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Article by DailyStocks_admin    (05-15-08 06:33 AM)

The Daily Magic Formula Stock for 05/15/2008 is Lincare Holdings Inc. According to the Magic Formula Investing Web Site, the ebit yield is 14% and the EBIT ROIC is 75-100 %.

Dailystocks.com only deals with facts, not biased journalism. What is a better way than to go to the SEC Filings? It's not exciting reading, but it makes you money. We cut and paste the important information from SEC filings for you to get started on your research on a specific company.


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BUSINESS OVERVIEW

General

Lincare Holdings Inc., together with its subsidiaries (“Lincare,” the “Company,” “we” or “our”), is one of the nation’s largest providers of oxygen and other respiratory therapy services to patients in the home. Our customers typically suffer from chronic obstructive pulmonary disease (“COPD”), such as emphysema, chronic bronchitis or asthma, and require supplemental oxygen or other respiratory therapy services in order to alleviate the symptoms and discomfort of respiratory dysfunction. Lincare currently serves approximately 670,000 customers in 47 states through 978 operating centers. Lincare Holdings Inc. is a Delaware corporation.

The Home Respiratory Market

We estimate that the home respiratory market (including home oxygen equipment and respiratory therapy services) represents in excess of $5.0 billion in annual sales, with growth estimated at approximately 6% per year over the last five years. This growth reflects the significant increase in the number of persons afflicted with COPD, which is largely attributable to the increasing proportion of the U.S. population over the age of 65 years. Growth in the home respiratory market is further driven by the continued trend toward treatment of patients in the home as a lower cost alternative to the acute care setting.

Business Strategy

Our strategy is to increase our market share through internal growth and strategic business acquisitions. Lincare achieves internal growth in existing geographic markets through the addition of new customers and referral sources to our network of local operating centers. In addition, we expand into new geographic markets on a selective basis, either through acquisitions or by opening new operating centers, when we believe such expansion will enhance our business. In 2006, Lincare acquired 10 local and regional companies with operations in multiple states. These acquisitions expanded our presence in states where we had existing locations.

Revenue growth is dependent upon the overall growth rate of the home respiratory market and on our ability to increase market share through effective marketing efforts and selective acquisitions. Continued cost containment efforts by government and private insurance reimbursement programs have created an increasingly competitive environment, accelerating consolidation trends within the home health care industry.

We will continue our focus on providing 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 primary business. In 2006, oxygen and other respiratory therapy services accounted for approximately 92% of Lincare’s net revenues.

Products and Services of Lincare

Lincare primarily provides oxygen and other respiratory therapy services to patients in the home. We also provide a variety of durable medical equipment (“DME”) and home infusion therapies in certain geographic markets. When a physician, hospital discharge planner, or other source refers a patient to one of our operating centers, our customer representative obtains the necessary medical and insurance coverage information, assignment of benefits to Lincare, and coordinates the delivery of patient care. The prescribed therapy is delivered by one of our service representatives or clinicians at the customer’s home, where instruction and training are provided to the customer and the customer’s family regarding appropriate equipment use and maintenance and compliance with the prescribed therapy. Following the initial setup, our service representatives and/or clinicians make periodic visits to the customer’s home, the frequency of which is dictated by the type of therapy prescribed and physician orders. All services and equipment provided by Lincare are coordinated with the prescribing physician. During the period that we provide services and equipment for a customer, the customer remains under the physician’s care and medical supervision. We employ respiratory therapists, nurses and other qualified clinicians to perform certain training and other functions in connection with our services. Clinicians are licensed where required by applicable law.

The principal products and services provided by Lincare are:

Home Oxygen Equipment. The major types of oxygen delivery equipment are oxygen concentrators and liquid oxygen systems. Each method of delivery has different characteristics that make it more or less suitable to specific customer applications.

*

Oxygen concentrators are stationary units that provide a continuous flow of oxygen by filtering ordinary room air. Customers most commonly use concentrators as their primary source of stationary oxygen. These systems are often supplemented with portable gaseous oxygen cylinders or liquid oxygen systems to meet the ambulatory or emergency needs of the customer.
*

Liquid oxygen systems are thermally insulated containers of liquid oxygen, generally consisting of a stationary unit and a portable unit, which are most commonly used by customers with significant ambulatory requirements.

Other Respiratory Therapy. Other respiratory therapy services offered by Lincare include the following:

*

Nebulizers and associated respiratory medications provide aerosol therapy for customers suffering from COPD and asthma.
*

Non-invasive ventilation provides nocturnal ventilatory support for customers with neuromuscular disease and COPD. This therapy improves daytime function and decreases incidence of acute illness.
*

Ventilators support respiratory function in severe cases of respiratory failure where the customer can no longer sustain the mechanics of breathing without the assistance of a machine.
*

Continuous positive airway pressure devices maintain open airways in customers suffering from obstructive sleep apnea by providing airflow at prescribed pressures during sleep.

Home Infusion Therapy. In certain geographic markets, Lincare provides a variety of home infusion therapies including parenteral nutrition, intravenous antibiotic therapy, enteral nutrition, chemotherapy, dobutamine infusions, immunoglobulin (IVIG) therapy, continuous pain management and central catheter management.

Lincare also supplies home medical equipment, such as hospital beds, wheelchairs and other supplies that may be required by our customers.

Company Operations

Management. We maintain a decentralized approach to management of our local business operations. Decentralization of managerial decision-making enables our operating centers to respond promptly and effectively to local market demands and opportunities. We believe that the personalized nature of customer requirements, and referral relationships characteristic of the home health care business, mandate that we maintain a localized operating structure.

Each of our 978 operating centers is managed by a center manager who is responsible and accountable for the operating and financial performance of the center. Service and marketing functions are performed at the local operating level, while strategic development, financial control and operating policies are administered at the corporate level. Reporting mechanisms are in place at the operating center level to monitor performance and ensure field accountability.

A team of area managers directly supervises individual operating center managers, serving as an additional mechanism for assessing and improving performance of our operations. Lincare’s operating centers are served by regional billing centers, which control all of our billing and reimbursement functions.

MIS Systems. We believe that our proprietary management information systems are one of our key competitive advantages. The systems provide management with critical information on a timely basis to measure and evaluate performance levels company-wide. Management reviews monthly reports including revenues and profitability by individual center, accounts receivable and cash collection performance, equipment controls and utilization, customer activity and manpower trends. We have an in-house staff of computer programmers, which enables us to continually enhance our computer systems in order to provide timely financial and operational information and to respond promptly to changes in reimbursement regulations and policies.

