UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

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

For The Quarterly Period Ended June 30, 2012

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO

Commission File Number 0-19946

LINCARE HOLDINGS INC.

(Exact name of registrant as specified in its charter)

Delaware

51-0331330

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

19387 US 19 North

Clearwater, FL

33764

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code:

(727) 530-7700

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

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


Class		Outstanding at July 25, 2012
Common Stock, $0.01 par value		87,474,461

LINCARE HOLDINGS INC. AND SUBSIDIARIES

FORM 10-Q

For The Quarterly Period Ended June 30, 2012

INDEX


		Page
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)		3
	Condensed consolidated balance sheets		3
	Condensed consolidated statements of operations		4
	Condensed consolidated statements of comprehensive income		5
	Condensed consolidated statements of cash flows		6
	Notes to condensed consolidated financial statements (unaudited)		7
Item 2.	Management’s Discussion and Analysis of Results of Operations and Financial Condition		24
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		42
Item 4.	Controls and Procedures		42

PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings		43
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		44
Item 3.	Defaults Upon Senior Securities		44
Item 4.	Mine Safety Disclosures		44
Item 5.	Other Information		44
Item 6.	Exhibits		44
SIGNATURE			45
INDEX OF EXHIBITS			S-1

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

LINCARE HOLDINGS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)


	June 30, 2012			December 31, 2011
ASSETS
Current assets:
Cash and cash equivalents	$	146,324		$	15,028
Short-term investments		19,608			39,939
Accounts receivable, net		328,581			254,799
Income tax receivable		2,834			4,903
Inventories		20,539			17,916
Prepaid and other current assets		8,557			9,609

Total current assets		526,443			342,194

Property and equipment, net		352,833			350,725
Goodwill		1,405,895			1,389,965
Other		33,699			34,776

Total assets	$	2,318,870		$	2,117,660


LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Current installments of long-term obligations	$	307,128		$	397,132
Accounts payable		68,887			53,294
Accrued expenses:
Compensation and benefits		32,459			33,142
Liability insurance		19,183			19,990
Other current liabilities		53,765			54,316
Deferred income taxes		8,972			8,769

Total current liabilities		490,394			566,643

Long-term obligations, excluding current installments		496,705			256,778
Deferred income taxes and other taxes		419,912			408,325

Total liabilities		1,407,011			1,231,746

Commitments and contingencies:
Stockholders’ equity:
Common stock		864			870
Additional paid-in capital		721,441			707,080
Retained earnings		189,586			177,964
Accumulated other comprehensive (loss) income		(32	)		0

Total stockholders’ equity		911,859			885,914

Total liabilities and stockholders’ equity	$	2,318,870		$	2,117,660

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

LINCARE HOLDINGS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)


	For The Three Months Ended						For The Six Months Ended
	June 30, 2012			June 30, 2011			June 30, 2012			June 30, 2011
Net revenues	$	496,163		$	449,033		$	997,041		$	880,600

Costs and expenses:
Cost of goods and services		160,247			142,300			323,776			266,509
Operating expenses		111,877			102,189			226,859			204,096
Selling, general and administrative expenses		89,604			85,495			183,000			168,374
Bad debt expense		12,923			8,981			22,941			17,612
Depreciation and amortization expense		33,040			29,987			65,592			59,304

		407,691			368,952			822,168			715,895

Operating income		88,472			80,081			174,873			164,705

Other income (expense):
Interest income		95			200			209			403
Interest expense		(10,457	)		(9,348	)		(20,781	)		(18,606	)

		(10,362	)		(9,148	)		(20,572	)		(18,203	)

Income before income taxes		78,110			70,933			154,301			146,502
Income tax expense		30,206			28,168			59,997			57,360

Net income	$	47,904		$	42,765		$	94,304		$	89,142

Basic earnings per common share	$	0.58		$	0.46		$	1.13		$	0.96

Diluted earnings per common share	$	0.56		$	0.45		$	1.10		$	0.94

Dividends declared per common share	$	0.20		$	0.20		$	0.40		$	0.40

Weighted average number of common shares outstanding		82,806			92,096			83,285			92,535

Weighted average number of common shares and common share equivalents outstanding		85,158			94,989			85,584			95,291

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

LINCARE HOLDINGS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)


	For The Three Months Ended				For The Six Months Ended
	June 30, 2012		June 30, 2011		June 30, 2012			June 30, 2011

Net income	$	47,904	$	42,765	$	94,304		$	89,142
Other comprehensive income (loss):
Foreign currency translation adjustment		16		0		(32	)		0


Comprehensive income	$	47,920	$	42,765	$	94,272		$	89,142

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

LINCARE HOLDINGS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)


	For The Six Months Ended
	June 30, 2012			June 30, 2011
Cash flows from operating activities:
Net income	$	94,304		$	89,142
Adjustments to reconcile net income to net cash provided by operating activities:
Bad debt expense		22,941			17,612
Depreciation and amortization expense		65,592			59,304
Net (gain) loss on disposal of property and equipment		(35	)		25
Gain on foreign currency fluctuations		(2	)		0
Amortization of debt issuance costs		956			884
Amortization of discount on bonds payable		10,450			9,744
Stock-based compensation expense		12,099			10,970
Deferred income taxes		14,036			24,822
Excess tax benefit from stock-based compensation		0			(240	)
Change in assets and liabilities net of effects of acquired businesses:
Accounts receivable		(96,420	)		(57,023	)
Inventories		(2,348	)		687
Prepaid and other assets		1,347			(3,972	)
Accounts payable		13,087			(3,454	)
Accrued expenses and other current liabilities		(4,612	)		(21,616	)
Income taxes payable		1,904			7,052
Long-term obligations and other obligations		(3,226	)		(2,161	)

Net cash provided by operating activities		130,073			131,776

Cash flows from investing activities:
Proceeds from sale of property and equipment		213			125
Capital expenditures		(62,385	)		(57,823	)
Purchases of investments		(2,749	)		(40,000	)
Sales and maturities of investments		23,080			40,000
Business acquisitions, net of cash acquired		(15,881	)		(73,021	)
Cash restricted for future payments		0			345

Net cash used in investing activities		(57,722	)		(130,374	)

Cash flows from financing activities:
Proceeds from issuance of debt		250,000			0
Proceeds from revolving credit line		220,000			0
Payments on revolving credit line		(320,000	)		0
Payments of principal on debt and long-term obligations		(9,112	)		(619	)
Payments of debt issuance costs		(1,652	)		0
Payments of cash dividends		(34,674	)		(38,186	)
Proceeds from exercise of stock options and issuance of common shares		4,412			5,104
Excess tax benefit from stock-based compensation		0			240
Payments to acquire treasury stock		(49,999	)		(49,998	)

Net cash provided by (used in) financing activities		58,975			(83,459	)

Effect of exchange rate changes on cash and cash equivalents		(30	)		0

Net increase (decrease) in cash and cash equivalents		131,296			(82,057	)
Cash and cash equivalents, beginning of period		15,028			164,203

Cash and cash equivalents, end of period	$	146,324		$	82,146

Supplemental disclosure of cash flow information:
Cash paid for interest	$	8,849		$	7,563

Cash paid for income taxes	$	43,886		$	25,566

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

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Summary of Significant Accounting Policies

Description of Business: Lincare Holdings Inc. and subsidiaries (“Lincare” or the “Company”) provide oxygen, respiratory therapy services, specialty pharmaceuticals, infusion therapy services and home medical equipment such as hospital beds, wheelchairs and other medical supplies to the home health care market. The Company’s customers are serviced from locations in 48 states in the United States and Canada. The Company’s equipment and supplies are readily available and the Company is not dependent on a single supplier or even a few suppliers.

Basis of Presentation: The accompanying condensed consolidated financial statements are unaudited and have been prepared in accordance with generally accepted accounting principles accepted in the United States for interim financial information and with the instructions to Form 10-Q. They should be read in conjunction with the consolidated financial statements and related notes to the financial statements of Lincare Holdings Inc. and Subsidiaries on Form 10-K for the fiscal year ended December 31, 2011. In the opinion of management, all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the results of operations for the interim periods presented have been reflected herein. The results of operations for interim periods are not necessarily indicative of the results to be expected for the entire year.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual amounts could differ from those estimates. It is at least reasonably possible that a change in those estimates will occur in the near term.

Investments: The Company determines the appropriate classification of investments at the time of purchase based upon management’s intent with regard to such investments. Based upon the Company’s intentions and ability to hold certain assets until maturity, the Company classifies certain debt securities as held-to-maturity and measures them at amortized cost. The Company classifies certain other debt securities as available-for-sale and measures them at fair value with unrealized gains or losses recorded in other comprehensive income. Realized gains and losses from both categories of investments are included in net income and are determined on a specific identification basis. Interest income and dividend income, if any, for both categories of investments are included in interest income.

Concentration of Credit Risk: The Company’s revenues are generated through locations in 48 states in the United States and Canada. The Company generally does not require collateral or other security in extending credit to customers; however, the Company routinely obtains assignment of (or is otherwise entitled to receive) benefits receivable under the health insurance programs, plans or policies of its customers. Included in the Company’s net revenues is reimbursement from government sources under Medicare, Medicaid and other federally and state funded programs, which represented approximately 61% of net revenues for the six months ended June 30, 2012 and 2011. The exclusion of the Company from participating in state and federally funded programs would have a material adverse effect on the Company’s business, financial condition, operating results and cash flows.

