LINCARE HOLDINGS INC – 10-Q – Management’s Discussion and Analysis of Results of Operations and Financial Condition

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

Medicare Reimbursement

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

Recent legislation, including the Patient Protection and Affordable Care Act ("PPACA"), the Medicare Improvements for Patients and Providers Act of 2008 ("MIPPA"), the Medicare, Medicaid and SCHIP Extension Act of 2007 ("SCHIP Extension Act"), the Deficit Reduction Act of 2005 ("DRA") and the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 ("MMA"), contain provisions that directly impact reimbursement for the primary respiratory and other DME products provided by Lincare. PPACA, as amended, is a comprehensive health care reform law that contains a large number of health-related provisions to take effect over the next several years, including various cost containment and program integrity changes that will apply to the home medical equipment industry. MIPPA delayed the implementation of a Medicare competitive bidding program for oxygen equipment and certain other DME items that was scheduled to begin on July 1, 2008 and instituted a 9.5% price reduction nationwide for these items as of January 1, 2009. The SCHIP Extension Act reduced Medicare reimbursement amounts for covered Part B drugs, including inhalation drugs that we provide, beginning April 1, 2008. DRA provisions negatively impacted reimbursement for oxygen equipment beginning in 2009 through the implementation of a capped rental arrangement. MMA changed the pricing formulas used to establish payment rates for inhalation drug therapies resulting in significantly reduced reimbursement beginning in 2005, established a competitive acquisition program for DME, established a Recovery Audit Contractors ("RAC") program, which implemented a new method for recovery of Medicare overpayments by utilizing private companies operating on a contingent fee basis to identify and recoup Medicare overpayments, and implemented quality standards and accreditation requirements for DME suppliers. These legislative provisions, as currently in effect and when fully implemented, have had and will continue to have a material adverse effect on our business, financial condition, operating results and cash flows.

PPACA was signed into law on March 23, 2010. Together with the Health Care and Education Reconciliation Act of 2010 (signed into law on March 30, 2010) which amended the statute, PPACA is a comprehensive health care law that is intended to expand access to health insurance, reform the health insurance market to provide additional consumer protections, and improve the health care delivery system to reduce costs and produce better outcomes through a combination of cost controls, subsidies and mandates. Among other things, PPACA:

(1) Introduced a productivity adjustment factor that is applied to Medicare price

    updates (covered item updates) for 2011 and each subsequent year.     Specifically, Medicare payment amounts are updated each year by the     percentage increase in the consumer price index for all urban consumers     (CPI-U) for the 12-month period ending with June of the previous year,     reduced by a productivity adjustment (as projected by the Secretary of Health     and Human Services). The application of the productivity adjustment may     result in the covered item update being negative for a year, and may result     in payment rates being less than such payment rates for the preceding year.     The covered item update for Medicare items subject to the update and     furnished in 2012, net of the productivity adjustment has been established at     positive 2.4%.    

(2) Made adjustments to the Medicare DME Competitive Acquisition Program

    ("competitive bidding"). PPACA expands the DME competitive bidding program to     100 markets from 79 markets under prior law. PPACA also added a requirement     to expand competitive bidding further to additional geographic markets     (certain markets may be excluded at the discretion of CMS) or use competitive     bid pricing information to adjust the payment amounts otherwise in effect for     areas that are not competitive acquisition areas by January 1, 2016.                                            20 

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   Table of Contents (3) Made important changes to key fraud and abuse statutes and increased funding     for fraud and abuse enforcement. PPACA increased funding for program     integrity initiatives, improved screening of providers and suppliers before     and after granting Medicare billing privileges and established new and     enhanced penalties and procedures to deter fraud and abuse. PPACA also     specifically added a requirement that physician orders for covered items of     DME must be written by a physician and must document that a physician, a     physician assistant, a nurse practitioner, or a clinical nurse specialist had     a face-to-face encounter (including through the use of telehealth) with the     individual involved during the six-month period preceding such written order,     or other reasonable timeframe as determined by the Secretary of Health and     Human Services.  

PPACA is a complex, sweeping health care reform law that will dramatically alter the structure of health insurance markets and the practice of medicine in the United States. Due to the complex nature of the legislation and the extended time period over which various provisions of the new law will be implemented (pursuant to yet unwritten regulations), we can not predict at this time what effects PPACA and related regulations will have on our business in the future.