Our billing system has both manual and computerized functions and processes that are designed to maintain the integrity of revenue and accounts receivable. Third-party payors, such as Medicare, that can accommodate electronic claims submission are billed electronically on a daily basis from our central computer system. Paper claims and invoices are generated and billed to various state Medicaid agencies, commercial payors and individual customers when electronic billing is unavailable. Electronic billing expedites the billing process and generally allows us to receive payment more quickly. The medical billing process requires the collection of various paper documents from customers and referral sources. Information such as customer demographics, insurance coverage and verification, prescriptions from physicians, delivery receipts, billing authorizations and assignments of benefits to Lincare, is gathered at the local operating centers and forwarded to our regional billing offices for review and manual input into our billing system. Item codes within the system representing specific products supplied to customers are matched against the Healthcare Common Procedure Coding System (“HCPCS”) for verification and accuracy of billing codes. Price tables within the system containing expected allowable payment amounts are manually input into the system and updated by the regional billing offices based on published Medicare and Medicaid fee schedules and bulletins, as well as contracts and supplier notifications from private insurance companies.

Accounts Receivable Management. We derive a substantial majority of our revenue 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.

Third-party reimbursement is a complicated process that involves submission of claims to multiple payors, each having its own specific claim requirements. To operate effectively in this environment, we have designed and implemented a proprietary computer system to decrease the time required for the submission and processing of third-party claims. Our systems are capable of tailoring the submission of claims to the specifications of individual payors. Our in-house management information system capabilities also enable reimbursement or regulatory changes to be adjusted quickly. These features serve to decrease the processing time of claims for payment resulting in more rapid collection of accounts receivable.

It is our policy to verify insurance benefits with the responsible third-party payor before or within 48 hours of delivery of products to customers. Medicare beneficiaries provide our service representatives with a Medicare identification card containing the beneficiary’s Health Identification Control Number (“HICN”) at the time of customer setup and delivery. The existence of an HICN indicates the beneficiary’s eligibility to receive benefits under the Medicare program for covered services. Medicare benefits are not separately verified with the applicable Medicare intermediaries.

Medicare and most other government and commercial payors that provide coverage to Lincare’s customers include a 20 percent co-payment provision in addition to a nominal deductible. Co-payments are generally not collected at the time of service and are invoiced to the customer or applicable secondary payor (supplemental providers of insurance coverage) on a monthly billing cycle as products are provided. A majority of our customers maintain, or are entitled to, secondary or supplemental insurance benefits providing “gap” coverage of this co-payment amount. In the event coverage is denied by the third-party payor, the customer is ultimately responsible for all services rendered by Lincare.

Sales and Marketing

Favorable trends affecting the U.S. population and home health care have created an environment that has produced increasing demand for the services provided by Lincare. The average age of the American population is increasing and, as a person ages, more health care services are generally required. Further, well-documented changes occurring in the health care industry show a trend toward home care rather than institutional care as a matter of patient preference and cost containment.

Sales activities are generally carried out by our full-time sales representatives located at our local operating centers with assistance from our center managers. In addition to promoting the high-quality of our equipment and services, the sales representatives are trained to provide information concerning the benefits of home respiratory care. Sales representatives are often licensed respiratory therapists who are highly knowledgeable in the provision of supplemental oxygen and other respiratory therapies.

Lincare primarily acquires new customers through referrals. Our principal sources of referrals are physicians, hospital discharge planners, prepaid health plans, clinical case managers and nursing agencies. Our sales representatives maintain continual contact with these medical professionals.

Lincare’s referral sources recognize our reputation for providing high-quality equipment and service and have historically provided a steady flow of customers. While we view our referral sources as fundamental to our business, no single referral source accounts for more than one percent of our revenues. Lincare has approximately 670,000 active customers, and the loss of any single referral source, customer or group of customers would not materially impact our business.

Lincare has received accreditation from the Community Health Accreditation Program. Accreditation by a national accrediting body represents a marketing benefit to our operating centers and provides for a recognized quality assurance program. Provisions contained in the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 will, once implemented, require home medical equipment providers to be accredited or licensed by independent agencies in order to participate in Medicare. Many private payors already require such accreditation.

Acquisitions

In 2006, we acquired, in unrelated acquisitions, certain operating assets of 10 local and regional companies with operations in multiple states resulting in the addition of 48 new operating centers.

In 2005, we acquired, in unrelated acquisitions, certain operating assets of 15 local and regional companies with operations in multiple states and also purchased the remaining equity interests in two companies in which we had previously acquired partial ownership. These acquisitions resulted in the addition of 34 new operating centers.

Quality Control

We are committed to providing consistently high-quality products and services. Our quality control procedures and training programs are designed to promote greater responsiveness and sensitivity to individual customer needs and to assure the highest level of quality and convenience to the customer and the referring physician. Licensed respiratory therapists, registered nurses and other clinicians provide professional health care support to our customers and assist in our sales and marketing efforts.

Suppliers

We purchase oxygen and other respiratory equipment from a variety of suppliers. We are not dependent upon any single supplier and believe that our product needs can be met by an adequate number of various manufacturers.

Competition

The home respiratory market is a fragmented and highly competitive industry that is served by Lincare, other national providers, and by our estimates, over 2,000 regional and local providers.

Home respiratory companies compete primarily on the basis of service, not pricing, since reimbursement levels are established by fee schedules promulgated by Medicare, Medicaid or by the individual determinations of private insurance companies. Furthermore, marketing efforts by home respiratory companies are typically directed toward referral sources, which generally do not share financial responsibility for the payment of services provided to customers. The relationships between a home respiratory company and its customers and referral sources are highly personal. There is no compelling incentive for either physicians or the patients to alter the relationship so long as the home respiratory company is providing responsive, professional and high-quality service.

Medicare Reimbursement

As a supplier 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.

On February 1, 2006, Congress passed the Deficit Reduction Act of 2005 (“DRA”). DRA contains provisions that will impact reimbursement for oxygen equipment and DME in 2007 and beyond. DRA changes 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 and maintenance of equipment, to a capped rental arrangement whereby payment for oxygen equipment (including portable oxygen equipment) may not extend over a period of continuous use of longer than 36 months. On the first day that begins after the 36 th continuous month during which payment is made for the oxygen equipment, the supplier would transfer title of the equipment to the beneficiary. Separate payments for oxygen contents would continue to be made for the period of medical need beyond the 36 th month. According to the legislation, additional payments for maintenance and service of the oxygen equipment would be made for parts and labor not covered by a supplier’s or manufacturer’s warranty. 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 begins on January 1, 2006. Accordingly, the first month in which the new payment methodology will impact our net revenues is January 2009.

On November 1, 2006, the Centers for Medicare and Medicaid Services (“CMS”) issued rule CMS-1304-F, describing the Medicare regulations, as interpreted by CMS, required to implement the DRA oxygen provisions. The rule codifies the new payment methodology and related provisions with respect to oxygen, including, but not limited to, defining the 36-month capped rental period of continuous use, transfer of title, payment for oxygen contents for beneficiary-owned oxygen equipment, payment for maintenance and servicing of oxygen equipment and procedures for replacement of beneficiary-owned equipment. 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 Company is evaluating the potential impact of the DRA oxygen provisions on its business and believes that the 36-month rental cap will have a material adverse impact on the Company’s net revenues, operating income, cash flows and financial position when it takes effect in 2009 and beyond. Additionally, the President’s 2008 budget proposes a reduction in the maximum continuous oxygen rental period from 36 months to 13 months. No further information on this proposal is available at this time and we can not predict whether or not the proposal will be included in the final budget approved by Congress.