Self-Insurance Risk: The Company is subject to workers’ compensation, professional liability, auto liability and employee health benefit claims, which are primarily self-insured. However, the Company maintains certain stop-loss and other insurance coverage which it believes to be appropriate. Provisions for estimated settlements relating to these self-insured liabilities are provided in the period of the related claims on a case-by-case basis plus an amount for incurred but not reported claims. Differences between the amounts accrued and subsequent settlements are recorded in operations in the period of settlement.

Revenue Recognition and Accounts Receivable: The Company’s revenues are recognized on an accrual basis in the period in which services and related products are provided to customers and are recorded at net realizable amounts expected to be paid by customers and third-party payors. The Company’s billing system contains payor-specific price tables that reflect the fee schedule amounts in effect or contractually agreed upon by various government and commercial payors for each item of equipment or supply provided to a customer. The Company has established an allowance to account for sales adjustments that result from differences between the payment amount received and the expected realizable amount. Actual adjustments that result from differences between the payment amount received and the

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

expected realizable amount are recorded against the allowance for sales adjustments and are typically identified and ultimately recorded at the point of cash application or when otherwise determined pursuant to the Company’s collection procedures. The Company reports revenues in its financial statements net of such sales 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 equipment at the end of the rental payment period). Once initial delivery of rental equipment is made to the patient, a monthly billing cycle is established based on the initial date of delivery. The Company recognizes rental arrangement revenues ratably over the monthly service period and defers revenue for the portion of the monthly bill that is unearned. No separate payment is earned from the initial equipment delivery and setup process. During the rental period, the Company is responsible for servicing the equipment and providing routine maintenance, if necessary.

The Company recognizes revenue at the time the following criteria are met:

•

persuasive evidence of an arrangement exists;

•

delivery has occurred;

•

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

•

collectability is reasonably assured.

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

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

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Net Revenues: 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 June 30,				For The Six Months Ended June 30,
	2012		2011		2012		2011
	(In thousands)				(In thousands)
Respiratory and other chronic therapies	$	445,054	$	403,022	$	894,598	$	789,042
DME, infusion and enteral therapies		51,109		46,011		102,443		91,558

Total	$	496,163	$	449,033	$	997,041	$	880,600

Included in net revenues in the three and six months ended June 30, 2012 are rental items that comprise approximately 53.2% and 53.6%, respectively, of total revenues and sale items that comprise approximately 46.8% and 46.4%, respectively, of total revenues. Included in net revenues in the three and six months ended June 30, 2011 are rental items that comprise approximately 56.8% and 58.0%, respectively, of total revenues and sale items that comprise approximately 43.2% and 42.0%, respectively, of total revenues.

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

Cost of Goods and Services: Cost of goods and services includes the cost of medical equipment (excluding depreciation of $30.4 million and $59.5 million for the three and six-month periods in 2012 and $28.1 million and $54.9 million for the three and six-month periods in 2011, 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 $14.2 million and $28.1 million for the three and six-month periods ended June 30, 2012. For the three and six-month periods of 2011, such costs amounted to $13.6 million and $27.5 million, respectively. Included in cost of goods and services in the three and six-month periods ended June 30, 2012 are salary and related expenses of pharmacists and other service professionals of approximately $2.6 million and $5.4 million, respectively. Such salary and related expenses for the three and six-month periods ended June 30, 2011 were $3.0 million and $5.8 million, respectively.

Operating Expenses: The Company manages 1,058 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 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).

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

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:

Operating Expenses (in thousands)


	For The Three Months Ended June 30,				For The Six Months Ended June 30,
	2012		2011		2012		2011
Salary and related	$	72,640	$	67,826	$	147,357	$	134,256
Facilities		15,612		12,796		32,022		28,561
Vehicles		14,533		13,756		29,553		26,420
General supplies/miscellaneous		9,092		7,811		17,927		14,859

Total	$	111,877	$	102,189	$	226,859	$	204,096

Included in operating expenses during the three and six-month periods ended June 30, 2012 are salary and related expenses for Service Reps in the amount of $28.9 million and $57.8 million, respectively. Such salary and related expenses for the three and six-month periods ended June 30, 2011 were $28.3 million and $55.9 million, respectively.

Selling, General and Administrative Expenses: Selling, general and administrative expenses (“SG&A”) include costs related to sales and marketing activities, corporate overhead and other business support functions. Included in SG&A during the three and six-month periods ended June 30, 2012 are salary and related expenses of $68.6 million and $138.0 million, respectively. These salary and related expenses include the cost of the Company’s respiratory therapists for the three and six-month periods ended June 30, 2012 of $18.0 million and $35.7 million, respectively. Included in SG&A during the three and six-month periods ended June 30, 2011 are salary and related expenses of $62.9 million and $125.1 million, respectively. These salary and related expenses include the cost of the Company’s respiratory therapists for the three and six-month periods ended June 30, 2011 of $17.9 million and $34.5 million, respectively. 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.

Comprehensive Income: Total comprehensive income and the components of other comprehensive income (loss) are presented in the Condensed Consolidated Statements of Comprehensive Income. Other comprehensive income (loss) is composed of foreign currency translation adjustments.

Note 2. Fair Value of Assets and Liabilities

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

•

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

•

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

•

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

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

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

Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, the Company’s own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date. The Company uses prices and inputs that are current as of the measurement date, including periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition has caused, and in the future may cause, the Company’s financial instruments to be reclassified from Level 1 to Level 2 or from Level 2 to Level 3. During the three and six-month periods ended June 30, 2012 and 2011, the Company did not have any reclassifications in levels.

Fair value measurements are prepared under the direction of the Chief Financial Officer and the Corporate Controller by Company personnel who have knowledge and experience in financial accounting and financial valuation. In situations where additional expertise is required the Company will engage independent valuation professionals. In all cases the valuations are those of management. Valuations are prepared on a quarterly basis and variances from prior valuations are analyzed by contributing factors including timing and/or amount of cash flows, discount rates and other underlying inputs. Unobservable inputs are developed and substantiated by reviewing trends in economic and other factors.

The Company estimated the fair value of acquisition-related contingent consideration arrangements by applying the income approach using a probability-weighted discounted cash flow model. This fair value measurement is based on significant inputs not observed in the market and thus represents a Level 3 measurement. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect the Company’s own assumptions in measuring fair value.

The significant unobservable inputs used in the fair value measurement of the Company’s contingent consideration liability are growth rates and discount rates. Significant decreases in growth rates, or significant increases in discount rates, in isolation would result in a significantly lower fair value measurement. Generally, a change in the assumption used for growth rates should be accompanied by a change in the assumption for discount rates in the same direction as excessively fast growth increases the risk of achieving the projections. The effects of these changes partially offset each other.

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The following tables report quantitative information for fair value measurements categorized within Level 3 of the fair value hierarchy at June 30, 2012 and December 31, 2011 (in thousands):

June 30, 2012


Description	Fair Value		Valuation Technique	Unobservable Input	Range	Weighted Average

Contingent consideration	$	16,935	Discounted	Growth Rate	1.0% - 20.0%		6.0	%
			Cash Flow	Discount Rate	1.0% - 15.0%		5.0	%

December 31, 2011


Description	Fair Value		Valuation Technique	Unobservable Input	Range	Weighted Average

Contingent consideration	$	21,595	Discounted	Growth Rate	4.0% - 12.0%		8.0	%
			Cash Flow	Discount Rate	1.0% - 15.0%		8.0	%

Contingent consideration of $9.6 million, $10.9 million and $1.1 million was recognized in connection with business acquisitions in February 2011, June 2011 and September 2011, respectively, totaling $21.6 million at December 31, 2011. During the three months ended June 30, 2012, $1.7 million was paid to the former shareholders of the business acquired in February 2011 based on achieving specified milestones outlined in the purchase agreement. At June 30, 2012, the amounts recognized for these contingent consideration arrangements, the range of outcomes, and the assumptions used to develop the estimates have been updated to reflect current results. During the three and six months ended June 30, 2012 this update resulted in the Company recording income of $3.5 million and expense of $0.6 million for the businesses acquired in February 2011 and June 2011, respectively, both of which are recorded in selling, general and administrative expenses in the condensed consolidated statement of operations.

The following tables present the valuation of the Company’s financial assets and liabilities as of June 30, 2012 and December 31, 2011, measured at fair value on a recurring basis (in thousands):


	Level 1		Level 2		Level 3		Fair Value
June 30, 2012
Assets
Money Market Funds (1)	$	392	$	0	$	0	$	392
Variable Rate Demand Notes (2)		0		19,608		0		19,608

Total assets measured at fair value	$	392	$	19,608	$	0	$	20,000

Liabilities
Acquisition-related contingent consideration-short-term (3)	$	0	$	0	$	8,085	$	8,085
Acquisition-related contingent consideration-long-term (4)		0		0		8,850		8,850

Total liabilities measured at fair value	$	0	$	0	$	16,935	$	16,935

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)


	Level 1		Level 2		Level 3		Fair Value
December 31, 2011
Assets
Money Market Funds (1)	$	67	$	0	$	0	$	67
Variable Rate Demand Notes (2)		0		19,939		0		19,939

Total assets measured at fair value	$	67	$	19,939	$	0	$	20,006

Liabilities
Acquisition-related contingent consideration-short-term (3)	$	0	$	0	$	10,483	$	10,483
Acquisition-related contingent consideration-long-term (4)		0		0		11,112		11,112

Total liabilities measured at fair value	$	0	$	0	$	21,595	$	21,595

(1)	Included in cash and cash equivalents in the accompanying condensed consolidated balance sheets.