The MIPPA legislation imposed a 9.5% reduction in Medicare payment rates for certain specified product categories, including oxygen, effective January 1, 2009. In addition to the 9.5% reduction, the Centers for Medicare and Medicaid Services ("CMS"), as required by statute, subjected the monthly payment amount for stationary oxygen equipment to additional cuts of 2.3%, thereby reducing the monthly payment rate from $199.28 in 2008 to $175.79 in 2009. The monthly payment amount was reduced by 1.5% in 2010, to $173.17. We estimate that this reduction negatively impacted our annual net revenues in 2010 by approximately $8.4 million when compared to the prior year period. The stationary oxygen payment rate for 2011 was increased to $173.31 per month, an increase of 0.1%, and was not material to the Company's operating results in 2011. The stationary oxygen payment rate for 2012 has been established by CMS at $176.06 per month, an increase of 1.6%. We estimate that this increase will favorably impact our revenues in 2012 by approximately $10.1 million.

The SCHIP Extension Act, which became law on December 29, 2007, required CMS to adjust the methodology used to determine Medicare payment amounts for inhalation drugs by using volume-weighted average selling prices ("ASP") based on actual sales volumes rather than average sales prices. CMS publishes payment rates for inhalation drugs each calendar quarter, representing the unit reimbursement rates in effect for inhalation drugs dispensed within that quarter. These payment rates may be subject to volatility as a result of the underlying ASP data used to determine the rates in effect each quarter. The quarterly ASP data published by CMS for inhalation drugs provided in 2010 and 2011 resulted in reductions in the Medicare payment rates for inhalation drugs that negatively impacted the Company's annual net revenues by approximately $5.0 million and $14.8 million, respectively. Based upon the ASP payment rates published by CMS for the first and second quarters of 2012, and assuming no changes in the volume or mix of drugs that we currently dispense, we estimate that our annual net revenues will be favorably impacted by approximately $12.5 million in 2012 when compared with 2011. We can not determine whether quarterly updates in ASP pricing data will result in future reductions in payment rates for inhalation drugs, or what impact such payment reductions could have on our business in the future.

Additionally, since 2011, CMS is using 103% of Average Manufacturer Price ("AMP") rather than 106% of ASP for a drug when ASP exceeds AMP by 5% for either two straight quarters or three of the past four quarters. The policy limits substitution of the price formula in a given quarter to only those drugs where ASP and AMP can be compared using the same set of national drug codes. We can not determine at this time which, if any, inhalation drugs might meet the criteria established for substitution in a particular future quarter, nor the impact on payment rates for such drugs in the event that the AMP formula is utilized.

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

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to negatively affect our net revenues on an ongoing basis, as each month additional customers reach the 36-month capped service period, resulting in no further rental income from these customers. During 2011, we estimate that our sequential net revenues were reduced as a result of additional customers reaching the payment cap by approximately $20.2 million when compared to the prior year period. During the first quarter of 2012, we estimate that our net revenues were reduced by $7.0 million compared to the first quarter of 2011, attributed to the oxygen rental payment cap.

In December 2003, MMA was signed into law. The MMA legislation directly impacted reimbursement for the primary respiratory and other DME products that we provide. Among other things, MMA:

(1) Established a competitive acquisition program for DME that was expected to

    commence in 2008, but was subsequently delayed by further legislation. MMA     instructed CMS to establish and implement programs under which competitive     acquisition areas would be established throughout the United States for     purposes of awarding contracts for the furnishing of competitively priced     items of DME, including oxygen equipment. The program was initially intended     to be implemented in phases such that competition under the program would     occur in nine of the largest metropolitan statistical areas ("MSAs") in the     first year and an additional 70 of the largest MSAs in a second, subsequent     round of bidding.  

For each competitive acquisition area, CMS is required to conduct a competition under which providers submit bids to supply certain covered items of DME. Successful bidders are 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 (there are, however, regulations in place that allow non-contracted providers to continue to provide equipment and services to their existing customers at the new prices determined through the bidding process). The contracts are expected to be re-bid at least every three years. CMS is required to award contracts to multiple entities submitting bids in each area for an item or service, but has the authority to limit the number of contractors in a competitive acquisition area to the number it determines to be necessary to meet projected demand.

CMS concluded the bidding process for the first round of MSAs in September 2007, however, in July 2008, Congress enacted the MIPPA legislation which retroactively delayed the implementation of competitive bidding and reduced Medicare prices nationwide by 9.5% beginning in 2009 for the product categories, including oxygen, that were initially included in competitive bidding.