Included in rule CMS-1304-F are changes to the Medicare payment rates for oxygen and oxygen equipment that will take effect on January 1, 2007. CMS is exercising its authority under the Balanced Budget Act of 1997 (“BBA”) to establish separate classes and monthly payment rates for oxygen. The rule establishes a new class and monthly payment amount for oxygen-generating portable equipment (“OGPE”), which includes oxygen transfilling equipment and portable oxygen concentrators. An OGPE add-on payment, applicable during the 36-month rental period, will be made for these systems in the amount of $51.63. Payments for the new OGPE add-on began on January 1, 2007 for new and existing oxygen users. CMS is also increasing the monthly payment amounts for portable oxygen contents for beneficiary-owned liquid or gaseous oxygen equipment from approximately $20.77 to $77.45. Payments for the increased portable oxygen contents became effective on January 1, 2007 for new and existing oxygen users. The BBA requires these changes to be budget neutral, and accordingly, CMS will reduce other Medicare oxygen payment rates beginning in 2007. As a result, the monthly payment amount for stationary oxygen equipment will decrease each year in order to offset the anticipated increase in Medicare spending for OGPE and oxygen contents. For 2007 and 2008, the payment rate for stationary oxygen equipment will be $198.40, which is expected to reduce our net revenues and operating income by approximately $6.0 million annually. According to CMS, the projected rates for 2009 and 2010 are $193.21 and $189.39, respectively. Budget neutrality requires that Medicare’s total spending for all modalities of oxygen equipment, including contents, be the same under the proposed changes as it would be without the changes. CMS’ budget neutral calculations were based on an assumption that five percent of oxygen users will shift to OGPE equipment. CMS will revise payment rates in future years under the methodology specified in the rule based on actual OGPE use and updated data on the distribution of beneficiaries using oxygen equipment. To the extent that the Company’s distribution of oxygen equipment and oxygen contents in future years mirrors that of the overall Medicare market, these changes would not be expected to have a significant effect on the overall level of reimbursement for the Company’s oxygen business.

DRA also changes 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. The option for a supplier to retain ownership of the item after a 15-month rental period and receive semi-annual maintenance and service payments will be eliminated. On the first day that begins after the 13 th continuous month during which payment is made for the item, the supplier will transfer title of the item to the beneficiary. Additional payments for maintenance and service of the item will be made for parts and labor not covered by a supplier’s or manufacturer’s warranty. The DME capped rental provisions contained in DRA apply to items furnished for which the first rental month occurs on or after January 1, 2006. Accordingly, the first month in which the new payment methodology will impact our net revenues is February 2007. Included in rule CMS-1304-F is a discussion of the Medicare regulations, as interpreted by CMS, necessary to implement the DME capped rental changes contained in the DRA. In addition, on January 26, 2006, CMS announced a final rule revising the payment classification of certain respiratory assist devices (“RADs”). RADs with a backup rate feature were reclassified as capped rental DME items effective April 1, 2006, whereby payments to providers of such devices will cease after the 13 th continuous month of rental. Prior to the rule, providers were paid a continuous monthly rental amount over the entire period of medical necessity. In cases where Medicare beneficiaries received the item prior to April 1, 2006, only the rental payments for months after the effective date count toward the 13-month cap. Accordingly, the first month in which the new payment methodology will impact our net revenues is May 2007. The Company estimates that the capped rental changes to DME and RADs will reduce the Company’s net revenues and operating income by approximately $12.0 million in 2007 and by approximately $24.0 million in 2008. In addition, the transfer of ownership provisions affecting Medicare capped rental equipment resulted in a change in estimates of the useful lives of such equipment beginning in 2006. The change in estimates resulted in the Company recording an additional $2.2 million of depreciation expense in 2006 and is expected to result in a $6.7 million increase in depreciation expense in 2007. The Company will continue to evaluate its estimates of useful lives based on its experience with ownership transfers of capped rental equipment in future periods, which may result in further increases in depreciation expense in 2007 and beyond.

On December 8, 2003, the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (“MMA”) was signed into law. The legislation, among other things, provides expanded Medicare prescription drug coverage, modifies payments to Medicare providers and institutes administrative reforms intended to improve Medicare program operations. MMA includes sweeping changes that impact a broad spectrum of health care industry participants, including physicians, pharmacies, manufacturers and pharmacy benefit managers, as well as other Medicare suppliers and providers including Lincare.

MMA 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 percent 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 percent 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.

In accordance with the provisions of MMA, on November 2, 2005, CMS issued rule CMS-1502-FC, establishing the dispensing fee amount for inhalation drugs for 2006. The final rule establishes a dispensing fee of $57.00 for the first 30-day period in which a Medicare beneficiary uses inhalation drugs and a reduced fee of $33.00 for a 30-day supply of inhalation drugs for all other months. We estimate that the reduction in the dispensing fee to $33.00 reduced our net revenues by approximately $39.1 million in 2006. Additionally, changes in the payment rates for inhalation drugs established by CMS during 2006 (based on available manufacturer ASP data) are estimated to have reduced the Company’s net revenues in 2006 by approximately $2.0 million and are expected to result in further reductions in our net revenues in 2007. The Company estimates that further reductions in inhalation drug payment rates will reduce our net revenues in 2007 by approximately $18.0 million.

We continue to evaluate the impact of the reduced Medicare payment rates on our business. We can not determine the outcome of any future rulemaking by CMS nor the impact that such rulemaking might have on our ability to continue to provide inhalation drugs to Medicare beneficiaries. Further, we can not determine whether quarterly updates in ASP pricing data submitted by drug manufacturers and adopted by CMS will result in ongoing reductions in payment rates for inhalation drugs, and what impact such payment reductions could have on our financial position and results of operations in 2007 and beyond.

(2)

Reduced payment amounts for five categories of DME, including oxygen, beginning in 2005 and froze payment amounts for other Medicare-covered DME items through 2007 . MMA contains provisions that reduced payment amounts, beginning in 2005, for oxygen equipment, standard wheelchairs (including standard power wheelchairs), nebulizers, diabetic supplies consisting of lancets and testing strips, hospital beds and air mattresses to the median prices paid under the Federal Employee Health Plan (“FEHP”). Reductions in payment rates for 2005 established by CMS for the non-oxygen items subject to the FEHP provisions went into effect as of January 1, 2005. MMA also froze payment amounts for other Medicare-covered DME items through 2007.

