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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended: September 30, 2003

For the transition period from            to           .

American HomePatient, Inc.

5200 Maryland Way, Suite 400, Brentwood, Tennessee 37027

(615) 221-8884

None

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 is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes  [  ]  No  [X]

16,367,389

(Outstanding shares of the issuer’s common stock as of November 6, 2003)

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AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES

INDEX

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PART I. FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES
INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)

(Continued)

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AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES
INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(Continued)

The accompanying notes to interim condensed consolidated financial statements are an integral part of these consolidated financial statements.

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AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES
INTERIM CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)

The accompanying notes to interim condensed consolidated financial statements are an integral part of these consolidated financial statements.

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AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES
INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

(Continued)

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AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES
INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(Continued)

The accompanying notes to interim condensed consolidated financial statements are an integral part of these consolidated financial statements.

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AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.

BASIS OF PRESENTATION

American HomePatient, Inc. was incorporated in Delaware in September 1991. American HomePatient Inc.’s principal executive offices are located at 5200 Maryland Way, Suite 400, Brentwood, Tennessee 37027-5018, and its telephone number at that address is (615) 221-8884. American HomePatient, Inc. and subsidiaries (the “Company”) provides home health care services and products consisting primarily of respiratory therapies, infusion therapies and the rental and sale of home medical equipment and home health care supplies. For the nine months ended September 30, 2003, these services represented 69%, 13% and 18% of revenues, respectively. These services and products are paid for primarily by Medicare, Medicaid and other third-party payors. As of September 30, 2003, the Company provided these services to patients primarily in the home through 288 centers in 35 states: Alabama, Arizona, Arkansas, Colorado, Connecticut, Delaware, Florida, Georgia, Illinois, Iowa, Kansas, Kentucky, Maine, Maryland, Michigan, Minnesota, Mississippi, Missouri, Nebraska, Nevada, New Jersey, New Mexico, New York, North Carolina, Ohio, Oklahoma, Pennsylvania, South Carolina, South Dakota, Tennessee, Texas, Virginia, Washington, West Virginia and Wisconsin.

The interim condensed consolidated financial statements of the Company for the nine months ended September 30, 2003 and 2002 herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. In the opinion of management of the Company, the accompanying unaudited interim condensed consolidated financial statements reflect all adjustments (consisting of only normally recurring accruals) necessary to present fairly the financial position at September 30, 2003 and the results of operations and the cash flows for the nine months ended September 30, 2003 and 2002.

The results of operations for the nine months ended September 30, 2003 and 2002 are not necessarily indicative of the operating results for the entire respective years. These unaudited interim condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K.

Certain reclassifications have been made to the 2002 interim condensed consolidated financial statements to conform to the 2003 presentation.

2.

HISTORY OF BANK CREDIT FACILITY

     Overview. The Company is indebted to a syndicate of lenders (the “Lenders”), with Bank of Montreal serving as agent for the Lenders. The indebtedness arose out of a credit agreement entitled the Fifth Amended and Restated Credit Agreement (the “Amended Credit Agreement”), entered into as of June 8, 2001. The indebtedness owed to the Lenders as of July 31, 2002, the date of the Company’s Bankruptcy Filing (as defined in Note 3), totaled approximately $278.7 million. Terms, including payment terms, for the indebtedness that arose out of the Amended Credit

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Agreement have been established by the Second Amended Joint Plan of Reorganization approved by the United States Bankruptcy Court for the Middle District of Tennessee (the “Approved Plan”) and are discussed in more detail in Note 3. The terms of the Amended Credit Agreement have been superseded by the terms of the Approved Plan.

     Historical Terms of the Bank Credit Facility. The Amended Credit Agreement was the latest in a series of credit agreements in connection with a credit facility (the “Bank Credit Facility”) that dated back to October 20, 1994. The Amended Credit Agreement was entered into after the Company breached several of the financial covenants in the Fourth Amended and Restated Credit Agreement.