In 2009, CMS reinstituted the bidding process in the nine largest MSA markets. Reimbursement rates from the re-bidding process were publicly released by CMS on June 30, 2010. CMS announced average savings of approximately 32% off the current payment rates in effect for the product categories included in competitive bidding. As of January 1, 2011, these payment rates were in effect in the nine markets only. Lincare was offered contracts to provide oxygen equipment in just two of the nine markets, Charlotte and Miami, and we accepted and signed those contracts. The Company's annual Medicare revenues from the product categories in the nine markets affected by competitive bidding were approximately $48.0 million at the time the program commenced. During 2011, we completed acquisitions of companies that were contracted to provide home oxygen equipment and positive airway pressure devices in all nine competitive bidding markets.

CMS is currently undertaking a second round of competitive bidding in 91 additional markets, with contracts expected to be effective in July 2013. The bid submission period closed on March 30, 2012, and CMS is expected to announce final pricing results in November 2012. The Company's Medicare revenues from the product categories in the 91 additional markets to be included in the second round of competitive bidding were approximately $267.0 million in 2011. The PPACA legislation requires CMS to expand competitive bidding further to additional geographic markets (certain markets may be excluded at the discretion of CMS) or to use competitive bid pricing information to adjust the payment amounts otherwise in effect for areas that are not competitive acquisition areas by January 1, 2016.

We will continue to monitor developments regarding the implementation of the competitive bidding program. While we can not predict the outcome of the competitive bidding program on our business when fully implemented nor the Medicare payment rates that will be in effect in future years for the items subjected to competitive bidding, it is likely that the program will materially adversely effect our financial position and operating results.

(2) Established a Recovery Audit Contractors ("RAC") program to identify and

    recoup Medicare overpayments from providers. Started in 2005 as a     demonstration project by CMS, the RAC program was designed to test a new     method for recovery of Medicare overpayments by utilizing private companies     operating on a contingent fee basis to identify and recoup Medicare     overpayments from providers. Section 302 of the Tax Relief and Health Care     Act of 2006                                            22 

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  Table of Contents     made the program permanent and requires the Department of Health and Human     Services to expand the program to all states. The RAC contractors are     empowered to audit claims submitted by health care providers and to withhold     future payments, including in cases where the reimbursement rules are unclear     or subject to differing interpretations. This activity, as well as the     activity of intermediaries and others involved in government reimbursement,     may include changes in long-standing interpretations of reimbursement rules,     which could have a material adverse effect on our future financial position     and operating results.  

In October 2008, CMS announced the establishment of new Zone Program Integrity Contractors ("ZPICs"), who are responsible for ensuring the integrity of all Medicare-related claims. The ZPICs assumed the responsibilities previously held by Medicare's Program Safeguard Contractors ("PSCs"). Industry-wide, ZPIC audit activity increased substantially throughout 2010 and 2011 and that activity is expected to continue to increase for the foreseeable future as additional ZPICs become operational across the country. The industry trade associations are advocating for more standardized audit procedures, contractor transparency and consistency surrounding all government audit activity directed toward the DME industry.

In order to ensure that Medicare beneficiaries only receive medically necessary and appropriate items and services, the Medicare program has adopted a number of documentation requirements. For example, the Durable Medical Equipment Medicare Administrative Contractor ("DME MAC") Supplier Manuals provide that clinical information from the "patient's medical record" is required to justify the initial and ongoing medical necessity for the provision of DME. Some DME MACs, CMS staff and government subcontractors have recently taken the position, among other things, that the "patient's medical record" refers not to documentation maintained by the DME supplier but instead to documentation maintained by the patient's physician, health care facility or other clinician, and that clinical information created by the DME supplier's personnel and confirmed by the patient's physician is not sufficient to establish medical necessity. It may be difficult, and sometimes impossible, for us to obtain documentation from other health care providers. Moreover, auditors' interpretations of these policies are inconsistent and subject to individual interpretation, leading to significant increases in individual supplier and industry-wide perceived error rates. High error rates lead to further audit activity and regulatory burdens. If these or other burdensome positions are generally adopted by auditors, DME MACs, other contractors or CMS in administering the Medicare program, we would have the right to challenge these positions as being contrary to law. If these interpretations of the documentation requirements are ultimately upheld, however, it could result in our making significant refunds and other payments to Medicare and our future revenues and cash flows from Medicare may be reduced. We can not currently predict the adverse impact these interpretations of the Medicare documentation requirements might have on our operations, cash flow and capital resources, but such impact could be material.

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

Government Regulation

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

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

Numerous federal and state laws and regulations, including the Federal Health Insurance Portability And Accountability Act of 1996 ("HIPAA") and the Health Information Technology For Economic And Clinical Health Act ("HITECH Act"), govern the collection, dissemination, security, use and confidentiality of patient-identifiable health

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information. As part of our provision of, and billing for, health care equipment and services, we are required to collect and maintain patient-identifiable health information. New health information standards, whether implemented pursuant to HIPAA, the HITECH Act, congressional action or otherwise, could have a significant effect on the manner in which we handle health care related data and communicate with payors, and the cost of complying with these standards could be significant. If we do not comply with existing or new laws and regulations related to patient health information, we could be subject to criminal or civil sanctions.

