry. We compete against other national providers and, by our estimate, more than 2,000 local and regional providers. Home respiratory companies compete primarily on the basis of service rather than price since reimbursement levels are established by Medicare and Medicaid or by the individual determinations of private health plans.

 

35

---

Table of Contents

Our ability to compete successfully and to increase our referrals of new customers are highly dependent upon our reputation within each local health care market for providing responsive, professional and high-quality service and achieving strong customer satisfaction. Given the relatively low barriers to entry in the home respiratory market, we expect that the industry will become increasingly competitive in the future. Increased competition in the future could limit our ability to attract and retain key operating personnel and achieve continued growth in our core business.

INCREASES IN OUR COSTS COULD ERODE OUR PROFIT MARGINS AND SUBSTANTIALLY REDUCE OUR NET INCOME AND CASH FLOWS.

Cost containment in the health care industry, fueled, in part, by federal and state government budgetary shortfalls, is likely to result in constant or decreasing reimbursement amounts for our equipment and services. As a result, we must control our operating cost levels, particularly labor and related costs, which account for a significant component of our operating costs and expenditures. We compete with other health care providers to attract and retain qualified or skilled personnel. We also compete with various industries for administrative and service employees. Since reimbursement rates are established by fee schedules mandated by Medicare, Medicaid and private payors, we are not able to offset the effects of general inflation in labor and related cost components, if any, through increases in prices for our equipment and services. Consequently, such cost increases could erode our profit margins and reduce our net income.

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

There were no material changes to the information provided in Item 7A in our Annual Report on Form 10-K regarding our market risk.

Our revolving credit facility is subject to changing LIBOR-based interest rates. At September 30, 2009, we had no outstanding borrowings under the credit facility.

 

Item 4.

Controls and Procedures

(a) Disclosure Controls and Procedures

The Company has conducted an evaluation of its disclosure controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report (the “Evaluation Date”). Based on its evaluation, the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company is recorded, processed, summarized and reported within the required time periods.

(b) Changes in Internal Control Over Financial Reporting

No change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d – 15(f) under the Securities and Exchange Act of 1934, as amended) occurred during the fiscal quarter ended September 30, 2009, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

36

---

Table of Contents

PART II. OTHER INFORMATION

 

Item 1.

Legal Proceedings

As a health care provider, the Company is subject to extensive government regulation, including numerous laws directed at preventing fraud and abuse and laws regulating reimbursement under various government programs. The marketing, billing, documenting and other practices of health care companies are all subject to government scrutiny. To ensure compliance with Medicare and other regulations, regional carriers often conduct audits and request patient records and other documents to support claims submitted by Lincare for payment of services rendered to customers. Similarly, government agencies periodically open investigations and obtain information from health care providers pursuant to legal process.

Violations of federal and state regulations can result in severe criminal, civil and administrative penalties and sanctions, including disqualification from Medicare and other reimbursement programs.

From time to time, the Company receives inquiries from various government agencies requesting customer records and other documents. It has been the Company’s policy to cooperate with all such requests for information. However, the Company can provide no assurances as to the duration or outcome of these inquiries.

Private litigants may also make claims against health care providers for violations of health care laws in actions known as qui tam suits. In these cases, the government has the opportunity to intervene in, and take control of, the litigation. From time to time we are named as a defendant in such qui tam proceedings. We vigorously defend these suits. The government has declined to intervene for purposes other than dismissal in all unsealed qui tam actions of which we are aware.

Our operating centers are also subject to federal and/or state laws regulating, among other things, interstate motor-carrier transportation, repackaging of oxygen, distribution of medical equipment, certain types of home health activities, pharmacy operations, nursing services and respiratory services and apply to those locations involved in such activities. Certain of our employees are subject to state laws and regulations governing the ethics and professional practice of respiratory therapy, pharmacy and nursing. From time to time, the Company receives inquiries and complaints from various government agencies related to its operations or personnel. It has been the Company’s policy to cooperate with all such inquiries and vigorously defend any administrative complaints. The Company can provide no assurances as to the duration or outcome of these inquiries and/or complaints.

We are also involved in certain other claims and legal actions arising in the ordinary course of our business. The ultimate disposition of all such matters is not currently expected to have a material adverse impact on our financial position, results of operations or liquidity.

The Company is subject to a five-year corporate integrity agreement with the Office of Inspector General that began in May 2006. Violations of the corporate integrity agreement can result in severe criminal, civil and administrative penalties and sanctions, including disqualification from Medicare and other reimbursement programs.

 

37

---

Table of Contents

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

During the three months ended September 30, 2009, the Company did not repurchase any shares of its common stock.

 

ISSUER PURCHASES OF EQUITY SECURITIES
Period		Total Number of Shares Purchased		Average Price Paid Per Share			Total Number of Shares Purchased as Part of the Repurchase Program		Approximate Dollar Value of Shares that May Yet Be Purchased Under the Repurchase Program
July 1, 2009 to July 31, 2009		0		$	0.00		0		$	304,548,000
August 1, 2009 to August 31, 2009		0			0.00		0		$	321,507,000
September 1, 2009 to September 30, 2009		0			0.00		0		$	323,997,000
Total		0		$	0.00		0

Our Board of Directors has authorized a share repurchase plan whereby the Company may repurchase shares of the Company’s common stock in amounts determined pursuant to a formula that takes into account both the ratio of the Company’s net debt to cash flow and its available cash resources and borrowing availability. As of September 30, 2009, $324.0 million of common stock was eligible for repurchase in accordance with the plan’s formula.

 

Item 3.

Defaults Upon Senior Securities - Not Applicable

 

Item 4.

Submission of Matters to a Vote of the Security Holders - Not Applicable

 

Item 5.

Other Information - Not Applicable

 

Item 6.

Exhibits

 

(a)

Exhibits included or incorporated herein: See Exhibit Index.

 

38

---

Table of Contents

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

November 4, 2009

 

39

---

Table of Contents

INDEX OF EXHIBITS

 

Exhibit Number		Exhibit
3.10 (A)		Amended and Restated Certificate of Incorporation of Lincare Holdings Inc.
3.11 (A)		Certificate of Amendment to the Amended and Restated Certificate of Incorporation of Lincare Holdings Inc.
3.20 (B)		Amended and Restated By-Laws of Lincare Holdings Inc.
4.10 (C)		Lincare Holdings Inc. Indenture dated as of June 11, 2003
4.20 (C)		Lincare Holdings Inc. Registration Rights Agreement dated as of June 11, 2003
4.30 (D)		Lincare Holdings Inc. Series A Indenture dated as of October 31, 2007
4.40 (D)		Lincare Holdings Inc. Series B Indenture dated as of October 31, 2007
4.50 (D)		Lincare Holdings Inc. Registration Rights Agreement dated as of October 31, 2007
4.60 (D)		First Amendment to Credit Agreement with Bank of America, N.A. as Agent and Calyon, New York Branch as Syndication Agent dated as of October 31, 2007
31.1		Certification Pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, executed by John P. Byrnes, Chief Executive Officer
31.2		Certification Pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, executed by Paul G. Gabos, Chief Financial Officer
32.1		Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by John P. Byrnes, Chief Executive Officer
32.2		Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by Paul G. Gabos, Chief Financial Officer

 

A	Incorporated by reference to the Registrant’s Form 10-Q dated August 12, 1998.

B	Incorporated by reference to the Registrant’s Form 10-Q dated August 13, 2002.

C	Incorporated by reference to the Registrant’s Form 8-K dated June 12, 2003.

D	Incorporated by reference to the Registrant’s Form 8-K dated November 6, 2007.

 

S-1