The Amended Credit Agreement provided a new loan to the Company from which the proceeds were used to pay off all existing loans under the Fourth Amended and Restated Credit Agreement. The Amended Credit Agreement also included modified financial covenants and a revised amortization schedule. In addition, the Amended Credit Agreement no longer contained a revolving loan component; all existing indebtedness was now in the form of a term loan which matured on December 31, 2002.

Substantially all of the Company’s assets were pledged as security for borrowings under the Bank Credit Facility.

Interest was payable on the unpaid principal amount under the Amended Credit Agreement, at the election of the Company, at either a Base Lending Rate or an Adjusted Eurodollar Rate (each as defined in the Amended Credit Agreement), plus an applicable margin of 2.75% and 3.50%, respectively. The Company was also required to pay additional interest in the amount of 4.50% per annum on that principal portion outstanding of the Amended Credit Agreement that is in excess of four times adjusted EBITDA, as defined by the Amended Credit Agreement. For the seven months ended July 31, 2002 (Bankruptcy Filing), the weighted average borrowing rate was 7.3%. Upon the occurrence and continuation of an event of default under the Amended Credit Agreement, interest would have been payable upon demand at a rate that is 2.00% per annum in excess of the interest rate otherwise payable under the Amended Credit Agreement and the Company no longer would have had the right to designate the Adjusted Eurodollar Rate plus the applicable margin as the applicable interest rate.

     Warrants. The Company was required to issue warrants to the Lenders representing 19.999% of the common stock of the Company issued and outstanding as of March 31, 2001, pursuant to the terms of the Second Amendment to the Fourth Amended and Restated Credit Agreement (which amendment was entered into on April 14, 1999). To fulfill these obligations, warrants to purchase 3,265,315 shares of common stock were issued to the Lenders on June 8, 2001. Fifty percent of these warrants are exercisable until May 31, 2011, and the remaining fifty percent are exercisable until September 29, 2011. The exercise price of the warrants is $0.01 per share. The Company accounted for the fair value of these warrants during the fourth quarter of 2000 as the issuance of these warrants was determined to be probable. Accordingly, the Company increased deferred financing costs by $686,000 to recognize the estimated fair value of the warrants as of December 31, 2000. On July 11, 2003, the Company filed a motion with the Bankruptcy Court seeking approval to reject these warrants as executory contracts. Several warrant holders objected to this motion, and a hearing has been scheduled in the Bankruptcy

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Court on November 21, 2003 with respect to these issues. If the warrants ultimately are rejected, then the holders of the rejected warrants may have an unsecured claim against the Company.

3.

PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE

The Amended Credit Agreement was due to mature on December 31, 2002. Because of the impending maturity and the Company’s inability to reach an agreement with its Lenders to restructure the Bank Credit Facility, on July 31, 2002, American HomePatient, Inc. and 24 of its subsidiaries (collectively, the “Debtors”) filed voluntary petitions for relief to reorganize under Chapter 11 of the U.S. Bankruptcy Code (the “Bankruptcy Filing”) in the United States Bankruptcy Court for the Middle District of Tennessee (the “Bankruptcy Court”). The Bankruptcy Filing stayed all payments and enforcement actions under the Amended Credit Agreement.