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

Operating Results

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

                                                     For The Three Months Ended                                                            March 31,                                                      2012               2011                                                         (In thousands)       Respiratory and other chronic therapies   $      449,544       $  386,020       DME, infusion and enteral therapies               51,334           45,547        Total                                     $      500,878       $  431,567   

Net revenues for the three months ended March 31, 2012, increased by $69.3 million (or 16.1%), compared with the three months ended March 31, 2011. The Company estimates that the 16.1% increase in net revenues in the three-month period of 2012 was comprised of approximately 16.6% internal and acquisition growth offset by approximately 0.5% negative impact from $2.2 million of Medicare payment changes (see "Medicare Reimbursement" above). The internal growth in net revenues is attributable to underlying demographic growth in the markets for our products and gains in customer counts resulting primarily from our sales and marketing efforts that emphasize high-quality equipment and customer service. Growth in net revenues from acquisitions is attributable to the effects of acquisitions of local and regional companies and is based on the estimated contribution to net revenues for the four quarters following such acquisitions.

The contribution of respiratory and other chronic therapy products to our net revenues was 89.8% during the three months ended March 31, 2012 and during the three months ended March 31, 2011 was 89.4%. Our strategy is to focus on the provision of oxygen, respiratory and other chronic therapy services to patients in the home and to provide home medical equipment, infusion and enteral nutrition products and services where we believe such services will enhance our core respiratory business.

Cost of goods and services, as a percentage of net revenues, was 32.6% for the three months ended March 31, 2012, compared with 28.8% for the comparable prior year period. Cost of goods and services for the three months ended March 31, 2012, increased $39.3 million, or 31.7%, when compared with the prior year period. The increase in cost of goods and services in 2012 is primarily attributable to the Company's acquisition of a specialty pharmacy business with gross margins that are substantially lower than other products and services provided by the Company and higher sale volumes of CPAP supplies and inhalation drugs.

Cost of goods and services for the three-month period includes the cost of medical equipment (excluding depreciation of $29.1 million in 2012 and $26.8 million in 2011, 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 $13.9 million for the three-month period of 2012 and the three-month period of 2011. Included in cost of goods and services in the three months ended March 31, 2012 are salary and related expenses of pharmacists and other service professionals of $3.1 million. Such salary and related expenses for the three months ended March 31, 2011, were $2.8 million.

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Operating expenses, as a percentage of net revenues, were 23.0% for the three months ended March 31, 2012, compared with 23.6% for the comparable prior year period. Operating expenses for the three months ended March 31, 2012, increased by $13.1 million, or 12.8%, over the prior year period. The Company has been successful in achieving productivity gains that have contributed to containment of the growth in wage expenses and in managing the growth of its employee health benefit costs. These positive developments were partially offset by increases in vehicle related expenses during the first three months of 2012, most significantly fuel costs.

The Company manages 1,091 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 "CSRs" - 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 clinical follow-up with the customer and communication to the prescribing physician) and a sales representative (marketing calls to local physicians and other referral sources).

The Company includes in operating expenses the costs incurred at the Company's operating centers for certain service personnel (center manager, CSRs and Service Reps), facilities (rent, utilities, communications, property taxes, etc.), vehicles (vehicle leases, gasoline, repair and maintenance), and general business supplies and miscellaneous expenses. Operating expenses for the interim periods of 2012 and 2011 within these major categories were as follows:

                                                  For The Three Months Ended          Operating Expenses (in thousands)              March 31,                                                   2012               2011           Salary and related                  $       74,717       $   66,430           Facilities                                  16,410           15,765           Vehicles                                    15,020           12,664           General supplies/miscellaneous               8,835            7,048            Total                               $      114,982       $  101,907   

Included in operating expenses during the three months ended March 31, 2012 are salary and related expenses for Service Reps in the amount of $28.9 million. Such salary and related expenses for the three months ended March 31, 2011 were $27.6 million.