(2)

Included in short-term investments in the accompanying condensed consolidated balance sheets. The interest rates on the variable rate demand notes (“VRDNs”) reset every seven days to adjust to current market conditions. The Company can redeem these investments at cost at any time with seven days’ notice. Therefore, the investments are held at cost, which approximates fair value, and are classified as available-for-sale short-term investments on the accompanying consolidated balance sheets. VRDNs are generally valued using published interest rates for instruments with similar terms and maturities, and, accordingly, are classified as Level 2 instruments of the fair value hierarchy. The Company believes the recorded values of its VRDNs approximate their fair values because of their nature and relatively short maturity dates or durations. The payment of principal and interest on the VRDNs held by the Company is guaranteed by letters of credit from the issuing financial institution.

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

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

The following table presents the changes in the estimated fair values of the Company’s financial assets and liabilities that are measured using significant unobservable inputs (Level 3) for the six months ended June 30, 2012:


	(In thousands)
	Assets		Liabilities
Balance on December 31, 2011	$	0	$	21,595
Change in fair value realized		0		(2,920	)
Payments		0		(1,740	)

Balance on June 30, 2012	$	0	$	16,935

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Fair Value of Financial Instruments

The estimated fair values of the Company’s financial instruments that are not measured at fair value on a recurring basis are as follows:


(In thousands)	June 30, 2012				December 31, 2011
	Carrying Value		Fair Value		Carrying Value		Fair Value
Assets:
Cash and cash equivalents	$	20,000	$	20,000	$	0	$	0
Short-term investments – held to maturity		0		0		20,000		20,000

Liabilities:
2.75% Series A Debentures		271,315		330,516		265,941		281,188
2.75% Series B Debentures		248,744		382,422		243,668		300,781
Short-term debt		0		0		100,000		100,000
Term loan		250,000		250,000		0		0
Deferred acquisition obligations		15,434		15,434		20,996		20,996

Fair values were determined as follows:

•

The carrying amounts of time deposits classified as cash equivalents and short-term investments at June 30, 2012 and December 31 2011, respectively, and short-term debt approximate fair value because of the short-term maturity of these instruments. These instruments are categorized under Level 2 of the fair value hierarchy. The time deposits are classified as held-to-maturity and are carried at amortized cost.

•

The carrying amount of deferred acquisition obligations approximates fair value because of their short-term maturity. They are categorized under Level 3 of the fair value hierarchy.

•

The fair values of the Series A and Series B Debentures are estimated based on several standard market variables, including the Company’s stock price, yield to put/call through conversion and yield to maturity. These instruments are classified under Level 2 of the fair value hierarchy.

•

The Company believes that the recorded values of all of its other financial instruments approximate their fair values because of their nature and respective relatively short maturity dates or durations.

•

Deferred acquisition obligations exclude acquisition-related contingent consideration measured at fair value using Level 3 inputs.

Note 3. Investments

At June 30, 2012 and December 31, 2011, the Company held $19.6 million and $19.9 million, respectively, of municipal and corporate variable rate demand notes, all of which were classified as available-for-sale. All municipal and corporate variable rate demand notes at June 30, 2012 and December 31, 2011 contain put options of seven days. The Company routinely buys and sells these securities and believes that it has the ability to quickly liquidate them. Redemptions at par of $0.3 million occurred during the quarter ended June 30, 2012. The Company’s investments in these securities are recorded at fair value and the interest rates reset every seven days. The Company believes it has the ability to tender its variable rate demand notes to the tender agent (agent to the issuer) or issuer at par value plus accrued interest in the event it decides to liquidate its investment in a particular variable rate demand note. At June 30, 2012 and December 31, 2011, all of the Company’s variable rate demand notes were supported by irrevocable direct pay letters of credit from a financial institution that the Company believes to be in good financial condition. As a result of these factors, the Company had no cumulative gross unrealized holding gains (losses) or gross realized gains (losses) from these investments. All income generated from these investments is recorded as interest income. The Company has not recorded any losses relating to municipal or corporate variable rate demand notes.

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

On April 17, 2012, the Company invested $20 million in a 91-day time deposit issued by Credit Agricole Corporate and Investment Bank maturing on July 17, 2012. The investment is classified as held-to-maturity and carried at amortized cost of $20.0 million in the accompanying condensed consolidated balance sheet at June 30, 2012. It is reported in cash and cash equivalents in the accompanying condensed consolidated balance sheet because it is readily convertible to cash and had an original maturity of three months or less at the time of purchase.

On October 17, 2011, the Company invested $20.0 million in a 183-day time deposit issued by Credit Agricole Corporate and Investment Bank which matured on April 17, 2012. The investment is classified as held-to-maturity and carried at amortized cost of $20.0 million in the accompanying condensed consolidated balance sheet at December 31, 2011.

Note 4. Business Combinations

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

During the six-month period ended June 30, 2012, the Company acquired the business of seven companies. During the six-month period ended June 30, 2011, the Company acquired the business of six companies.

The acquisition date fair value of the total consideration transferred for the 2012 acquisitions was $19.5 million, which consisted of the following:


	(In thousands)
Cash consideration, net of cash acquired	$	15,881
Deferred acquisition obligations		3,666

	$	19,547

The following table summarizes the fair values of the assets and liabilities assumed based on preliminary estimates that are subject to change during the subsequent twelve months upon completion of the final valuation analyses.


	(In thousands)
Current assets, net of cash acquired	$	860
Property and equipment		1,191
Intangible assets		60
Goodwill		17,774
Deferred revenue		(338	)

	$	19,547

The results of the 2012 acquisitions have been included in the Company’s financial statements from the acquisition date forward and were not significant for the first six months of 2012. Pro forma information for the comparable period of 2011 would not be materially different from amounts reported.

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Note 5. Accounts Receivable, Net

Accounts receivable, net at June 30, 2012 and December 31, 2011 consist of:


	June 30, 2012			December 31, 2011
	(In thousands)
Trade accounts receivable	$	387,525		$	310,125
Less allowance for sales adjustments and uncollectible accounts		(58,944	)		(55,326	)

Accounts receivable, net	$	328,581		$	254,799

Note 6. Property and Equipment, Net

Property and equipment, net at June 30, 2012 and December 31, 2011 consist of:


	June 30, 2012			December 31, 2011
	(In thousands)
Property and equipment at cost	$	1,324,167		$	1,271,634
Less accumulated depreciation		(971,334	)		(920,909	)

Property and equipment, net	$	352,833		$	350,725

Note 7. Other Current Liabilities

Other current liabilities at June 30, 2012 and December 31, 2011 consist of:


	June 30, 2012		December 31, 2011
	(In thousands)
Deferred revenue	$	43,174	$	41,395
Other current liabilities		10,591		12,921

Other current liabilities	$	53,765	$	54,316

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Note 8. Long-Term Obligations

Long-term obligations at June 30, 2012 and December 31, 2011 consist of:


	June 30, 2012			December 31, 2011
	(In thousands)
Series A convertible debentures to mature in 2037, bearing fixed interest of 2.75%, with a put/call option in 2012	$	275,000		$	275,000
Unamortized discount		(3,685	)		(9,059	)
Series B convertible debentures to mature in 2037, bearing fixed interest of 2.75%, with a put/call option in 2014		275,000			275,000
Unamortized discount		(26,256	)		(31,332	)
Single draw Eurodollar five-year term loan bearing interest equal to the British Bankers Association LIBOR Rate (“BBA LIBOR”) plus an applicable margin based on the Company’s consolidated leverage ratio (consolidated funded indebtedness to consolidated EBITDA)		250,000			0
Eurodollar loans under five-year revolving credit agreement bearing annual interest equal to the British Bankers Association LIBOR Rate (“BBA LIBOR”) plus an applicable margin based on the Company’s consolidated leverage ratio (consolidated funded indebtedness to consolidated EBITDA)		0			100,000
Other long-term obligations		1,405			1,710
Contingent consideration		16,935			21,595
Unsecured acquisition obligations, net of imputed interest, payable in various installments through 2015		15,434			20,996

Total long-term obligations		803,833			653,910
Less: current installments		307,128			397,132

Long-term obligations, excluding current installments	$	496,705		$	256,778

The Company’s revolving credit agreement with several lenders and Wells Fargo Bank, National Association, as agent, as amended June 29, 2012, permits the Company to borrow amounts up to $450.0 million under a five-year revolving credit facility and up to $250.0 million under a five-year single draw term loan facility documented as the second tranche to the existing 2011 Credit Facility. The revolving credit facility contains a $60.0 million letter of credit sub-facility, which reduces the principal amount available under the facility by the amount of outstanding letters of credit on the sub-facility. As of June 30, 2012, there were no borrowings outstanding under the revolving credit facility and $36.8 million in standby letters of credit were issued. As of June 30, 2012, $250.0 million was outstanding on the single draw term loan facility. The principal amount of the term loan is due in quarterly installments, with 50% of the principal amortizing in the five-year period ending on the final maturity date. The Company pays an annual administration agency fee along with a quarterly facility fee. The facility fee is based on the Company’s consolidated leverage ratio and ranges between 0.175% and 0.275% annually. The leverage ratio is calculated each quarter to determine the applicable interest rate on revolving loans, the letter of credit fee and the facility fee for the following quarter. The revolving credit agreement contains several financial and other negative and affirmative covenants customary in such agreements and is secured by a pledge of the stock of the wholly-owned subsidiaries of Lincare Holdings Inc. The financial covenants in the Company’s credit agreement include interest coverage and leverage ratios, as defined in the agreement. The Company’s credit agreement requires compliance with all covenants set forth in the agreement and the Company was in compliance with all covenants as of June 30, 2012. The credit agreement defines the occurrence of certain specified events as events of default which, if not waived by or cured to the satisfaction of the requisite lenders, allow the lenders to take actions against the Company, including termination of commitments under the agreement, acceleration of any unpaid principal and accrued interest in respect of outstanding borrowings, payment of additional cash collateral to be held in escrow for the benefit of the lenders and enforcement of any and all rights and interests created and existing under the credit agreement. Under certain conditions, an event of default may result in an increase in the interest rate (the “Default Rate”) payable by the Company on loans outstanding under the credit facility. The Default Rate is equal to the interest rate (including any applicable percentage as set forth in the agreement) otherwise applicable to such loans plus 2% per annum. In the case of a bankruptcy event (as defined in the credit agreement), all commitments automatically terminate and all amounts outstanding under the credit facility become immediately due and payable.