These cases (the “Chapter 11 Cases”) were consolidated for the purpose of joint administration under Case Number 02-08915-GP3-11. On January 2, 2003, the Debtors filed their Second Amended Joint Plan of Reorganization (the “Proposed Plan”), proposed by the Debtors and the Official Committee of Unsecured Creditors appointed by the Office of the United States Trustee in the Chapter 11 Cases. The hearing before the Bankruptcy Court on confirmation of the Proposed Plan was held on April 23–25 and 28-29, 2003. On May 15, 2003, the Bankruptcy Court entered a memorandum opinion overruling the Lenders’ objections to the Proposed Plan. On May 27, 2003, the Bankruptcy Court entered an Order confirming the Proposed Plan (“Confirmation Order”) (hereafter referred to as the “Approved Plan”). On June 30, 2003, the United States District Court for the Middle District of Tennessee (the “District Court”) rejected the secured Lenders’ request to stay the effective date of the Approved Plan. On July 1, 2003, the Company’s Approved Plan became effective and the Company successfully emerged from bankruptcy protection. The Lenders filed an appeal to the District Court of the order confirming the Approved Plan. On September 12, 2003 the District Court issued an opinion affirming in all respects the Confirmation Order. The Lenders have now filed an appeal to the order confirming the Approved Plan with the United States Court of Appeals for the Sixth Circuit. The Company intends to vigorously defend the Confirmation Order entered by the Bankruptcy Court and upheld by the District Court.

The Approved Plan allows the Company to continue its business operations uninterrupted, led by its current management team, and accomplishes the Company’s primary goal of restructuring its long-term debt obligations to its Lenders. In addition, the Approved Plan provides that the Company’s shareholders retain their equity interest in the Company and that all of the Company’s creditors and vendors will be paid 100% of all amounts they are owed, either immediately or over time with interest.

The Approved Plan provides for the treatment of all of the claims subject to compromise in the Bankruptcy Filing. The Approved Plan provides for the extension of the maturity on the debt to the Lenders, a reduction of the related interest cost on such debt, and the payment of all of the Company’s reported liabilities. The Lenders retained their liens on substantially all of the assets of the Company.

Pursuant to the Approved Plan, the Company’s secured debt to the Lenders is $250 million and is evidenced by a promissory note in that amount and is secured by various security agreements. To

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the Company’s knowledge, the Lenders have not executed the agreements as of the date of this filing. The Company is no longer a party to a credit agreement. The remainder of the amounts due to the Lenders is treated as unsecured.

The Approved Plan provides that principal is payable annually on the $250 million secured debt on March 31 of each year, beginning March 31, 2005, in the amount of one third of the Company’s Excess Cash Flow (as defined in the Approved Plan) for the previous fiscal year. After the unsecured debt of the Lenders and the general unsecured debt is paid in full, 100% of the Company’s Excess Cash Flow is paid on the $250 million secured debt on March 31 of each year. On September 30 of each year, beginning September 30, 2004, the Approved Plan provides that the Company make an estimated payment of the amount due on March 31, based upon the Company’s current cash forecast. The maturity date of the $250 million secured debt is July 1, 2009. The Approved Plan provides that interest is payable monthly on the $250 million secured debt at a rate of 6.785% per annum.

The Approved Plan provides that the Lenders are paid on their unsecured debt semi-annually in six equal installments (on June 30 and December 31 of each year) beginning December 31, 2003. In addition to the scheduled payments referenced above, the Lenders (together with the holders of the general unsecured debt) also receive a payment on March 31, 2004 in the amount of 100% of the Company’s Excess Cash Flow for fiscal year 2003 and a payment on March 31, 2005 in the amount of two-thirds of the Company’s Excess Cash Flow for the previous fiscal year. These payments are defined as Pro Rata Payments in the Approved Plan. Additionally, an estimated prepayment of the Pro Rata Payment was due on September 30, 2003 and will be due on September 30, 2004 in an amount equal to one-half of the anticipated Pro Rata Payment for each fiscal year. Prior to emergence from bankruptcy protection, the Company made adequate protection payments to the Lenders totaling approximately $15.8 million. These payments will be applied to the Lenders’ unsecured debt and earn interest until applied to the Company’s debt. The Company made prepayments (including prepayment of the Pro Rata Payment due September 30, 2003) of $14.4 million during the nine months ended September 30, 2003 by the application of $14.4 million of the adequate protection payments previously made to the Lenders. The Approved Plan allows the Company to make prepayments to the Lenders on the Lender unsecured debt, either in whole or in part, at any time without penalty. Any partial prepayments shall reduce and be a credit against any mandatory payments coming due after the time of the prepayment. The maturity date of the Lenders’ unsecured debt is June 30, 2006. The Approved Plan provides that interest is payable on the Lender’s unsecured debt at a rate of 8.3675% per annum.