Selling, general and administrative ("SG&A") expenses, as a percentage of net revenues, were 18.6% for the three months ended March 31, 2012, compared with 19.2% for the comparable prior year period. SG&A expenses for the three months ended March 31, 2012 increased by $10.5 million, or 12.7% when compared to the prior year period. SG&A expenses include costs related to sales and marketing activities, corporate overhead and other business support functions. Included in SG&A during the three months ended March 31, 2012 are salary and related expenses of $69.4 million. These salary and related expenses include the cost of the Company's respiratory therapists for the three months ended March 31, 2012 of $17.7 million. Included in SG&A during the three months ended March 31, 2011 are salary and related expenses of $62.2 million. These salary and related expenses include the cost of the Company's respiratory therapists for the three months ended March 31, 2011 of $16.6 million. The Company's respiratory therapists generally provide non-reimbursable clinical follow-up with the customer and communication, as appropriate, to the prescribing physician with respect to the customer's prescribed 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.

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Bad debt expense as a percentage of net revenues was 2.0% for the three months ended March 31, 2012 and the three months ended March 31, 2011. Bad debt expense for the three months ended March 31, 2012 increased by $1.4 million over the comparable prior year period.

Included in depreciation and amortization expense in the three months ended March 31, 2012 is depreciation of medical equipment of $29.1 million and depreciation of other property and equipment of $2.5 million. Included in depreciation and amortization expense in the three months ended March 31, 2011 is depreciation of medical equipment of $26.8 million and depreciation of other property and equipment of $2.2 million.

Operating income for the three months ended March 31, 2012, was $86.4 million (17.2% of net revenues) compared with $84.6 million (19.6% of net revenues) for the comparable prior year period. The increase in operating income in 2012 is attributed primarily to the growth in net revenues in the three months ended March 31, 2012, compared with the prior year period.

Liquidity and Capital Resources

Our primary sources of liquidity have been internally generated funds from operations 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. The Company also has access to borrowings under its credit facilities.

Net cash provided by operating activities was $55.8 million for the three months ended March 31, 2012, compared with $81.3 million for the three months ended March 31, 2011. Net cash used in investing and financing activities was $41.6 million for the three months ended March 31, 2012. Investing and financing activities during the three-month period ended March 31, 2012 included our net investment in property and equipment of $31.0 million, payments of principal on debt of $3.2 million, $1.0 million of purchases of short-term investments, $17.4 million of dividends paid, $12.4 million of business acquisition expenditures, $50.0 million of repurchases of our common stock, net proceeds of $70.0 million from our revolving credit facility, proceeds of $1.0 million from the sale of investments, and proceeds of $2.4 million from the exercise of stock options and issuance of common shares.

As of March 31, 2012, our principal sources of liquidity consisted of approximately $29.2 million of cash and cash equivalents, $39.9 million of short-term investments and $243.2 million available under our revolving credit agreement. The revolving credit agreement, dated September 15, 2011, makes available to us up to $450.0 million over a five-year period, subject to certain terms and conditions set forth in the agreement. As of March 31, 2012, there were $170.0 million of borrowings outstanding and $36.8 million of standby letters of credit issued under the credit facility.

On April 2, 2012, the Company announced that its Board of Directors had declared a quarterly cash dividend of $0.20 per share which was paid on April 30, 2012, to stockholders of record as of April 16, 2012. The payment of future dividends is dependent on our future earnings and cash flow and is subject to the discretion of our Board of Directors.

Our Board of Directors has authorized a share repurchase plan whereby the Company may repurchase from time to time, on the open market or in privately negotiated transactions, shares of the Company's common stock in amounts determined pursuant to a formula (the "share repurchase formula") that takes into account both the ratio of the Company's net debt to cash flow and its available cash resources and borrowing availability. During the three months ended March 31, 2012, the Company repurchased and retired 1,877,670 shares for $50.0 million pursuant to the repurchase plan. As of March 31, 2012, $215.4 million of the Company's common stock was eligible for repurchase in accordance with the plan's formula.

On October 31, 2007, we completed the sale of $275.0 million principal amount of convertible senior debentures, due 2037 - Series A (the "Series A Debentures") and $275.0 million principal amount of convertible senior debentures due 2037 - Series B (the "Series B Debentures" and together with the Series A Debentures, the "Series Debentures") in a private placement. The Series Debentures pay interest semi-annually at a rate of 2.75% per annum. The Series Debentures are unsecured and unsubordinated obligations and are convertible under specified circumstances based upon a base conversion rate, which, under certain circumstances, will be increased pursuant to a formula that is subject to a maximum conversion rate. Upon conversion, holders of the Series Debentures will receive cash up to the principal amount, and any excess conversion value will be delivered in shares of our common stock or in a combination of cash and shares of common stock, at our option. The base conversion rate for the Debentures as of March 31, 2012 is 30.5977