On March 30, 2005, CMS released the new Medicare fee schedule amounts for oxygen equipment. The new payment rates were made effective for claims for oxygen equipment furnished after January 1, 2005, that were received by Medicare on or after April 1, 2005. We estimate that the new fee schedule resulted in a net price reduction of approximately 8.7% for oxygen equipment provided by the Company to Medicare beneficiaries beginning in the second fiscal quarter of 2005.

(3)

Establishes a competitive acquisition program for DME beginning in 2007 . MMA instructs CMS to establish and implement programs under which competitive acquisition areas are established throughout the United States for contract award purposes for the furnishing of competitively priced items of DME, including oxygen equipment. The program will be implemented in phases such that competition under the program occurs in 10 of the largest metropolitan statistical areas (“MSAs”) in 2007, 80 of the largest MSAs in 2009, and additional areas after 2009. Items selected for competitive acquisition may be phased in first among the highest cost and highest volume items and services or those items and services that CMS determines have the largest savings potential. In carrying out such


programs, CMS may exempt rural areas and areas with low-population density within urban areas that are not competitive, unless there is a significant national market through mail order for a particular item or service.

For each competitive acquisition area, CMS will 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 amount otherwise in effect for an area that is not a competitive acquisition area.

On April 24, 2006, CMS issued its proposed rule, CMS-1270-P, which would implement the DME competitive bidding program. Comments on the proposed rule were due to CMS by June 30, 2006. The final rule was not issued by CMS as of December 31, 2006 and we will evaluate the impact of the final regulation on our business once it is issued. We can not predict the effect of the competitive acquisition program or the Medicare payment rates that will be in effect in 2007 and beyond for the items ultimately subjected to competitive bidding.

(4)

Implements quality standards and accreditation requirements for DME suppliers . MMA instructs the Secretary to establish and implement quality standards for DME suppliers to be applied by recognized independent accreditation organizations. Suppliers must comply with these standards in order to receive payment for furnishing any covered item of DME to a Medicare beneficiary and to receive or retain a supplier number used to submit claims for reimbursement. CMS has published the new quality standards and expects to implement them pursuant to a program instruction memorandum. We believe we will be in compliance with the new quality standards at the time they become effective.

In January 2006, pursuant to the contracting reform provisions of MMA, CMS announced the selection of four specialty carriers, or DME Medicare Administrative Contractors (the “DME MACs”), that will be responsible for the processing and payment of claims for DME items provided to Medicare Part B beneficiaries. The DME MACs are replacing the four Durable Medical Equipment Regional Carriers (the “DMERCs”) pursuant to a transition schedule that began on July 1, 2006, with the final DME MAC not expected to transition until April 1, 2007. The transition of claims processing from the DMERCs to the DME MACs is causing disruptions in the payment of DME claims and is having a negative impact on the timing of collections of our accounts receivable. In addition, the DRA mandated that a brief hold be placed on Medicare payments for all claims for the last nine days of the federal fiscal year (i.e., September 22, 2006 through September 30, 2006). This payment hold is estimated to have reduced our cash provided by operating activities in the third quarter and to have increased our accounts receivable balances as of September 30, 2006 by approximately $19.8 million. These held payments were subsequently released to us during the first week of October, 2006.

On February 13, 2006, a final rule governing CMS’s Inherent Reasonableness (“IR”) authority became effective. The IR rule establishes a process for adjusting payments for Medicare Part B services when existing payment amounts are determined to be either grossly excessive or deficient. The rule describes the factors 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 eventually could have a significant impact on Medicare payments for such Part B services as home oxygen, DME and Part B covered prescription drugs. We can not predict whether CMS will exercise its IR authority with respect to reimbursement or payment of certain products and services that we provide to Medicare beneficiaries, or the effect such payment adjustments would have on our financial position or operating results.




programs, CMS may exempt rural areas and areas with low-population density within urban areas that are not competitive, unless there is a significant national market through mail order for a particular item or service.

For each competitive acquisition area, CMS will 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 amount otherwise in effect for an area that is not a competitive acquisition area.

On April 24, 2006, CMS issued its proposed rule, CMS-1270-P, which would implement the DME competitive bidding program. Comments on the proposed rule were due to CMS by June 30, 2006. The final rule was not issued by CMS as of December 31, 2006 and we will evaluate the impact of the final regulation on our business once it is issued. We can not predict the effect of the competitive acquisition program or the Medicare payment rates that will be in effect in 2007 and beyond for the items ultimately subjected to competitive bidding.

(4)

Implements quality standards and accreditation requirements for DME suppliers . MMA instructs the Secretary to establish and implement quality standards for DME suppliers to be applied by recognized independent accreditation organizations. Suppliers must comply with these standards in order to receive payment for furnishing any covered item of DME to a Medicare beneficiary and to receive or retain a supplier number used to submit claims for reimbursement. CMS has published the new quality standards and expects to implement them pursuant to a program instruction memorandum. We believe we will be in compliance with the new quality standards at the time they become effective.

In January 2006, pursuant to the contracting reform provisions of MMA, CMS announced the selection of four specialty carriers, or DME Medicare Administrative Contractors (the “DME MACs”), that will be responsible for the processing and payment of claims for DME items provided to Medicare Part B beneficiaries. The DME MACs are replacing the four Durable Medical Equipment Regional Carriers (the “DMERCs”) pursuant to a transition schedule that began on July 1, 2006, with the final DME MAC not expected to transition until April 1, 2007. The transition of claims processing from the DMERCs to the DME MACs is causing disruptions in the payment of DME claims and is having a negative impact on the timing of collections of our accounts receivable. In addition, the DRA mandated that a brief hold be placed on Medicare payments for all claims for the last nine days of the federal fiscal year (i.e., September 22, 2006 through September 30, 2006). This payment hold is estimated to have reduced our cash provided by operating activities in the third quarter and to have increased our accounts receivable balances as of September 30, 2006 by approximately $19.8 million. These held payments were subsequently released to us during the first week of October, 2006.

On February 13, 2006, a final rule governing CMS’s Inherent Reasonableness (“IR”) authority became effective. The IR rule establishes a process for adjusting payments for Medicare Part B services when existing payment amounts are determined to be either grossly excessive or deficient. The rule describes the factors 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 eventually could have a significant impact on Medicare payments for such Part B services as home oxygen, DME and Part B covered prescription drugs. We can not predict whether CMS will exercise its IR authority with respect to reimbursement or payment of certain products and services that we provide to Medicare beneficiaries, or the effect such payment adjustments would have on our financial position or operating results.

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. Future legislative and regulatory changes could have a material adverse impact on us.

Employees

As of December 31, 2006, we had 9,070 employees. None of our employees are covered by collective bargaining agreements. We believe that the relations between our management and employees are good.

Environmental Matters

We believe that we are currently in compliance, in all material respects, with applicable federal, state and local statutes and ordinances regulating the discharge of hazardous materials into the environment. We do not believe we will be required to expend any material amounts in order to remain in compliance with these laws and regulations or that such compliance will materially affect our capital expenditures, earnings or competitive position.