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

On October 31, 2007, the Company 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 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 the Company’s common stock or in a combination of cash and shares of common stock, at the Company’s option. The base conversion rate for the Debentures as of June 30, 2012 is 31.0828 shares of common stock per $1,000 principal amount of Series Debentures, equivalent to a base conversion price of approximately $32.17 per share. In addition, if at the time of conversion the applicable price of the Company’s common stock exceeds the base conversion price, holders of the Series A Debentures and Series B Debentures will receive an additional number of shares of common stock per $1,000 principal amount of the Debentures, as determined pursuant to a specified formula. The Company will have the right to redeem the Series A Debentures and the Series B Debentures at any time after November 1, 2012 and November 1, 2014, respectively. Holders of the Series Debentures will have the right to require the Company to repurchase for cash all or some of their Series Debentures upon the occurrence of certain fundamental change transactions or on November 1, 2012, 2017, 2022, 2027 and 2032, in the case of the Series A Debentures, and November 1, 2014, 2017, 2022, 2027 and 2032, in the case of the Series B Debentures. Due to the right of the Series A holders to put the securities to the Company for cash within one year of the June 30, 2012 and December 31, 2011 consolidated balance sheet dates, the Series A Debentures are classified as current liabilities in the accompanying consolidated balance sheets.

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

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


	June 30, 2012						December 31, 2011
	Series A			Series B			Series A			Series B
Principal amount of convertible debentures	$	275,000		$	275,000		$	275,000		$	275,000
Unamortized discount		(3,685	)		(26,256	)		(9,059	)		(31,332	)
Net carrying amount		271,315			248,744			265,941			243,668
Additional paid-in capital		29,065			41,238			29,065			41,238

At June 30, 2012, the remaining period over which the discount on the liability components will be amortized is 4 months and 28 months for the Series A and Series B convertible debentures, respectively.

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The amount of interest expense recognized for the three months ended June 30, 2012 and 2011 was as follows (in thousands):


	June 30, 2012				June 30, 2011
	Series A		Series B		Series A		Series B
Contractual coupon interest	$	1,890	$	1,890	$	1,890	$	1,890
Amortization of discount on convertible debentures		2,710		2,561		2,532		2,383

Interest expense	$	4,600	$	4,451	$	4,422	$	4,273

The amount of interest expense recognized for the six months ended June 30, 2012 and 2011 was as follows (in thousands):


	June 30, 2012				June 30, 2011
	Series A		Series B		Series A		Series B
Contractual coupon interest	$	3,781	$	3,781	$	3,781	$	3,781
Amortization of discount on convertible debentures		5,374		5,076		5,020		4,724

Interest expense	$	9,155	$	8,857	$	8,801	$	8,505

Note 9. Income Taxes

In the normal course of business the Company is subject to examination by taxing authorities throughout the United States and in Canada. With few exceptions, the Company is no longer subject to U.S. and Canada federal, state and local income tax examinations for years before 2008.

The Company settled an examination with a taxing jurisdiction for $2.8 million during the first quarter of 2012 and continues to negotiate with another tax jurisdiction that may result in an increase in the amount of unrecognized tax positions in the next twelve months.

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

The Internal Revenue Service has completed its examination of the Company’s U.S. income tax returns through 2010. The U.S. federal statute of limitations remains open for the years 2008 and forward. There are no material disputes for the open tax years. The years 2011 and 2012 are currently under examination.

Note 10. Earnings Per Common Share

Basic earnings per common share is computed by dividing earnings available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per common share reflect the potential dilution of securities that could share in the Company’s earnings, including exercise of outstanding stock options and non-vested restricted stock. As discussed in Note 8, as of June 30, 2012, the conditions for conversion related to the Company’s Convertible Debentures had not been met. Accordingly, there was no impact on diluted earnings per share attributable to assumed conversion. When the exercise of stock options or the inclusion of awards would be anti-dilutive, they are excluded from the earnings per common share calculation. For the three and six months ended June 30, 2012, the number of excluded shares underlying anti-dilutive stock options and awards was 3,772,103 and 3,778,968, respectively. For the three and six months ended June 30, 2011, there were no excluded shares underlying anti-dilutive stock options and awards.

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

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


	For The Three Months Ended June 30,				For The Six Months Ended June 30,
	2012		2011		2012		2011
	(In thousands, except per share data)
Numerator:
Income available to common stockholders and holders of dilutive securities	$	47,904	$	42,765	$	94,304	$	89,142

Denominator:
Weighted average shares		82,806		92,096		83,285		92,535
Effect of dilutive securities:
Incremental shares under stock compensation plans		2,352		2,893		2,299		2,756

Adjusted weighted average shares		85,158		94,989		85,584		95,291

Per share amount:
Basic	$	0.58	$	0.46	$	1.13	$	0.96

Diluted	$	0.56	$	0.45	$	1.10	$	0.94

Note 11. Stock-Based Compensation

For the three months ended June 30, 2012 and 2011, the Company recognized total stock-based compensation expense of $6.6 million and $5.5 million, respectively, as well as related tax benefits of $1.3 million in each period. For the six months ended June 30, 2012 and 2011, the Company recognized total stock-based compensation expenses of $12.1 million and $11.0 million, respectively, as well as related tax benefits of $2.3 million and $2.7 million, respectively. All stock-based compensation expenses are recognized using a graded method approach and are either classified within operating expenses or selling, general and administrative expenses on the accompanying condensed consolidated statements of operations, with substantially all of the expense being in selling, general and administrative expenses.

Stock Options

Stock option activity for the six months ended June 30, 2012 is summarized below:


	Number of Options			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (Years)		Aggregate Intrinsic Value
Outstanding at December 31, 2011		6,303,732		$	24.76
Options granted in 2012		0		$	0.00
Exercised in 2012		(171,080	)	$	21.21
Cancelled/forfeited/expired in 2012		(39,675	)	$	27.57

Outstanding at June 30, 2012		6,092,977		$	24.84		2.20	$	55,946,657

Exercisable at June 30, 2012		5,644,977		$	25.19		1.94	$	49,835,937

Vested or expected to vest in the future as of June 30, 2012		6,092,663		$	24.84		2.20	$	55,942,379

Of the stock options outstanding at June 30, 2012, options for 5,644,977 shares were exercisable and options for 448,000 shares were unvested. Of the total stock options outstanding at June 30, 2012, 6,092,663 were vested or expected to vest in the future, net of expected cancellations and forfeitures of 314. The intrinsic value of options exercised during the six months ended June 30, 2012 and 2011 amounted to $0.7 million and $0.7 million, respectively.

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

As of June 30, 2012, the total remaining unrecognized compensation cost related to unvested stock options amounted to $0.4 million, which will be amortized over the weighted-average remaining requisite service period of 0.3 years.

Restricted Stock

The following table summarizes information about restricted stock activity for the six months ended June 30, 2012:


	Shares			Weighted- Average Grant Date Fair Value Per Share
Unvested at December 31, 2011		2,542,989		$	21.67
Granted		1,113,500		$	25.46
Vested		(144,966	)	$	26.01
Forfeited		(30,424	)	$	24.06

Unvested at June 30, 2012		3,481,099		$	22.68

As of June 30, 2012, the total remaining unrecognized compensation cost related to restricted stock amounted to $35.5 million, which will be amortized over the weighted-average remaining requisite service period of 1.5 years.

Note 12. Subsequent Events

On July 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 July 30, 2012 to stockholders of record as of July 16, 2012. The total dividend paid was $17.3 million.

On July 1, 2012, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Linde AG, a stock corporation organized under the laws of Germany (“Parent”), and Linde US Inc., a Delaware corporation and a wholly owned indirect subsidiary of Parent (“Purchaser”).

On July 11, 2012, the Purchaser commenced a tender offer (the “Offer”) to acquire all of the shares of common stock, par value $0.01 per share, of the Company issued and outstanding (the “Shares”) for $41.50 per Share (the “Offer Price”), subject to any required withholding of taxes, net to the seller in cash and without any interest thereon.