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shares of common stock per $1,000 principal amount of Series Debentures, equivalent to a base conversion price of approximately $32.68 per share. In addition, if at the time of conversion the applicable price of our common stock exceeds the base conversion price, holders of the Series Debentures will receive an additional number of shares of common stock per $1,000 principal amount as determined pursuant to a specified formula. We have the right to redeem the Series A Debentures and the Series B Debentures at any time after November 1, 2012 and November 1, 2014, respectively. Holders of the Series Debentures will have the right to require us to repurchase for cash all or some of their Series Debentures upon the occurrence of certain fundamental change transactions or on November 1, 2012, 2017, 2022, 2027 and 2032 in the case of the Series A Debentures and November 1, 2014, 2017, 2022, 2027 and 2032 in the case of the Series B Debentures.

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 sales 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.

Accounts receivable balance concentrations by major payor category as of March 31, 2012 and December 31, 2011 were as follows:

      Percentage of Accounts Receivable Outstanding:                                                       March 31,       December 31,                                                        2012              2011     Medicare                                                38.8 %             37.2 %     Medicaid/Other Government                               14.1 %             14.7 %     Private Insurance                                       36.6 %             38.4 %     Customer Pay                                            10.5 %              9.7 %      Total                                                  100.0 %            100.0 %                                             27 

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Aged accounts receivable balances by major payor category as of March 31, 2012 and December 31, 2011 were as follows:

          Percentage of Accounts Aged in Days:             March 31, 2012                                                0-60       61-120        Over 120        Medicare                                 63.5 %       14.7 %          21.8 %        Medicaid/Other Government                52.9 %       20.5 %          26.6 %        Private Insurance                        58.5 %       17.1 %          24.4 %        Customer Pay                             47.3 %       12.7 %          40.0 %        All Payors                               58.5 %       16.2 %          25.3 %            Percentage of Accounts Aged in Days:            December 31, 2011                                                0-60       61-120        Over 120        Medicare                                 67.5 %       12.9 %          19.6 %        Medicaid/Other Government                55.1 %       18.0 %          26.9 %        Private Insurance                        60.1 %       13.7 %          26.2 %        Customer Pay                             30.5 %       15.0 %          54.5 %        All Payors                               59.2 %       14.2 %          26.6 %  

We operate 39 regional billing and collection offices ("RBCOs") that are responsible for the billing and collection of accounts receivable. The RBCOs are aligned geographically to support the accounts receivable activity of the operating centers within their assigned territories. As of March 31, 2012, there were 1,491 full-time employees in the RBCOs. Accounts receivable collections are performed by designated collectors within each of the RBCOs. The collectors use various reporting tools available within our proprietary billing system to identify claims that have been denied or partially paid by the responsible party and claims that have not been processed by the third-party payor in a timely manner. Collections of accounts receivable are typically pursued using direct phone contact to determine the reason for non-payment and, if necessary, corrected claims are prepared for resubmission and further follow-up with the responsible party. In some cases, third-party payors have developed electronic inquiry methods that we can access to determine the status of individual claims. We have benefited from the increasing availability of electronic funds transfers from payors, which now account for approximately 76.4% of all payments received.

Our accounts receivable days sales outstanding ("DSO") increased to 56 days at March 31, 2012 compared with 45 days at March 31, 2011. Our bad debt expense, as a percentage of net revenues, was 2.0% during the three-month priods ended March 31, 2012 and March 31, 2011. Contributing to the increase in our accounts receivable is a significant increase in the number of Medicare claims subject to prepayment review, primarily by the DME MACs. These reviews are substantially delaying the collection of our Medicare accounts receivable as well as related secondary amounts due under supplemental insurance plans. Also contributing to the increase in accounts receivable and bad debt expense are copayments and deductibles due from customers who are finding it difficult to pay their out-of-pocket charges due to loss of insurance coverage or reductions in their investment or employment income.

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

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

Income Taxes

Our effective income tax rate was 39.10% for the three months ended March 31, 2012 compared with 38.63% for the three months ended March 31, 2011. The income tax rate increased from the first quarter of 2011 primarily due to an increase in unfavorable permanent differences.

We have elected to treat our portion of all foreign subsidiary earnings through March 31, 2012 as permanently reinvested under the relevant accounting guidance and accordingly have not provided for any U.S. federal or state tax thereon. As of March 31, 2012, approximately $0.07 million of retained earnings attributable to foreign subsidiaries was considered to be indefinitely invested. Our intention is to reinvest the earnings permanently or to repatriate the earnings when it is tax effective to do so. It is not practicable to determine the amount of incremental taxes that might arise were these earnings to be remitted. However, the amount of cash for all foreign subsidiaries permanently reinvested, and the amount of incremental taxes that might arise were these earnings to be remitted, are not material.