CEO BACKGROUND

John P. Byrnes has served as the Chief Executive Of fi cer of the Company since January 1997 and as a Director of the Company since May 1997. Mr. Byrnes was appointed Chairman of the Board in March 2000. Mr. Byrnes also served as the Company’s President from June 1996 until April 2003. Prior to becoming the Company’s President, Mr. Byrnes served the Company in a number of capacities over a ten-year period, including serving as the Company’s Chief Operating Of fi cer throughout 1996. Mr. Byrnes is also a director of Kinetic Concepts, Inc.

Stuart H. Altman, Ph.D. has been a director of the Company since December 2001. Dr. Altman, Professor of National Health Policy at Brandeis University, is Dean and a member of the faculty of The Heller School for Social Policy and Management on Brandeis’ Waltham, Massachusetts campus and is an economist whose research interests are primarily in the area of federal and state health policy. He was Co-Chair of the Governor/Legislative Health Care Task Force for the Commonwealth of Massachusetts. In 1997, he was appointed by President Clinton to the National Bipartisan Commission on the Future of Medicare. Dr. Altman was Dean of the Heller School from 1977 to 1993 and served as interim President of Brandeis University from 1990 to 1991. Earlier in his career, Dr. Altman was Deputy Assistant Secretary for Planning and Evaluation/Health at the U.S. Department of Health Education & Welfare and has since advised national and state governments on major health care issues and legislation. Dr. Altman is a director of Visicu Corporation, a developer of remote site systems for treating patients in hospital intensive care units, and a director of Aveta Corp., a managed care company with plans in Puerto Rico and California.

Chester B. Black has been a director of the Company since January 1991. From November 1990 until December 1995, Mr. Black served as Chairman and Vice Chairman of Med Alliance, Inc. From June 1989 until November 1990, Mr. Black was Chairman and President of RB Diagnostic, a provider of diagnostic imaging services. During the past fi ve years, Mr. Black has been involved as an investor and director in several privately-held health care services businesses.

Frank D. Byrne, M.D. has been a director of the Company since December 1999. Since 2004, Dr. Byrne has served as President of St. Mary’s Hospital, a 440-bed community hospital in Madison, Wisconsin. From 1991 until 2004, he served Parkview Health, an integrated delivery network headquartered in Fort Wayne, Indiana, in a variety of executive, governance, and clinical leadership roles, including President of Parkview Hospital, from 1995 to 2002. From 1982 to 1994, Dr. Byrne practiced pulmonary and critical care medicine. He is a Clinical Professor of Medicine at the University of Wisconsin School of Medicine and holds fellowships in the American College of Physicians, the American College of Chest Physicians, the American College of Healthcare Executives, and the American College of Physician Executives. Dr. Byrne has a B.S. from the University of Notre Dame, a Master of Medical Management from Carnegie Mellon University, and an M.D. from the State University of New York Downstate Medical Center. He has attended the Executive Program at the University of Michigan Business School and corporate governance education programs at Harvard Business School and the University of Wisconsin. Dr. Byrne also serves as a director of Steel Dynamics, Inc.

William F. Miller, III has been a director of the Company since December 1997. From 2000 to 2005, Mr. Miller served as Chairman and Chief Executive Officer of HMS Holdings Corp., a publicly traded revenue cycle and cost containment company. From 1983 to 1999, Mr. Miller served as President and Chief Operating Of fi cer of Emcare Holdings, Inc., a provider of emergency care services to hospitals. Prior to joining Emcare, Mr. Miller held fi nancial and management positions in the health care industry, including positions as chief executive of fi cer and chief fi nancial of fi cer of various hospitals and as administrator/director of operations of a multi-specialty physician group practice. Mr. Miller is a director of AMN Healthcare Services, HMS Holdings Corp., and other private health care companies.

Paul G. Gabos, age 42, has served as the Chief Financial Of fi cer of the Company since June 1997. Prior to his appointment as Chief Financial Of fi cer, Mr. Gabos served as Vice President, Administration. Before joining Lincare in 1993, Mr. Gabos worked for Coopers & Lybrand and for Dean Witter Reynolds Inc. Mr. Gabos holds a Bachelor of Science in Economics from The Wharton School of the University of Pennsylvania. Mr. Gabos is also a director of Pediatrix Medical Group, Inc.

Shawn S. Schabel, age 42, was appointed President of the Company in April 2003 and Chief Operating Of fi cer of the Company in January 2001. From 1998 to 2001, Mr. Schabel served as Senior Vice President of the Company. Mr. Schabel served the Company in a number of management capacities since joining Lincare in 1989. Mr. Schabel holds a Respiratory Therapy degree from Wichita State University. Mr. Schabel is also a director of Odyssey HealthCare, Inc.

MANAGEMENT DISCUSSION FROM LATEST 10K

General

We continue to pursue a strategy of increasing market share in existing and surrounding geographic markets through internal growth and selective acquisition of local and regional companies. In addition, we will continue to expand into new geographic markets on a selective basis, either through acquisition or by opening new operating centers, when we believe it will enhance our business. Our focus remains primarily on oxygen and other respiratory therapy services, which represent approximately 92% of our revenues.

Critical Accounting Policies

The consolidated financial statements include the accounts of Lincare Holdings Inc. and its subsidiaries. We have made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles.

Critical accounting policies are those we believe are both most important to the portrayal of our financial condition and operating results and require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Judgments and uncertainties affecting the application of those policies may result in materially different amounts being reported under different conditions or using different assumptions. We consider the following policies to be most critical in understanding the judgments that are involved in preparing our consolidated financial statements.

Revenue Recognition and Accounts Receivable

Our 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. Insurance benefits are assigned to the Company and, accordingly, the Company bills on behalf of its customers. 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 payment amount received and the expected realizable amount. 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. We report revenues in our 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 which limit the rental payment periods in some instances and which may result in a transfer of title to the patient 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 which is unearned. No separate payment is earned from the initial equipment delivery and setup process. During the rental period, we are responsible for servicing the equipment and providing routine maintenance, if necessary.

Our 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. We recognize 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 we operate, certain estimates are required to record net revenues and accounts receivable at their net realizable values at the time products and/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 at the point of cash application, claim denial or account review.

Included in accounts receivable are earned but unbilled receivables. Unbilled accounts receivable represent charges for equipment and supplies delivered to customers for which invoices have not yet been generated by the billing system. Prior to the delivery of equipment and supplies to customers, we perform certain certification and approval procedures to ensure collection is reasonably assured and that unbilled accounts receivable are recorded at net amounts expected to be paid by customers and third-party payors. Billing delays, ranging from several weeks to several months, can occur due to delays in obtaining certain required payor-specific documentation from internal and external sources, 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 for payment, the customer is ultimately responsible.