The Approved Plan provides that the holders of general unsecured debt are paid semi-annually in six equal installments (on June 30 and December 31 of each year) beginning December 31, 2003. In addition to the scheduled payments referenced above, the holders of the general unsecured debt (together with the Lenders as to the Lender unsecured debt) also receive a payment on March 31, 2004 in the amount of 100% of the Company’s Excess Cash Flow for fiscal year 2003 and a payment on March 31, 2005 in the amount of two thirds of the Company’s Excess Cash Flow for the previous fiscal year. These payments are defined as Pro Rata Payments in the Approved Plan. Additionally, an estimated prepayment of the Pro Rata Payment is due on September 30, 2003 and September 30, 2004 in an amount equal to one-half of the anticipated Pro Rata Payment for each fiscal year. The Company made prepayments of $7.7 million (including prepayment of the Pro Rata Payment due September 30, 2003) during the nine months

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ended September 30, 2003 to the holders of the general unsecured debt. The Approved Plan allows the Company to make prepayments to the holders of the general unsecured debt, either in whole or in part, at any time without penalty. Any partial prepayments shall reduce and be a credit against any mandatory payments coming due after the time of the prepayment. The maturity date of the general unsecured debt is June 30, 2006. The Approved Plan provides that interest is payable on the general unsecured debt at a rate of 8.3675% per annum.

The Approved Plan treated all unsecured claims totaling less than $10,000 separately from the general unsecured claims. On July 1, 2003, the Company paid, in full, all such unsecured claims.

The Company’s funding of day-to-day operations going forward and all payments required under the Approved Plan will rely on cash flow and cash on hand as it has since the Lenders terminated the Company’s ability to access a revolving line of credit in 2000. At September 30, 2003 the Company had cash and cash equivalents of approximately $14.9 million after giving effect to the payments described above.

As the reorganization value of the assets of the Company immediately before confirmation date is greater than the total of all post petition liabilities and allowed claims and the holders of the existing voting shares immediately before the confirmation received more than 50% of the voting shares of the Company, it did not apply the provisions of SOP 90-7 for fresh-start reporting. Upon emergence from bankruptcy protection on July 1, 2003, and prior to the application of payments made on July 1, 2003, approximately $30,552,000 and $284,039,000 of the total liabilities subject to compromise (which was $298,797,000 at June 30, 2003) were classified as current and non-current, respectively, and were offset by a current asset of $9,568,000 and a non-current asset of $6,226,000.

4.

STOCK BASED COMPENSATION

In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123” (“SFAS No. 148”), which amends SFAS No. 123, “Accounting for Stock-Based Compensation”, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The disclosure provisions of this Statement are effective for financial statements for annual and interim periods beginning after December 15, 2002.

Prior to the issuance of SFAS No. 148, SFAS No. 123 encouraged, but did not require, companies to record compensation cost for stock-based employee compensation plans at fair value. Historically, the Company has chosen to account for stock option plans using the intrinsic value method as prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB Opinion No. 25”), and related Interpretations. Under APB Opinion No. 25, no compensation cost related to stock options has been recognized because all options are issued with exercise prices equal to the stock’s fair market value at the date of grant.

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To date, the Company has adopted the disclosure provisions of SFAS No. 123. Accordingly, no compensation cost has been recognized for the option plans. Had compensation cost for the Company’s stock option plan been determined based on the stock’s fair value at the grant date of awards for the three and nine months ended September 30, 2003 and 2002 consistent with the provisions of SFAS No. 123, the Company’s net income (loss) and net income (loss) per common share would have been decreased or increased to the pro forma amounts indicated below:

5.