Future Minimum Obligations

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

New Accounting Standards

In May 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update 2011-04, "Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS," to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and International Financial Reporting Standards. The guidance expands the disclosure requirements around fair value measurements categorized in Level 3 of the fair value hierarchy and requires disclosure of the level in the fair value hierarchy of items that are not measured at fair value but whose fair value must be disclosed. It also clarifies and expands upon existing requirements for fair value measurements of financial assets and liabilities as well as instruments classified in shareholders' equity. The guidance is effective for interim and annual financial periods beginning after December 15, 2011 with early adoption not permitted. The adoption of ASU 2011-04 did not have an impact on our financial condition, results of operations or cash flows.

In June 2011, the FASB issued Accounting Standards Update 2011-05, "Presentation of Comprehensive Income," to eliminate the current option to present the components of other comprehensive income in the statement of changes in equity and to require presentation of net income and other comprehensive income (and their respective components) either in a single continuous statement or in two separate but consecutive statements. The amendments do not alter any current recognition or measurement requirements in respect of items of other comprehensive income. The guidance is to be applied retrospectively and is effective for interim and annual periods beginning after December 15, 2011, with early adoption permitted. The adoption of ASU 2011-05 did not have an impact on our financial condition, results of operations or cash flows.

In September 2011, the FASB issued Accounting Standards Update 2011-08, "Testing Goodwill for Impairment," which allows an initial assessment of qualitative factors to determine whether it is more likely than not (i.e., there is more than a 50% likelihood) that the fair value of a reporting unit is less than its carrying amount for purposes of determining whether it is necessary to perform the first step of the two-step goodwill impairment test. Accordingly, the calculation of a reporting unit's fair value is not required unless, as a result of the qualitative assessment, it is more likely than not that fair value of the reporting unit is less than its carrying amount. The amendments do not affect the manner in which the first and second steps of the impairment test are performed. The guidance is to be applied prospectively and is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 with early adoption permitted. The adoption of ASU 2011-08 did not have an impact on our financial condition, results of operations or cash flows.

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In December 2011, the FASB issued Accounting Standards Update 2011-11, "Disclosures about Offsetting Assets and Liabilities," which requires disclosures to provide information to help reconcile differences in the offsetting requirements under U.S. GAAP and IFRS. The guidance applies to disclosures concerning financial instruments and derivative instruments that are either (1) offset in the balance sheet, or (2) subject to an enforceable master netting arrangement. The guidance is to be applied retrospectively and is effective for interim and annual financial periods beginning on or after January 1, 2013. We will adopt the new guidance effective January 1, 2013. The Company does not expect the adoption of this guidance to have an impact on its financial condition, results of operations or cash flows.

In December 2011, the FASB issued Accounting Standards Update 2011-12, "Deferral of the Effective Date for the Presentation of Reclassification Adjustments Out of Accumulated Other Comprehensive Income," which indefinitely defers the effective date of the provision in ASU No. 2011-05, "Presentation of Comprehensive Income", pertaining only to the presentation of reclassification adjustments out of accumulated other comprehensive income ("OCI"), and reinstates the previous requirements to present reclassification adjustments either on the face of the statement in which OCI is reported or to disclose them in a note to the financial statements. The other requirements in ASU No. 2011-05 are not affected by ASU No. 2011-12, including the requirement to report comprehensive income either in a single continuous statement or in two separate but consecutive statements. The guidance is to be applied retrospectively and is effective for interim and annual periods beginning after December 15, 2011, with early adoption permitted. The adoption of ASU 2011-12 did not have an impact on our financial condition, results of operations or cash flows.

Forward Looking Statements

Statements in this report concerning future results, performance or expectations are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. All forward-looking statements included in this document are based upon information available to us as of the date hereof and we assume no obligation to update any such forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any results, levels of activity, performance or achievements expressed or implied by any forward-looking statements. In some cases, forward-looking statements that involve risks and uncertainties contain terminology such as "may," "will," "should," "could," "expects," "intends," "plans," "anticipates," "believes," "estimates," "predicts," "potential," or "continue" or variations of these terms or other comparable terminology.