We perform analyses to evaluate the net realizable value of accounts receivable. Specifically, we consider historical realization data, accounts receivable aging trends, other operating trends and relevant business conditions. Because of continuing changes in the health care industry and third-party reimbursement, it is possible that our estimates could change, which could have a material impact on our operations and cash flows.

Bad Debt Expense, Sales Adjustments and Related Allowances for Uncollectible Accounts Receivable

Accounts receivable are reported net of allowances for sales adjustments and uncollectible accounts. The majority of our accounts receivable are due from Medicare, Medicaid and private insurance carriers, as well as from customers under co-insurance provisions. Third-party reimbursement is a complicated process that involves submission of claims to multiple payors, each having its own claims requirements. In some cases, the ultimate collection of accounts receivable subsequent to the service dates may not be known for several months. 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. 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, including current and historical cash collections, bad debt write-offs, and aging of accounts receivable. Our proprietary management information systems are utilized to provide this data in order to assess bad debts. In the event that collection results of existing accounts receivable are not consistent with historical experience, there may be a need to increase our allowances for doubtful accounts, which may materially impact our financial position or results of operations. The Company has established an allowance to account for sales adjustments that result from differences between the payment amounts received from customers and third-party payors and the expected realizable amounts. Actual adjustments that result from such differences 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. We report revenues in our financial statements net of such adjustments.

Business Acquisition Accounting

The Financial Accounting Standards Board’s Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets,” provide guidance on the application of generally accepted accounting principles for business acquisitions. We apply the purchase method of accounting for business acquisitions, and use available cash from operations, borrowings under our revolving credit agreement and the assumption of certain liabilities as the consideration for business acquisitions. We allocate the purchase price of our business acquisitions based on the fair market value of identifiable tangible and intangible assets. The difference between the total cost of the acquisition and the sum of the fair values of acquired tangible and identifiable intangible assets less liabilities is recorded as goodwill.

Impairment of Intangible and Long-Lived Assets

We assess the Company’s intangible assets for impairment annually, pursuant to SFAS No. 142, “Goodwill and Other Intangible Assets”. Additionally, intangible and long-lived assets impairment is tested whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered important that could trigger an impairment review include, without limitation, (i) significant under-performance of acquired assets relative to expected historical or projected future operating results; (ii) significant changes in the manner or use of the acquired assets or the strategy for the overall business; (iii) significant negative industry or economic trends; (iv) increased competitive pressures; (v) a significant decline in our stock price for a sustained period; and (vi) technological and regulatory changes.

When we determine that the carrying value of intangibles and long-lived assets may be impaired, we evaluate the ability to recover those assets. If those assets are determined to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.

Contingencies

We are involved in certain claims and legal matters arising in the ordinary course of business. The Financial Accounting Standards Board’s Statement of Financial Accounting Standards (“SFAS”) No. 5, “Accounting for Contingencies,” provides guidance on the application of generally accepted accounting principles related to contingencies. We evaluate and record liabilities for contingencies based on known claims and legal actions when it is probable a liability has been incurred and the liability can be reasonably estimated. We have concluded that accrued liabilities related to contingencies are appropriate and in accordance with generally accepted accounting principles.

Results of Operations

Net Revenues

Net revenues for the year ended December 31, 2007 increased by $186.2 million, an increase of 13.2% above net revenues for 2006. The 13.2% increase in net revenues in 2007 was comprised of 11.3% internal growth and 3.5% acquisition growth, partially offset by Medicare price changes taking effect in 2007 (see “Medicare Reimbursement”). Net revenues for the year ended December 31, 2006 increased by $143.2 million, an increase of 11.3% above net revenues for 2005. The 11.3% increase in net revenues in 2006 was comprised of 13.3% internal growth and 2.6% acquisition growth partially offset by Medicare price changes taking effect in 2006. The internal growth in net revenues is attributable to underlying growth in the market for our products (estimated at 6.0% annually) and increased market share resulting primarily from our reputation for 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 estimated based on the contribution to net revenues for the four quarters following such acquisitions. During 2007 and 2006, we completed the acquisition of three businesses with annual revenues of approximately $4.3 million and ten businesses with annual revenues of approximately $67.0 million, respectively.

The contribution of oxygen and other respiratory therapy products to our net revenues was 92.1%, 91.9% and 91.1%, respectively, for the years ended December 31, 2007, 2006 and 2005. 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

Cost of goods and services as a percentage of net revenues was 24.4% for the year ended December 31, 2007, 22.4% for the year ended December 31, 2006 and 20.0% for the year ended December 31, 2005. Cost of goods and services increased by $73.8 million, or 23.3%, in 2007 and $62.8 million, or 24.8% in 2006. The increase in cost of goods and services in 2007 is attributable primarily to an increase in drug purchasing costs due to a product mix shift away from compounded to higher cost commercially-available products in our inhalation drug business as a result of a determination by CMS to eliminate Medicare coverage of compounded medications as of July 1, 2007. Also contributing to higher cost of goods and services in 2007 were increased sales of medical supplies and nutritional products to pediatric customers associated with our acquisition of the business of a pediatric respiratory provider in the fourth quarter of 2006. We also experienced significant growth in our sleep therapy product lines during 2007, which generally carry a lower gross margin than other products we provide. The increase in cost of goods and services in 2006 is attributable primarily to increased patient and drug shipment volumes and an increase in drug purchasing costs due to a product mix shift in our inhalation drug product line. Cost of goods and services in 2006 was also impacted by growth in shipments of disposables and accessories related to our sleep therapy product lines.

Cost of goods and services includes the cost of equipment (excluding depreciation of $82.6 million, $68.6 million and $62.3 million in 2007, 2006 and 2005, 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 $48.8 million, $49.2 million and $50.0 million in 2007, 2006 and 2005, respectively. Included in cost of goods and services for the year ended December 31, 2007 are salary and related expenses of pharmacists and pharmacy technicians of $10.5 million. Such salary and related expenses for the years ended December 31, 2006 and 2005 were $10.3 million and $10.2 million, respectively.

Operating and Other Expenses

Operating expenses as a percentage of net revenues for the years ended December 31, 2007, 2006 and 2005 were 22.9%, 23.5% and 23.4%, respectively. Operating expenses in 2007 and 2006 increased by $33.1 million, or 10.0%, and $36.1 million, or 12.2%, respectively, when compared with the prior year periods. Gains in productivity at our operating centers and modest growth in office rent and related facility expenses helped to offset higher freight charges due to gains in customer shipment volumes in our inhalation drug and sleep accessory product lines and significant vehicle-related cost increases attributable to higher fuel prices and vehicle lease expenses.

The Company manages over 1,000 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).

Included in operating expenses during the year ended December 31, 2007 are salary and related expenses for Service Reps in the amount of $100.0 million. Such salary and related expenses for the years ended December 31, 2006 and 2005 were $91.2 million and $80.7 million, respectively.