Pursuant to the Merger Agreement, after the consummation of the Offer, and subject to the satisfaction or waiver of certain conditions set forth in the Merger Agreement, Purchaser will merge with and into the Company (the “Merger”), with the Company surviving as a wholly owned indirect subsidiary of Parent. At the effective time of the Merger, each Share not acquired in the Offer (other than (i) Shares owned by Parent or Purchaser or Shares owned by the Company as treasury stock, which will be cancelled and will cease to exist, (ii) Shares owned by a subsidiary of the Company or a subsidiary of Parent (other than purchaser), which will be converted into and become shares of common stock of the surviving corporation, and (iii) Shares owned by the Company’s stockholders who properly demand appraisal of their Shares pursuant to the Delaware General Corporation Law (the “DGCL”)) will be converted into the right to receive an amount in cash equal to the Offer Price (without interest and subject to applicable withholding taxes).

The Offer is initially scheduled to expire at 12:00 midnight, New York City time, on Tuesday, August 7, 2012 (which is the end of day on August 7, 2012), subject to extension in certain circumstances as required or permitted by the Merger Agreement, the SEC or the NASDAQ Stock Market.

If Parent, Purchaser and any of Parent’s other subsidiaries acquire in the aggregate at least 90% of the outstanding Shares (the “Short-Form Threshold”) pursuant to the Offer or otherwise, the Company, Parent and Purchaser will take all necessary and appropriate actions to effect a “short-form” merger under the DGCL without additional approval by the Company’s stockholders. In addition, subject to the terms of the Merger Agreement, the Company has granted Purchaser an irrevocable option (the “Top-Up Option”), exercisable only after Purchaser has accepted and purchased Shares tendered in the Offer and on the terms and conditions set forth in the Merger Agreement, to purchase from the Company that number of Shares as would be necessary for Parent and its subsidiaries to own one Share more than the Short-Form Threshold. If the Offer is consummated but the Short-Form Threshold is not attained, the Company will hold a special stockholders’ meeting to obtain stockholder approval of the Merger. Parent has agreed to vote all Shares then owned by it and its subsidiaries (whether acquired in the Offer or otherwise) in favor of approval of the Merger, thereby assuring approval.

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Consummation of the Offer is subject to several conditions, including, among other customary conditions, the following:

•

the expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended;

•

there being validly tendered into the Offer and not withdrawn that number of Shares which, when taken together with Shares (if any) owned by Parent or any of its subsidiaries, represents more than 50% of the Shares then outstanding determined on a fully-diluted basis;

•

the absence of a material adverse effect on the Company;

•

the absence of any injunction, judgment, ruling, order or decree instituted, issue or entered, or any law enacted, issued, promulgated or enforced, by any governmental authority having jurisdiction over the Company, Parent or Purchaser which (i) restrains, enjoins or prohibits consummation of the Offer or the Merger or makes the consummation of the Offer or the Merger illegal or (ii) would reasonably be expected to result in a Substantial Detriment (as defined in the Merger Agreement); and

•

the absence of any pending (i) proceeding, claim, suit or action brought by any governmental authority seeking to (a) restrain, enjoin or prohibit the consummation of the Offer or the Merger or make the consummation of the Offer or the Merger illegal or (b) impose a Substantial Detriment (as defined in the Merger Agreement) or (ii) proceeding, claim, suit or action brought by any other person that (x) relates to the Merger Agreement or the transaction and (y) would reasonably be expected to have a material adverse effect on the Company.

The Merger Agreement does not contain a financing condition.

The Merger Agreement includes customary representations, warranties and covenants of the Company, Parent and Purchaser. The Company has agreed to operate its business in the ordinary course until the earlier of the termination of the Merger Agreement and the effective time of the Merger. The Company has also agreed not to solicit or initiate discussions with third parties regarding other proposals to acquire the Company and to certain restrictions on its ability to respond to any such proposals.

The Merger Agreement includes customary termination provisions for both the Company and Parent and provides that, in connection with the termination of the Merger Agreement, under certain circumstances, the Company must pay Parent a termination fee of $155,000,000 or Parent’s out-of-pocket expenses related to the Merger (up to a cap of $10,000,000).

The Board of Directors of the Company has unanimously resolved to recommend that the Company’s stockholders accept the Offer, tender their shares of the Company’s common stock to Purchaser in the Offer and, to the extent stockholder approval is required under applicable law, adopt the Merger Agreement.

On July 11, 2012, a putative shareholder class action complaint, captioned Fader v. Lincare Holdings, Inc., et. al., Case No. 12-8401, was filed in the Circuit Court of the 6th Judicial Circuit in and for Pinellas County, Florida, Circuit Civil Division (the “Fader Complaint”), against the Company, the members of the Board, Parent and Purchaser. The Fader Complaint alleges that the members of the Board breached their fiduciary duties to the Company’s shareholders by entering into the Merger Agreement, and further alleges that Parent and Purchaser aided and abetted the members of the Board in breaching their fiduciary duties. The Fader Complaint seeks, among other things, to enjoin the transactions contemplated by the Merger Agreement. The Company, Parent and Purchaser intend to vigorously defend against these claims.

LINCARE HOLDINGS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Also on July 11, 2012, a putative shareholder class action complaint, captioned Himmel v. Lincare Holdings, Inc., et al., Case No. 12-8392, was filed in the Circuit Court of the 6th Judicial Circuit in and for Pinellas County, Florida, Circuit Civil Division (the “Himmel Complaint”), against the Company, the members of the Board, Parent and Purchaser. The Himmel Complaint, like the Fader Complaint, alleges that the members of the Board breached their fiduciary duties to the Company’s shareholders by entering into the Merger Agreement and that Parent, Purchaser and the Company aided and abetted the members of the board in breaching their fiduciary duties. The Himmel Complaint seeks, among other things, to enjoin the transactions contemplated by the Merger Agreement. The Company, Parent and Purchaser intend to vigorously defend against these claims.

On July 16, 2012, two additional putative shareholder class action complaints, captioned Britt v. Lincare Holdings Inc., et al., Case No. 12-8607 (the “Britt Complaint”), and Coyne v. Lincare Holdings Inc., et al., Case No. 12-8608 (the “Coyne Complaint”), were filed in the Circuit Court of the 6th Judicial Circuit in and for Pinellas County, Florida, Circuit Civil Division. The Britt Complaint and the Coyne Complaint, like the Himmel Complaint and Fader Complaint, allege that the members of the Board breached their fiduciary duties to the Company’s shareholders by entering into the Merger Agreement and that Parent, Purchaser and the Company aided and abetted the members of the board in breaching their fiduciary duties. The Britt Complaint and the Coyne Complaint also allege that the Schedule 14D-9, filed with the Securities and Exchange Commission on July 11, 2012, was materially incomplete and omitted certain information. The Britt Complaint and the Coyne Complaint each seek, among other things, to enjoin the transactions contemplated by the Merger Agreement. The Company, Parent and Purchaser intend to vigorously defend against these claims.

Also on July 16, 2012, Plaintiffs Himmel and Britt filed a motion in the Himmel action seeking an order (i) consolidating the Himmel, Fader, Britt and Coyne actions, (ii) appointing a leadership structure among plaintiffs’ law firms, (iii) expediting discovery, and (iv) setting a schedule for preliminary injunction proceedings. On July 18, 2012, the Company and the board filed papers opposing Plaintiffs’ request for expedited discovery and a schedule for preliminary injunction proceedings. On July 20, 2012, a fifth putative shareholder class action, captioned Souksavath v. Lincare Holdings Inc., et al., Case No. 12-8990 (the “Souksavath Complaint”), was filed in the Circuit Court of the 6th Judicial Circuit in and for Pinellas County, Florida, Circuit Civil Division. The Souksavath Complaint, like the Himmel Complaint, the Fader Complaint, the Britt Complaint and the Coyne Complaint, alleges that the members of the Board Breached their fiduciary duties to the Company’s shareholders by entering into the Merger Agreement and that Parent and Purchaser aided and abetted the members of the Board in breaching their fiduciary duties. The Souksavath Complaint, like the Britt Complaint and the Coyne Complaint, also alleges that the Schedule 14D-9, filed with the Securities and Exchange Commission on July 11, 2012, was materially incomplete and omitted certain information. The Souksavath Complaint seeks, among other things, to enjoin the transactions contemplated by the Merger Agreement. The Company, Parent and Purchaser intend to vigorously defend against these claims.

On July 23, 2012, the court held a hearing on Plaintiffs Himmel and Britt’s Emergency Motion to Consolidate Related Actions, Appoint a Leadership Structure, Order Expedited Discovery and Schedule Preliminary Injunction Proceedings. The court granted plaintiffs’ request to consolidate related actions and to appoint a leadership structure among plaintiffs’ counsel’s law firms. The court denied plaintiffs’ request for expedited discovery and to set a schedule for preliminary injunction proceedings. On July 27, 2012, Plaintiffs Himmel and Britt appealed the court’s denial of their request for expedited discovery and to set a schedule for preliminary injunction proceedings by filing an Emergency Petition for Alternative Writs of Certiorari or Mandamus Requiring the Trial Court to Adjudicate Petitioners’ Motion to Preliminarily Enjoin a $4.6 Billion Corporate Takeover Prior to the August 7, 2012 Close of the Tender Offer in the Second District Court of Appeal of the State of Florida. The Company, Parent and Purchaser intend to oppose the appeal.