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

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

Certain Risk Factors Relating to the Company's Business

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

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

As a provider of oxygen, respiratory and other chronic therapy services for the home health care market, we have historically depended heavily on Medicare reimbursement as a result of the high proportion of elderly persons suffering

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from respiratory disease. Medicare Part B, the Supplementary Medical Insurance Program, provides coverage to eligible beneficiaries for DME, such as oxygen equipment, respiratory assistance devices, continuous positive airway pressure devices, nebulizers and associated inhalation medications, hospital beds and wheelchairs for the home setting. Approximately 63% of our customers have primary coverage under Medicare Part B. There are increasing pressures on Medicare to control health care costs and to reduce or limit reimbursement rates for home medical equipment and services. Medicare reimbursement is subject to statutory and regulatory changes, retroactive rate adjustments, administrative and executive orders and governmental funding restrictions, all of which could materially decrease payments to us for the services and equipment we provide.

Recent legislation, including the Patient Protection and Affordable Care Act ("PPACA"), the Medicare Improvements for Patients and Providers Act of 2008 ("MIPPA"), the Medicare, Medicaid and SCHIP Extension Act of 2007 ("SCHIP Extension Act"), the Deficit Reduction Act of 2005 ("DRA") and the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 ("MMA"), contain provisions that directly impact reimbursement for the primary respiratory and other DME products provided by Lincare. PPACA, as amended, is a comprehensive health care reform law that contains a large number of health-related provisions to take effect over the next several years, including various cost containment and program integrity changes that will apply to the home medical equipment industry. MIPPA delayed the implementation of a Medicare competitive bidding program for oxygen equipment and certain other DME items that was scheduled to begin on July 1, 2008 and instituted a 9.5% price reduction nationwide for these items as of January 1, 2009. The SCHIP Extension Act reduced Medicare reimbursement amounts for covered Part B drugs, including inhalation drugs that we provide, beginning April 1, 2008. DRA provisions negatively impacted reimbursement for oxygen equipment beginning in 2009 through the implementation of a capped rental arrangement. MMA changed the pricing formulas used to establish payment rates for inhalation drug therapies resulting in significantly reduced reimbursement beginning in 2005, established a competitive acquisition program for DME, established a Recovery Audit Contractors ("RAC") program, which implemented a new method for recovery of Medicare overpayments by utilizing private companies operating on a contingent fee basis to identify and recoup Medicare overpayments, and implemented quality standards and accreditation requirements for DME suppliers. These legislative provisions, as currently in effect and when fully implemented, have had and will continue to have a material adverse effect on our business, financial condition, operating results and cash flows. See "MEDICARE REIMBURSEMENT" for a full discussion of the PPACA, MIPPA, SCHIP Extension Act, DRA and MMA provisions.

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

DRA changed the reimbursement methodology for oxygen equipment from continuous monthly payment for as long as the equipment is in use by a Medicare beneficiary, which includes payment for oxygen contents, related disposable supplies and accessories and maintenance of equipment, to a capped rental arrangement whereby payment for oxygen equipment may not extend over a period of continuous use of longer than 36 months. Separate payments for oxygen contents continue to be made for the period of medical need beyond the 36th month. Additionally, payment for routine maintenance and service of the oxygen equipment may be made following each six-month period after the 36-month rental period ends. The oxygen provisions contained in DRA became effective on January 1, 2006. In the case of beneficiaries receiving oxygen equipment prior to the effective date, the 36-month period of continuous use began on January 1, 2006. Accordingly, the first month in which the new payment methodology impacted our net revenues was January 2009. We anticipate that the new oxygen payment rules will continue to negatively affect our net revenues on an ongoing basis, as each month additional customers reach the 36-month capped service period, resulting in up to two or more years without rental income from these customers. During 2011, we estimate that our sequential net revenues were reduced as a result of additional customers reaching the payment cap by approximately $20.2 million when compared to the prior year period. During the first quarter of 2012, we estimate that our net revenues were reduced by $7.0 million compared to the first quarter of 2011, attributed to the oxygen rental payment cap.

On July 15, 2008, Congress enacted the MIPPA legislation which reduced Medicare payment rates nationwide for certain DME items, including oxygen equipment, by 9.5% beginning in 2009. In addition to the 9.5% reduction, CMS subjected the monthly payment amount for stationary oxygen equipment to additional cuts of 2.3% in 2009, thereby reducing the monthly payment rate from $199.28 in 2008 to $175.79 in 2009. The monthly payment amount was reduced by 1.5% in 2010, to $173.17. We estimate that this reduction negatively impacted our annual net revenues in 2010 by approximately $8.4 million when compared to the prior year period. The stationary oxygen payment rate for 2011 was increased to $173.31 per month, an increase of 0.1%, and was not material to the Company's operating results in 2011. The stationary oxygen payment rate for 2012 has been established by CMS at $176.06 per month, an increase of 1.6%. We estimate that this increase will favorably impact our revenues in 2012 by approximately $10.1 million.

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