Selling, general and administrative expenses (“SG&A”) as a percentage of net revenues for the years ended December 31, 2007, 2006 and 2005, were 19.9%, 20.7%, and 19.9%, respectively. SG&A expenses in 2007 increased by $26.1 million, or 8.9%, compared with the prior year period. Contributing to the increase in SG&A expenses in 2007 were higher payroll costs included in selling expenses and higher liability insurance expenses, partially offset by cost controls at our administrative, field overhead and billing office locations and lower stock-based compensation expense. SG&A expenses in 2006 increased by $39.8 million, or 15.8%, compared with the prior year period. SG&A expenses in 2006 were impacted by the adoption of SFAS No. 123R (see Notes 1 and 11 to the consolidated financial statements) effective January 1, 2006, resulting in the recognition of $20.3 million of stock-based compensation expense during the year. Also contributing to the increase in SG&A expenses in 2006 were higher payroll costs included in selling expenses and higher legal expenses, partially offset by cost controls at our administrative, field overhead and billing office locations.

SG&A expenses include costs related to sales and marketing activities, clinical respiratory services, corporate overhead and other business support functions. Included in SG&A during the year ended December 31, 2007 are salary and related expenses of $226.2 million. These salary and related expenses include the cost of the Company’s respiratory therapists in the amount of $63.0 million during 2007. 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 that do not employ respiratory therapists. Included in SG&A during the years ended December 31, 2006 and 2005 are salary and related expenses of $207.9 million and $168.6 million, respectively. These salary and related expenses include the cost of the Company’s respiratory therapists in the amount of $54.0 million and $45.9 million during the respective years.

Bad debt expense as a percentage of net revenues was 1.5% for the years ended December 31, 2007, 2006 and 2005. Days sales outstanding (“DSO”) were 43 days at December 31, 2007, up from 42 days and 40 days at December 31, 2006 and 2005, respectively. The increase in DSO over the three-year period is attributable primarily to disruptions caused by the transition in the contractors that process Medicare claims during 2006 and 2007 (see “Medicare Reimbursement”), an increase in accounts receivable from business acquisitions and growth in our sleep therapy product line, which generally has a higher mix of managed care and commercial insurance payors than our traditional Medicare business. Our net accounts receivable balance as of December 31, 2006 was also impacted by the adoption by the Company of the provisions of Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”) during the fourth quarter of 2006 which resulted in the Company recording an allowance for sales adjustments of $10.7 million (see Note 3 and Note 9 of the Notes to Consolidated Financial Statements). While we have achieved consistent results in managing bad debt expense over the past three years, business acquisition activities may contribute to an increase in our bad debt expense in the future. The integration of acquired companies into our regional billing and collections offices may temporarily disrupt collections, increasing the amount of accounts receivable written off as uncollectible.

Depreciation expense as a percentage of net revenues was 7.3% for the year ended December 31, 2007 compared with 7.1% and 7.4% for the years ended December 31, 2006 and 2005, respectively. Included in depreciation expense in the year ended December 31, 2007 is depreciation of medical equipment of $82.6 million and depreciation of other property and equipment of $33.4 million. Included in depreciation expense in the years ended December 31, 2006 and 2005 is depreciation of medical equipment of $68.6 million and $62.3 million, respectively, and depreciation of other property and equipment of $31.9 million and $31.0 million, respectively. The growth in depreciation expense in 2007 compared with 2006 is attributed to increased purchases of medical and other equipment necessary to support the growth in the Company's customer base during 2007. Approximately $7.1 million and $2.2 million of the increase in depreciation expense in 2007 and 2006, respectively, is attributable to a reduction in the estimated useful lives of certain DME equipment attributable to provisions contained in the Deficit Reduction Act of 2005 that change the Medicare reimbursement methodology for items of DME in the capped rental payment category (see “Medicare Reimbursement”).

During 2007, we amortized $0.3 million of intangible assets compared with $1.5 million in 2006 and $1.7 million in 2005. Our net intangible assets were $1.2 billion as of December 31, 2007. Of this total, $0.4 million (consisting of various covenants not-to-compete) is being amortized over periods of one to seven years, as the remainder represents goodwill.

Operating Income

As shown in the table below, operating income for the year ended December 31, 2007 increased $36.1 million when compared to the prior year. The increase in operating income in 2007 is attributable primarily to revenue growth from increases in customer volumes partially offset by higher costs and expenses as noted above. The decrease in operating income in 2006 is attributable to several factors, including the negative impact on our net revenues resulting from reduced Medicare payment rates for inhalation drugs and related dispensing fees that took effect on January 1, 2006 and the reduction of Medicare reimbursement rates for oxygen equipment that took effect on April 1, 2005, and higher reported SG&A expenses due to the required adoption of SFAS No. 123R and the resulting recognition of $20.3 million of stock-based compensation expense during the year.

Interest Expense

Interest expense for the year ended December 31, 2007 was $26.5 million, compared to $9.9 million and $12.4 million for the years ended December 31, 2006 and 2005, respectively. Interest expense in 2007 was higher than interest expense in 2006 due to the placement of $550.0 million of convertible senior debentures in the fourth quarter of 2007 and higher average balances outstanding under our revolving credit facility. Interest expense in 2006 was lower than the prior year due to the full year effect of the repayment of $45.0 million of 9.11% Senior Secured Notes in September of 2005. Included in interest expense is amortization of debt issuance costs of $5.7 million, $1.0 million and $0.7 million in 2007, 2006 and 2005, respectively.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Operating Results

Net revenues for the three months ended March 31, 2008, increased by $37.0 million (or 9.8%) compared with the three months ended March 31, 2007. The Company estimates that the 9.8% increase in net revenues in the three-month period was comprised of 11.1% internal growth and 0.2% acquisition growth partially offset by Medicare price changes taking effect in 2008 (see “Medicare Reimbursement”). 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. During the three months ended March 31, 2008, and March 31, 2007, we did not acquire the business or assets of any companies.

The contribution of oxygen and other respiratory therapy products to our net revenues was 92.1% and 92.5%, respectively, during the three months ended March 31, 2008 and 2007. 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 increased to 23.5% for the three months ended March 31, 2008, compared with 23.3% for the comparable prior year period. The increase in cost of goods and services in 2008 is attributable primarily to an increase in drug purchasing costs due to a product mix shift away from compounded to higher cost commercially-available products in our inhalation drug business as a result of a determination by CMS to eliminate Medicare coverage of compounded medications as of July 1, 2007. We also experienced significant growth in our sleep therapy product lines during the first three months of 2008, compared with the first three months of 2007, which generally carry a higher cost of goods sold than other products we provide.

Cost of goods and services for the three month periods include the cost of equipment (excluding depreciation of $20.7 million in 2008 and $18.6 million in 2007, 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 for the three-month period of 2008 and approximately $12.3 million for the three-month period of 2007, respectively. Included in cost of goods and services in the three months ended March 31, 2008 are salary and related expenses of pharmacists and pharmacy technicians of $2.7 million. Such salary and related expenses for the three months ended March 31, 2007, were $2.6 million.