LINCARE HOLDINGS INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition

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

(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 $10.0 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 three 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 $11.7 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 36^th 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

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 half of 2012, we estimate that our net revenues were reduced by approximately $19.7 million compared to the first half of 2011, due 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 payment rates then 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 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 governments of the United States and Canada and all states and provinces 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 and provincial laws, where applicable, 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 in the United States, we are subject to extensive government regulation, including numerous laws directed at preventing fraud and abuse and laws regulating reimbursement under various government programs. In Canada, we are subject to numerous similar and other laws and regulations including anti-corruptions laws and regulations. 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, state and provincial laws and regulations, including the Federal Health Insurance Portability And Accountability Act of 1996 (“HIPAA”) and the Health Information Technology For Economic And Clinical Health Act (“HITECH Act”), govern the collection, dissemination, security, use and confidentiality of patient-identifiable health

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

Health care is an area of rapid regulatory change. Changes in the laws and regulations and new interpretations of existing laws and regulations may affect permissible activities, the relative costs associated with doing business, and reimbursement amounts paid by federal, state, provincial 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 June 30,				For The Six Months Ended June 30,
	2012		2011		2012		2011
	(In thousands)				(In thousands)
Respiratory and other chronic therapies	$	445,054	$	403,022	$	894,598	$	789,042
DME, infusion and enteral therapies		51,109		46,011		102,443		91,558

Total	$	496,163	$	449,033	$	997,041	$	880,600

Net revenues for the three months ended June 30, 2012, increased by $47.1 million (or 10.5%), compared with the three months ended June 30, 2011 and for the six months ended June 30, 2012, increased by $116.4 million (or 13.2%) compared with the six months ended June 30, 2011. The Company estimates that the 10.5% increase in net revenues in the three-month period of 2012 was comprised of approximately 11.0% internal and acquisition growth offset by approximately 0.5% negative impact from $2.1 million of Medicare payment changes (see “Medicare Reimbursement” above). The Company estimates that the 13.2% increase in net revenues in the six-month period of 2012 was comprised of approximately 13.7% internal and acquisition growth offset by approximately 0.5% negative impact from $4.3 million of Medicare payment changes in 2012. 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 89.7% during the three and six months ended June 30, 2012 and during the three and six months ended June 30, 2011 was 89.8% and 89.6%, respectively. 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 32.3% and 32.5%, respectively, for the three and six months ended June 30, 2012, compared with 31.7% and 30.3%, respectively, for the comparable prior year periods. Cost of goods and services for the three months ended June 30, 2012, increased $17.9 million, or 12.6%, when compared with the prior year period. Cost of goods and services for the six months ended June 30, 2012, increased $57.3 million, or 21.5%, 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 and six-month periods includes the cost of medical equipment (excluding depreciation of $30.4 million and $59.5 million in 2012 and $28.1 million and $54.9 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 $14.2 million and $28.1 million for the three and six-month periods of 2012, respectively, and approximately $13.6 million and $27.5 million for the three and six-month periods of 2011, respectively. Included in cost of goods and services in the three and six months ended June 30, 2012 are salary and related expenses of pharmacists and other service professionals of $2.6 million and $5.4 million, respectively. Such salary and related expenses for the three and six months ended June 30, 2011, were $3.0 million and $5.8 million, respectively.

Operating expenses, as a percentage of net revenues, were 22.5% and 22.8%, respectively, for the three and six months ended June 30, 2012, compared with 22.8% and 23.2%, respectively, for the comparable prior year periods. Operating expenses for the three and six months ended June 30, 2012, increased by $9.7 million, or 9.5%, and $22.8 million, or 11.2%, respectively, over the prior year periods. 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 six months of 2012, most significantly fuel costs.

The Company manages 1,058 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).

Operating Expenses (in thousands)


	For The Three Months Ended June 30,				For The Six Months Ended June 30,
	2012		2011		2012		2011
Salary and related	$	72,640	$	67,826	$	147,357	$	134,256
Facilities		15,612		12,796		32,022		28,561
Vehicles		14,533		13,756		29,553		26,420
General supplies/miscellaneous		9,092		7,811		17,927		14,859

Total	$	111,877	$	102,189	$	226,859	$	204,096

Included in operating expenses during the three and six months ended June 30, 2012 are salary and related expenses for Service Reps in the amount of $28.9 million and $57.8 million, respectively. Such salary and related expenses for the three and six months ended June 30, 2011 were $28.3 million and $55.9 million, respectively.

Selling, general and administrative (“SG&A”) expenses, as a percentage of net revenues, were 18.1% and 18.4%, respectively, for the three and six months ended June 30, 2012, compared with 19.0% and 19.1% for the comparable prior year periods. SG&A expenses for the three and six months ended June 30, 2012 increased by $4.1 million, or 4.8%, and $14.6 million, or 8.7% when compared to the prior year periods. SG&A expenses include costs related to sales and marketing activities, corporate overhead and other business support functions. Included in SG&A during the three and six months ended June 30, 2012 are salary and related expenses of $68.6 million and $138.0 million, respectively. These salary and related expenses include the cost of the Company’s respiratory therapists for the three and six months ended June 30, 2012 of $18.0 million and $35.7 million, respectively. Included in SG&A during the three and six months ended June 30, 2011 are salary and related expenses of $62.9 million and $125.1 million, respectively. These salary and related

expenses include the cost of the Company’s respiratory therapists for the three and six months ended June 30, 2011 of $17.9 million and $34.5 million, respectively. 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.

Bad debt expense as a percentage of net revenues was 2.6% and 2.3% for the three and six months ended June 30, 2012, respectively, and 2.0% for the three and six months ended June 30, 2011. Bad debt expense for the three and six months ended June 30, 2012 increased by $3.9 million and $5.3 million, respectively, over the comparable prior year period.

Included in depreciation and amortization expense in the three and six months ended June 30, 2012 is depreciation of medical equipment of $30.4 million and $59.5 million, respectively, and depreciation of other property and equipment of $1.8 million and $4.3 million, respectively. Included in depreciation and amortization expense in the three and six months ended June 30, 2011 is depreciation of medical equipment of $28.1 million and $54.9 million, respectively, and depreciation of other property and equipment of $1.5 million and $3.7 million, respectively.

Operating income for the three and six months ended June 30, 2012, was $88.5 million (17.8% of net revenues) and $174.9 million (17.5% of net revenues), respectively, compared with $80.1 million (17.8% of net revenues) and $164.7 million (18.7% of net revenues), respectively, for the comparable prior year periods. Operating income for the three and six months ended June 30, 2012, increased by $8.4 million, or 10.5%, and $10.2 million, or 6.2% when compared to the prior year periods. The increase in operating income in 2012 over 2011 is attributed primarily to the growth in net revenues and containment of costs and expenses during the 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 $130.1 million for the six months ended June 30, 2012, compared with $131.8 million for the six months ended June 30, 2011. Net cash used in investing activities was $57.7 million for the six months ended June 30, 2012. Investing activities during the six-month period ended June 30, 2012 included our net investment in property and equipment of $62.2 million, $2.7 million of purchases of short-term investments and $15.9 million of business acquisition expenditures offset by the sale and maturity of investments of $23.1 million. Net cash provided by financing activities was $59.0 million for the six months ended June 30, 2012. Financing activities during the six-month period ended June 30, 2012 included advances under our revolving credit agreement of $220.0 million, proceeds from the issuance of a $250.0 million single draw term loan facility and proceeds of $4.4 million from the exercise of stock options and issuance of common shares offset by repayments under the revolving credit agreement of $320.0 million, payment of $34.7 million of dividends, payments on debt and long-term obligations of $9.1 million and $50.0 million of repurchases of our common shares.

As of June 30, 2012, our principal sources of liquidity consisted of approximately $146.3 million of cash and cash equivalents, $19.6 million of short-term investments and $413.2 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 June 30, 2012, there were no borrowings outstanding and $36.8 million of standby letters of credit issued under the credit facility.

On July 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 July 30, 2012, to stockholders of record as of July 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 first quarter of 2012, the Company repurchased and retired 1,877,670 shares for $50.0 million pursuant to the repurchase plan. The Company did not repurchase any shares in the second quarter of 2012. As of June 30, 2012, $273.7 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 June 30, 2012 is 31.0828 shares of common stock per $1,000 principal amount of Series Debentures, equivalent to a base conversion price of approximately $32.17 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 June 30, 2012 and December 31, 2011 were as follows:

Percentage of Accounts Receivable Outstanding:


	June 30, 2012			December 31, 2011
Medicare		43.3	%		37.2	%
Medicaid/Other Government		13.6	%		14.7	%
Private Insurance		32.9	%		38.4	%
Customer Pay		10.2	%		9.7	%

Total		100.0	%		100.0	%

Aged accounts receivable balances by major payor category as of June 30, 2012 and December 31, 2011 were as follows:

Percentage of Accounts Aged in Days:


	June 30, 2012
	0-60			61-120			Over 120
Medicare		48.3	%		16.5	%		35.2	%
Medicaid/Other Government		44.2	%		18.6	%		37.2	%
Private Insurance		50.6	%		15.2	%		34.2	%
Customer Pay		32.6	%		19.9	%		47.5	%
All Payors		46.9	%		16.7	%		36.4	%

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 June 30, 2012, there were 1,533 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 77.4% of all payments received.

Our accounts receivable days sales outstanding (“DSO”) increased to 60 days at June 30, 2012 compared with 47 days at December 31, 2011. Our bad debt expense, as a percentage of net revenues, was 2.3% during the six-month period ended June 30, 2012 and 2.0% during the six-month period ended June 30, 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. We estimate that accounts receivable subject to Medicare pre-payment review were approximately $59.9 million as of June 30, 2012. 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.