REORGANIZATION ITEMS

Reorganization items represent expenses that are incurred by the Company as a result of reorganization under Chapter 11 of the Federal Bankruptcy Code. Reorganization items for the three and nine months ended September 30, 2003 were $920,000 and $3,776,000, respectively, and are comprised primarily of professional fees.

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6.

LIQUIDITY

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. The Company had net income of $426,000 and $9,283,000 for the three and nine months ended September 30, 2003, respectively, and incurred net losses of $2,404,000, $69,345,00 and $61,154,000 for the three and nine months ended September 30, 2002 and the year ended December 31, 2002, respectively. The Company has a shareholders’ deficit of $38,311,000 at September 30, 2003. The Company has substantial debt balances related to the Approved Plan, of which $5,862,000 is due on or before September 30, 2004. See Note 3 for further information related to the Bankruptcy Filing.

The Company’s Approved Plan provides for the extension of the maturity on the debt to the Lenders, a reduction of the related interest cost on such debt, and the payment of all of its reported liabilities. The Lenders retained their liens on substantially all of the assets of the Company. Under the Approved Plan, the Company will continue to be highly leveraged and subject to substantial debt service requirements. The Company intends to improve financial performance through consolidating operations, stabilizing and increasing profitable revenues, decreasing and controlling operating expenses and improving accounts receivable performance. The Company is unable to predict whether it will be able to successfully execute the operational results contemplated by the Approved Plan. If the Company is unable to continue to improve its operations, its financial position, results of operations and cash flows would be impacted adversely.

Management’s cash flow projections and related operating plans indicate that the Company can operate on its existing cash and cash flow and make all payments provided for in its Approved Plan over the next twelve months. The Company has operated in this manner since the Bankruptcy Filing. However, as with all projections, there can be no guarantee that management’s projections will be achieved. Failure of the Company to achieve its projections and make all payments provided for in its approved plan would have a material adverse effect to the Company. The accompanying financial statements do not include any adjustments of recorded asset carrying amounts or the amounts and classification of liabilities that might result should the Company be unable to continue as a going concern.

7.

GOVERNMENT INVESTIGATION AND LITIGATION

     Government Settlement. On June 11, 2001, a settlement agreement (the “Government Settlement”) was entered among the Company, the United States of America, acting through the United States Department of Justice (“DOJ”) and on behalf of the Office of Inspector General of the Department of Health and Human Services (“OIG”) and the TRICARE Management Activity, and a former Company employee, as relator. The Government Settlement was approved by the United States District Court for the Western District of Kentucky, the court in which the relator’s false claim action was filed. The Government Settlement covers alleged improprieties by the Company during the period from January 1, 1995 through December 31, 1998, including allegedly improper billing activities and allegedly improper remuneration to and contracts with physicians, hospitals and other healthcare providers. Pursuant to the Government Settlement, the Company made an initial payment of $3,000,000 in the second quarter of 2001 and agreed to make additional payments in the principal amount of $4,000,000, together with interest on this amount, in installments due at various times until March 2006. The Company also paid the relator’s attorneys’ fees and expenses. Pursuant to the Approved Plan, amounts owed pursuant to the Government

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Settlement will be paid in full in accordance with the Government Settlement. The Company has accrued $4,358,000 for its remaining obligations pursuant to the Government Settlement.

     Other Claims and Litigation. Other than the Government Settlement, all other claims and litigation described below are disputed by the Company. To the extent the Bankruptcy Court ultimately determines that any of the parties has a valid claim pursuant to the Approved Plan it will be paid as a general unsecured claim.

The relator in the false claim action giving rise to the Government Settlement also asserted in his amended complaint that the Company discriminated against him because of his reports of alleged wrong-doing to the government. The relator filed a claim in the Company’s bankruptcy proceeding for damages allegedly sustained as a result of the alleged discrimination. The Company has objected to that claim.