Operating expenses as a percentage of net revenues were 23.2% for the three months ended March 31, 2008, compared with 24.3% for the comparable prior year period. Operating expenses for the three months ended March 31, 2008, increased by $4.4 million, or 4.8%, over the prior year period. Contributing to the decrease in operating expenses as a percentage of net revenues during the first three months of 2008 were containment of payroll and related expenses and freight costs, partially offset by higher growth in vehicle, fuel and utility costs.

The Company manages 1,029 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).

Included in operating expenses during the three months ended March 31, 2008 are salary and related expenses for Service Reps in the amount of $25.2 million. Such salary and related expenses for the three months ended March 31, 2007 were $24.4 million.

Selling, general and administrative (“SG&A”) expenses as a percentage of net revenues were 19.8% for the three months ended March 31, 2008, compared with 20.2% for the comparable prior year period. SG&A expenses for the three months ended March 31, 2008 increased by $5.8 million, or 7.6% over the prior year period. Contributing to the decrease in SG&A expenses as a percentage of net revenues in 2008 were containment of payroll and related expenses and lower advertising expenses, partially offset by an increase in reserves for auto and workers’ compensation insurance claims.

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 months ended March 31, 2008 are salary and related expenses of $59.1 million. These salary and related expenses include the cost of the Company’s respiratory therapists in the amount of $15.3 million. Included in SG&A during the three months ended March 31, 2007 are salary and related expenses of $56.0 million. These salary and related expenses include the cost of the Company’s respiratory therapists in the amount of $15.5 million. 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 expense in the three months ended March 31, 2008 is depreciation of patient service equipment of $20.7 million and depreciation of other property and equipment of $8.8 million. Included in depreciation expense in the three months ended March 31, 2007 is depreciation of patient service equipment of $18.6 million and depreciation of other property and equipment of $7.3 million. The increase in depreciation expense in the three months ended March 31, 2008 compared with the prior year period is attributable to increased purchases of medical and other equipment necessary to support the growth in the Company’s customer base during 2008.

Operating income for the three months ended March 31, 2008, was $103.6 million (24.9% of net revenues) compared with $90.4 million (23.9% of net revenues) for the comparable prior year period. The increase in operating income in the three-month period ended March 31, 2008 is attributable primarily to revenue growth from increases in customer volumes partially offset by higher costs and expenses as noted above.

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.

At March 31, 2008, our current liabilities exceeded our current assets by $130.9 million, resulting in negative working capital. The working capital deficit is primarily attributable to the reclassification in June 2007 of our $275.0 million principal amount of 3.0% Convertible Debentures due 2033 (the “Debentures”) to a current liability and the reclassification in March 2008 of $98.1 million of investment grade auction rate securities from short-term to long-term investments.

Net cash provided by operating activities increased by 18.4% to $126.4 million for the three months ended March 31, 2008, compared with $106.7 million for the three months ended March 31, 2007. Net cash used in investing and financing activities was $73.9 million for the three months ended March 31, 2008. Activity during the three-month period ended March 31, 2008 included our net investment in property and equipment of $29.5 million, payments of principal on debt of $10.0 million, repurchases of our common stock of $35.2 million and proceeds from the exercise of stock options and issuance of common shares of $0.6 million.

As of March 31, 2008, our principal sources of liquidity consisted of $104.2 million of cash and equivalents and $366.5 million available under our revolving bank credit facility. At March 31, 2008, the Company held $98.1 million of investment grade 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. Under the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” the investments are classified as available-for-sale and are carried at fair value, with any unrealized gains and losses included in comprehensive income as a separate component of shareholders’ equity. The book value of available-for-sale investments held at March 31, 2008, approximated fair value. Therefore, the Company had no reported unrealized gains or losses.

During the first quarter of 2008, the Company reclassified all of its investments in auction rate securities from short-term to long-term investments. Of the auction rate securities held as of March 31, 2008, $60.7 million are secured by pools of student loans guaranteed by state-designated guaranty agencies or monoline insurers or reinsured by the United States government. The remaining $37.4 million was comprised of securities backed by pools of municipal bonds. All of 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 March 31, 2008, 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, at par, in the amount of $175,000 in February 2008 and $250,000 in April 2008.

We will continue to monitor credit market conditions to assess the liquidity of our investments. 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.

On February 14, 2006, our Board of Directors 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 three months ended March 31, 2008, the Company repurchased and retired 1,009,250 shares for $35.2 million pursuant to the repurchase plan. On January 23, 2007 and October 23, 2007, our Board of Directors approved modifications to the share repurchase formula to increase the ratio of debt to cash flow to allow additional share repurchases. As of March 31, 2008, $308.3 million of the Company’s common stock was eligible for repurchase in accordance with the amended formula.

On October 31, 2007, we completed the sale of $275.0 million principal amount (including exercise of a $25.0 million over-allotment option) of convertible senior debentures due 2037 – Series A (the “Series A Debentures”) and $275.0 million principal amount (including exercise of a $25.0 million over-allotment option) 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 will 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 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 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. We 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 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. The terms of our Series Debentures include registration payment arrangements whereby we would be required to pay additional interest in the event of a registration default. Should the registration statement cease to be effective or fail to be useable, and such failure is not cured, or the prospectus become suspended, additional interest will accrue on the Series Debentures at an annual rate per year equal to: (i) 0.25% of the principal amount of the Series Debentures to and including the 90 th day following such registration default; and (ii) 0.50% of the principal amount of the Series Debentures from and after the 91 st day following such registration default. In no event will additional interest accrue after the registration statement termination date as defined in the indenture and in no event beyond October 31, 2009. The maximum potential amount of additional consideration that we could be required to pay under the registration payment arrangements for the period after March 31, 2008 and until the October 31, 2009 registration statement termination date is $4.0 million. As of March 31, 2008, no registration default exists and no liability has been recorded in our consolidated financial statements.

On June 11, 2003, we completed the sale of $250.0 million aggregate principal amount of 3.0% Convertible Senior Debentures due 2033 (the “Debentures”) in a private placement. The Debentures are convertible into shares of our common stock based on a conversion rate of 18.7515 shares for each $1,000 principal amount of Debentures. This is equivalent to a conversion price of approximately $53.33 per share of common stock. On June 23, 2003, we sold an additional $25.0 million principal amount of Debentures pursuant to the exercise in full of an over-allotment option granted to the initial purchasers of the Debentures. Interest on the Debentures is payable at the rate of 3.0% per annum on June 15 and December 15 of each year. The Debentures are senior unsecured obligations and will mature on June 15, 2033. The Debentures are redeemable by us on or after June 15, 2008 and may be put to us for repurchase on June 15, 2008, 2010, 2013, or 2018. On April 21, 2008, we announced our intention to redeem the Debentures in full on June 15, 2008. We intend to fund the redemption with cash on hand and borrowings under our revolving credit facility.

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.

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.


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