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 38.67% and 38.88%, respectively, for the three and six month periods ended June 30, 2012 compared with 39.71% and 39.15%, respectively, for the three and six month periods ended June 30, 2011. The income tax rate decreased from the three and six month periods ended June 30, 2011 primarily due to an increase in favorable adjustments associated with the filing of amended state returns.

We have elected to treat our portion of all foreign subsidiary earnings through June 30, 2012 as permanently reinvested under the relevant accounting guidance and accordingly have not provided for any U.S. federal or state tax thereon. 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.

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.

Risks Related to Our Pending Merger with Parent and Purchaser and the Related Tender Offer

COMPLETION OF THE OFFER AND THE MERGER ARE SUBJECT TO VARIOUS CONDITIONS, AND NEITHER THE OFFER NOR THE MERGER MAY OCCUR EVEN IF WE OBTAIN STOCKHOLDER APPROVAL.

Consummation of the Offer and Merger is subject to customary conditions, including, in the case of the Merger, adoption of the Merger Agreement by our stockholders in certain circumstances, the absence of legal restraints and the receipt of requisite antitrust approval. Each party’s obligation to consummate the Merger is also subject to the accuracy of the representations and warranties of the other party (subject to certain qualifications and exceptions) and the performance in all material respects of the other party’s covenants under the Merger Agreement, including, with respect to us, customary covenants regarding operation of our and our subsidiaries’ respective business prior to closing. As a result of these conditions, we cannot assure you that either the Offer or the Merger will be completed, even if stockholder approval of the Merger is required and obtained. If the Merger is not completed for any reason, we expect that we would continue to be managed by our current management, under the direction of our board of directors.

THE MERGER PROCESS COULD ADVERSELY AFFECT OUR BUSINESS, SHARE PRICE, REPUTATION AND RESULTS OF OPERATIONS.

Our efforts to complete the Merger could cause substantial disruptions in our business, which could have an adverse effect on our financial results. Among other things, uncertainty as to whether a transaction will be completed with Parent and Purchaser may affect our ability to recruit prospective employees or to retain and motivate existing employees. Employee retention may be particularly challenging while the merger is pending, because employees may experience uncertainty about their future roles with Parent and Purchaser.

Uncertainty as to our future could adversely affect our business, reputation and our relationship with customers and potential customers. For example, vendors, customers and others that deal with us could defer decisions concerning working with us, or seek to change existing business relationships with us. Further, a substantial amount of the attention of management and employees is being directed toward the completion of the Merger and thus is being diverted from our day-to-day operations because matters related to the Merger (including integration planning) require substantial commitments of time and resources.

If the proposed Offer and/or Merger is not completed, the share price of our common stock will likely fall to the extent that the current market price of our common stock reflects an assumption that a transaction will be completed. In addition, under circumstances described in the Merger Agreement, we may be required to pay a termination fee of up to $155,000,000 or Parent’s out-of-pocket expenses related to the Merger (up to a cap of $10,000,000) if the Merger Agreement is terminated. Further, the failure of the proposed Merger to be completed may result in negative publicity and/or a negative impression of us in the investment community and may affect our relationship with employees, vendors and other partners in the business community.

WHILE THE MERGER AGREEMENT IS IN EFFECT, WE ARE SUBJECT TO RESTRICTIONS ON OUR BUSINESS ACTIVITIES.

While the Merger Agreement is in effect, we are subject to restrictions on our business activities and must generally operate our business in the ordinary course consistent with past practice (subject to certain exceptions). These restrictions could prevent us from pursuing attractive business opportunities that arise prior to the completion of the Merger and are generally outside the ordinary course of business, and otherwise have a material adverse effect on our future results of operations or financial condition.

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 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.

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

DRA changed the reimbursement methodology for oxygen equipment from continuous monthly payment for as long as the equipment is in use by a Medicare beneficiary, which includes payment for oxygen contents, related disposable supplies and accessories and maintenance of equipment, to a capped rental arrangement whereby payment for oxygen equipment may not extend over a period of continuous use of longer than 36 months. Separate payments for oxygen contents continue to be made for the period of medical need beyond the 36^th month. Additionally, payment for routine

maintenance and service of the oxygen equipment 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 half of 2012, we estimate that our net revenues were reduced by approximately $19.7 million compared to the first half 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 $10.0 million.

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

Recently enacted legislation negatively affected Medicare reimbursement amounts for covered Part B drugs, including inhalation drugs that we provide, beginning April 1, 2008 (See “MEDICARE REIMBURSEMENT”). The SCHIP Extension Act required CMS to adjust the average sales price (“ASP”) calculation methodology used to determine Medicare payment amounts for inhalation drugs by using volume-weighted ASPs based on actual sales volume rather than average sales price. 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 three 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 $11.7 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.

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

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

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

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

CMS is required by law to establish and implement programs under which competitive acquisition areas will be established throughout the United States for purposes of awarding contracts for the furnishing of competitively priced items of DME, including oxygen equipment (See “MEDICARE REIMBURSEMENT”). The program was initially intended to be implemented in phases such that competition under the program would occur in nine of the largest MSAs in the first year, and an additional 70 of the largest MSAs in a second, subsequent round of bidding. The PPACA legislation expands the DME competitive bidding program from 79 markets under prior law to 100 markets. PPACA also adds a requirement to competitively bid all areas or use competitive bid information to set prices in all areas by 2016, effectively expanding the program to all geographic markets.

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. We were 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 up to 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 future financial position and operating results.

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

Due to budgetary shortfalls, many states are considering, or have enacted, cuts to their Medicaid programs, including funding for our equipment and services. These cuts have included, or may include, elimination or reduction of

coverage for some or all of our equipment and services, amounts eligible for payment under co-insurance arrangements, or payment rates for covered items. Approximately 7% of our customers are eligible for primary Medicaid benefits, and State Medicaid programs fund approximately 12% of our payments from primary and secondary insurance benefits. Continued state budgetary pressures could lead to further reductions in funding for the reimbursement for our equipment and services which, in turn, could have a material adverse effect on our financial position and operating results.

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

Payors such as private insurance companies and employers are under pressure to increase profitability and reduce costs. In response, certain payors are limiting coverage or reducing reimbursement rates for the equipment and services we provide. Approximately 28% of our customers and approximately 32% of our primary and secondary payments are derived from private payors. Continued financial pressures on these entities could lead to further reimbursement reductions for our equipment and services that could have a material adverse effect on our financial condition and operating results.

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

We derive a significant majority of our revenues from reimbursement by third-party payors. We accept assignment of insurance benefits from customers and, in most instances, invoice and collect payments directly from Medicare, Medicaid and private insurance carriers, as well as from customers under co-payment provisions. Approximately 49% of our revenues are derived from Medicare, 32% from private insurance carriers, 12% from Medicaid and the balance directly from individual customers and commercial entities.

Our financial condition and results of operations may be affected by the reimbursement process, which in the health care industry is complex and can involve lengthy delays between the time that services are rendered and the time that the reimbursement amounts are settled. Depending on the payor, we may be required to obtain certain payor-specific documentation from physicians and other health care providers before submitting claims for reimbursement. Certain payors have filing deadlines and they will not pay claims submitted after such time. We are also subject to extensive pre-payment and post-payment audits by governmental and private payors that could result in material refunds of monies received or denials of claims submitted for payment under such third-party payor programs and contracts. We can not ensure that we will be able to continue to effectively manage the reimbursement process and collect payments for our equipment and services promptly.

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

As a health care provider in the United States, we are subject to extensive government regulation, including numerous laws directed at preventing fraud and abuse and laws regulating reimbursement under various government programs. In Canada, we are subject to numerous similar and other laws and regulations including anti-corruption laws and regulations. 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.

reimbursement amounts paid by federal, state, provincial and other third-party payors. We can not predict the future of federal, state and local regulation or legislation, including Medicare and Medicaid statutes and regulations, or possible changes in national health care policies. Future legislation and regulatory changes could have a material adverse effect on our business.

WE ARE SUBJECT TO BURDENSOME AND COMPLEX BILLING AND RECORD-KEEPING REQUIREMENTS IN ORDER TO SUBSTANTIATE OUR CLAIMS FOR PAYMENT UNDER FEDERAL, STATE AND COMMERCIAL HEALTH CARE REIMBURSEMENT PROGRAMS, AND OUR FAILURE TO COMPLY WITH EXISTING REQUIREMENTS, OR CHANGES IN THOSE REQUIREMENTS OR INTERPRETATIONS THEREOF, COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS AND RESULTS OF OPERATIONS.

We are subject to many comprehensive and frequently changing laws and regulations, and interpretations thereof, at both the federal and state levels, requiring compliance with burdensome and complex billing and record-keeping requirements in order to substantiate our claims for payment under federal, state and commercial health care reimbursement programs. On an ongoing basis, we have implemented policies and procedures designed to meet the various documentation requirements of government payors as they have been interpreted and applied. Examples of such documentation requirements are contained in the Durable Medical Equipment Medicare Administrative Contractor (“DME MAC”) Supplier Manuals which provide that clinical information from the “patient’s medical record” is required to justify the medical necessity for the provision of DME. Auditors working on behalf of the DME MACs 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. Other government auditors have recently taken the same or a similar position. It may be difficult, and sometimes impossible, for us to obtain such documentation from other health care providers. If these or other burdensome positions continue to be adopted by auditors, DME MACs, other contractors or CMS in administering the Medicare program, we 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 from Medicare would likely be substantially reduced. We have also experienced a significant increase in pre-payment reviews of our claims by the DME MACs, which has caused substantial delays in the collection of our Medicare accounts receivable as well as related amounts due under supplemental insurance plans. We estimate that accounts receivable subject to Medicare pre-payment review were approximately $59.9 million as of June 30, 2012. We can not currently predict the adverse impact that these new, more burdensome interpretations of the Medicare documentation requirements might have on our financial position or operating results, but such impact could be material.