The Company also was named as a defendant in two other False Claims Act cases filed prior to the Company’s bankruptcy. In each of those cases, the DOJ declined to intervene and both cases were subsequently dismissed in March 2001. The first of these cases, United States ex rel. Kirk S. Corsello v. Lincare, et al. (N.D. Ga.), was dismissed with prejudice on motion of the Company on March 9, 2001. The appeal of that dismissal was argued in November 2001; however, in December 2001 the Court of Appeals for the Eleventh Circuit dismissed the appeal on jurisdictional grounds and returned the case to the trial court. In January 2002, one of the other defendants filed a Motion for Reconsideration with the Court of Appeals, and the Court of Appeals denied the motion on July 10, 2002. On August 5, 2002 the Company filed a Notice of Bankruptcy which stayed the proceedings as to the Company. Mr. Corsello’s qui tam complaint alleged that the Company and numerous other unrelated defendants, including other large DME suppliers, engaged in a kickback scheme to provide free or below market value equipment and medicine to physicians who would in turn refer patients to the defendants in violation of the False Claims Act. The other case, United States ex rel. Alan D. Hutchison v. Respironics, et al. (S.D. NY and N.D. Ga.), was dismissed without prejudice on Mr. Hutchison’s own motion on March 22, 2001. To the best of the Company’s knowledge, neither Corsello or Hutchison filed a claim in the Company’s bankruptcy.

The Company was informed in May 2001 that the United States was investigating its conduct during periods after December 31, 1998, and the Company believes that this investigation was prompted by another qui tam complaint against the Company under the False Claims Act. The Company has not seen a complaint in this action and, to the Company’s knowledge, no claim was filed against the Company in the Chapter 11 proceedings by the United States or any party purporting to act on its behalf for any amounts other than those owed pursuant to the Government Settlement.

There can be no assurances as to the final outcome of any pending False Claims Act lawsuits. Possible outcomes include, among other things, the repayment of reimbursements previously received by the Company related to improperly billed claims, the imposition of fines or penalties, and the suspension or exclusion of the Company from participation in the Medicare, Medicaid and other government reimbursement programs. Other than the $4,358,000 accrued liabilities for its remaining obligations pursuant to the Government Settlement, the Company has not recorded any liabilities related to the unsettled government investigations. In the unlikely event that the Company were to lose the pending false claim lawsuits or be subject to remaining settlements, such

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amounts could have a material adverse effect on the Company’s financial position or results of operations.

The Company is a party to other legal proceedings incidental to its business. In the opinion of management, any ultimate liability with respect to these other actions should not have a material adverse effect on its financial position or results of operations.

8.

RELATED PARTY TRANSACTIONS

A partner in the law firm of Harwell Howard Hyne Gabbert & Manner, P.C. (“H3GM”), which the Company engaged during 2003 and 2002 to render legal advice in a variety of activities, was a director of the Company until July 2002. The Company paid H3GM $173,000, $512,000, $460,000 and $852,000 during the three and nine months ended September 30, 2003 and the three and nine months ended September 30, 2002, respectively.

The Company maintains an employee benefit trust for the purpose of paying health insurance claims for its employees. The trust was established in June 2002 and was funded with an initial deposit of $0.5 million in July 2002. Disbursements from the trust began in late July 2002. The Company deposits funds into the trust on an as-needed basis to pay claims. The Company intends to terminate the trust effective December 31, 2003.

9.

SALE OF ASSETS OF CENTER

In the quarter ended March 31, 2002, the Company recorded a pre-tax gain of approximately $0.7 million related to the sale of the assets of an infusion business and nursing agency (collectively , the “Center”). Effective March 19, 2002 substantially all of the assets of the Center were sold for approximately $1.3 million in cash. During the nine months ended September 30, 2002, the Center generated approximately $1.9 million in total revenues. The proceeds of this sale were used to pay down debt under the Company’s Bank Credit Facility.