EXPANDED GOVERNMENT AUDITING AND OVERSIGHT OF MEDICARE AND MEDICAID SUPPLIERS AND MORE STRINGENT INTERPRETATIONS BY THOSE AUDITORS OF REGULATIONS AND RULES CONCERNING BILLING FOR OUR PRODUCTS AND SERVICES COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS AND RESULTS OF OPERATIONS.

Current law provides for a significant expansion of the government’s auditing and oversight of suppliers who care for patients covered by various government health care programs. Examples of this expansion include audit programs being implemented by the DME MAC contractors, the Zone Program Integrity Contractors (“ZPICs”), the Recovery Audit Contractors (“RACs”) and the Comprehensive Error Rate Testing contractors (“CERTs”) operating under the direction of CMS. We work cooperatively with these auditors and have long maintained a process for centrally tracking and managing our responses to their audit requests. However, unlike other government programs that are subject to a formal rulemaking process, there are only limited publicly-available guidelines and methodologies for determining errors or for providing clear and timely communications to DME suppliers in connection with these new types of audits. As a result, there is significant lack of clarity regarding the authority of the auditors, their expectations for document production requested during audits and the methodologies for issuing claim denials, determining billing errors and calculating billing error rates.

Along with other health care providers and suppliers, we have recently been subject to a significant increase in the number of pre-payment audits conducted under these new programs. Many of these audits have resulted in claim denial rates at our audited locations that are significantly higher than we, and others in the industry, have experienced in the past. In some cases, these high claim denial rates appear to be based on the auditors’ incomplete or erroneous review of our submitted documentation or unclear scoring methodologies used by the auditors. In other instances, high claim denial rates have resulted from the auditors’ use of inconsistent interpretations of the types of medical necessity documentation required for CMS to pay for the services we provide. We are appealing the results of these recent audits and making

changes to our operating policies and procedures. We can not predict the adverse impact that the government’s expanded auditing activities may have on our business, financial condition or results of operations, but such impact could be material.

We have been informed by these auditors that health care providers and suppliers of certain DME product categories are expected to experience further increased scrutiny from these audit programs. When a government auditor ascribes a high billing error rate to one or more of our locations, it generally results in protracted pre-payment claims review, payment delays, refunds and other payments to the government and/or our need to request more documentation from referral sources than has historically been required. It may also result in additional audit activity in other company locations in that state or DME MAC jurisdiction. We can not currently predict the adverse impact that these new audits, methodologies and interpretations might have on our operations, cash flow and capital resources, but such impact could be material.

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

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

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

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

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

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

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

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

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

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

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

IF THE COVERAGE LIMITS ON OUR INSURANCE POLICIES ARE INADEQUATE TO COVER OUR LIABILITIES OR OUR INSURANCE COSTS CONTINUE TO INCREASE, THEN OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS WOULD LIKELY DECLINE.

Participants in the health care industry, including the Company, are subject to substantial claims and litigation in the ordinary course, often involving large claims and significant defense costs. As a result of the liability risks inherent in our lines of business we maintain liability insurance intended to cover such claims. Our insurance policies are subject to annual renewal. The coverage limits of our insurance policies may not be adequate, and we may not be able to obtain liability insurance in the future on acceptable terms or at all. In addition, our insurance premiums could be subject to increases in the future, which increases may be material. If the coverage limits are inadequate to cover our liabilities or our insurance costs continue to increase, then our financial condition and results of operations would likely decline.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

Our revolving credit facility is subject to changing LIBOR-based interest rates. At June 30, 2012, we had no outstanding borrowings under the $450.0 million credit facility and $250.0 million outstanding under the five-year single draw term loan.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

The Company has conducted an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.

(b) Changes in Internal Control Over Financial Reporting

There has been no change in the Company’s internal control over financial reporting (as such term is defined in Exchange Act Rule 13a-15(f)) during the fiscal quarter ended June 30, 2012, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

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

Our operating centers are also subject to federal and/or state laws regulating, among other things, interstate motor-carrier transportation, repackaging of oxygen, distribution of medical equipment, certain types of home health activities, pharmacy operations, nursing services and respiratory services and apply to those locations involved in such activities. Certain of our employees are subject to state laws and regulations governing the ethics and professional practice of respiratory therapy, pharmacy and nursing.

From time to time, the Company receives inquiries and complaints from various government agencies related to its operations or personnel. It has been the Company’s policy to cooperate with all inquiries, investigations and requests for information from government agencies and to vigorously defend any administrative complaints. There are several pending government inquiries, but the government has not instituted any proceedings or served the Company with any complaints as a result of these inquiries. However, the Company can give no assurances as to the duration or outcome of these inquiries.

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

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.

On July 11, 2012, in connection with the transactions contemplated by the Merger Agreement, two putative shareholder class action complaints were filed in the Circuit Court of the 6th Judicial Circuit in and for Pinellas County, Florida against the Company, the members of the Board, Parent and Purchaser. On July 16, 2012, two additional putative shareholder class action complaints, were filed in the same Circuit Court. A fifth putative shareholder class action was filed on July 20, 2012, also in the same Circuit Court. Please see Item 1, Note 12 Subsequent Events, above, for a detailed summary of these legal proceedings.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

During the three months ended June 30, 2012, the Company did not repurchase any shares of its common stock in the open market.

Our Board of Directors has authorized a share repurchase plan whereby the Company may repurchase shares of the Company’s common stock in amounts determined pursuant to a formula that takes into account both the ratio of the Company’s net debt to cash flow and its available cash resources and borrowing availability. As of June 30, 2012, $273.7 million of common stock was eligible for repurchase in accordance with the plan’s formula.

Item 3. Defaults Upon Senior Securities – Not Applicable

Item 4. Mine Safety Disclosures – Not Applicable

Item 5. Other Information – Not Applicable

Item 6. Exhibits

(a) Exhibits included or incorporated herein: See Exhibit Index.

SIGNATURE

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

LINCARE HOLDINGS INC.

Registrant

/S/ PAUL G. GABOS

Paul G. Gabos
Secretary, Chief Financial Officer
and Principal Accounting Officer

August 6, 2012

INDEX OF EXHIBITS


Exhibit Number		Exhibit

2.1 (A)		Agreement and Plan of Merger, dated as of July 1, 2012, by and among Lincare Holdings Inc., Linde AG and Linde US Inc.

3.10 (B)		Amended and Restated Certificate of Incorporation of Lincare Holdings Inc.

3.11 (B)		Certificate of Amendment to the Amended and Restated Certificate of Incorporation of Lincare Holdings Inc.

3.20 (C)		Amended and Restated By-Laws of Lincare Holdings Inc.

4.10 (D)		Lincare Holdings Inc. Indenture dated as of June 11, 2003

4.20 (D)		Lincare Holdings Inc. Registration Rights Agreement dated as of June 11, 2003

4.30 (E)		Lincare Holdings Inc. Series A Indenture dated as of October 31, 2007

4.40 (E)		Lincare Holdings Inc. Series B Indenture dated as of October 31, 2007

4.50 (E)		Lincare Holdings Inc. Registration Rights Agreement dated as of October 31, 2007

4.70 (F)		Credit Agreement with Bank of America, N.A. as Agent and Credit Agricole Corporate and Investment Bank and Wells Fargo Bank, National Association, as Co-Syndication Agents and U.S. Bank National Association, and RBS Citizens, National Association, as Co-Documentation Agents.

4.80 (G)		First Amendment to Credit Agreement and Joinder, dated as of June 29, 2012, among Lincare Holdings Inc., as Borrower, certain subsidiaries of the Borrower from time to time party thereto, as Guarantors, the several lenders from time to time party thereto and Wells Fargo Bank, National Association as Agent and Fifth Third Bank, TD Bank, N.A. and Credit Agricole Corporate and Investment Bank as Co-Syndication Agents and RBS Citizens, National Association as Documentation Agent and Wells Fargo Securities, LLC, Fifth Third Bank, TD Securities (USA) LLC and Credit Agricole Corporate and Investment Bank, as Joint Bookrunners and Joint Lead Arrangers.

31.1		Certification Pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, executed by John P. Byrnes, Chief Executive Officer

31.2		Certification Pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, executed by Paul G. Gabos, Chief Financial Officer

32.1		Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by John P. Byrnes, Chief Executive Officer

32.2		Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by Paul G. Gabos, Chief Financial Officer

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema Document

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF		XBRL Definition Linkbase Document

101.LAB		XBRL Taxonomy Extension Label Linkbase Document

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

A		Incorporated by reference to the Registrant’s Form 8-K dated July 6, 2012.

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

C		Incorporated by reference to the Registrant’s Form 8-K dated December 21, 2010.

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

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

F		Incorporated by reference to the Registrant’s Form 8-K dated September 19, 2011.

G		Incorporated by reference to the Registrant’s Form 8-K dated July 5, 2012.

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LINCARE HOLDINGS INC 10-Q