10.

EARNINGS PER SHARE

Under the standards established by Statement of Financial Accounting Standards No. 128, “Earnings Per Share,” earnings per share is measured at two levels: basic earnings per share and diluted earnings per share. Basic earnings per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income (loss) by the weighted average number of common shares after considering the additional dilution related to options and warrants. In computing diluted earnings per share, the outstanding stock warrants and stock options are considered dilutive using the treasury stock method. For the three months ended September 30, 2003 and 2002, and for the nine months ended September 30, 2003 and 2002 approximately 713,000, 3,998,000, 1,344,000 and 4,099,000 shares, respectively, were attributable to the exercise of outstanding options and were excluded from the calculation of diluted earnings per share because the effect was antidilutive.

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The following information is necessary to calculate earnings per share for the periods presented:

11.

ADOPTION OF NEW ACCOUNTING PRONOUCEMENTS

The Company adopted the provisions of Statement of Financial Accounting Standards No. 142, “Goodwill and other Intangible Assets” (SFAS No. 142) effective January 1, 2002. As of the adoption date, the Company had unamortized goodwill in the amount of $189.7 million. In accordance with SFAS No. 142, effective January 1, 2002 the Company discontinued amortization of goodwill. Goodwill was tested for impairment by comparing the fair value of goodwill to the carrying value of goodwill. Fair value was determined using projected operating results and a combination of analyses which included discounted cash flow calculations, market multiples and other market information. Key assumptions used in these estimates include projected operating results, discount rates and peer market multiples. The implied fair value of goodwill did not support the carrying value of goodwill primarily due to the Company’s highly leveraged capital structure.

Based upon the results of the Company’s initial impairment tests, the Company recorded an impairment loss of $68.5 million in the quarter ended March 31, 2002, recognized as a cumulative effect of change in accounting principle. There was no tax effect on the impairment loss due to the fact that the majority of the related goodwill was non-tax deductible and because of the Company’s federal net operating loss position. The Company is required to conduct annual impairment tests hereafter, unless specific events arise which warrant more immediate testing. The Company completed its annual impairment testing in September 2003 and based on this testing,

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no impairments were recorded. Any subsequent impairment loss will be recognized as an operating expense in the Company’s consolidated statements of operations.

The change in the carrying amount of goodwill for the nine months ended September 30, 2003 and 2002 is as follows:

In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an Interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34” (“FIN No. 45”). This Interpretation requires guarantors to account at fair value for and disclose certain types of guarantees. The Interpretation’s disclosure requirements were effective for the Company’s year ended December 31, 2002; the Interpretation’s accounting requirements are effective for guarantees issued or modified after December 31, 2002. The Company’s adoption of this Interpretation’s accounting requirements did not have a material impact on its financial position or results of operations.

12.

RECENT ACCOUNTING PRONOUNCEMENTS

In January, 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN No. 46”). This Interpretation requires consolidation of variable interest entities (“VIE”) (formerly referred to as “special purpose entities”) if certain conditions are met. The Interpretation applies immediately to VIE’s created after January 31, 2003, and to variable interests obtained in VIE’s after January 31, 2003. Effective with the quarter beginning October 1, 2003, the Interpretation applies also to VIE’s created or variable interests obtained in VIE’s before January 31, 2003. The Company’s adoption of the applicable provisions of this Interpretation did not have an impact on its financial position or results of operations. The Company does not expect the adoption of the remaining provisions of this Interpretation to have an impact on its financial position or results of operations based on current interpretations.

On May 15, 2003, the Financial Accounting Standards Board issued Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (“SFAS No. 150”). The Statement requires issuers to classify as liabilities (or assets in some circumstance) three classes of freestanding financial instruments that embody obligations for the issuer. Generally, the Statement is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company adopted the provisions of the Statement on July 1, 2003. The Company has not entered into any financial instruments within the scope of the Statement since May 31, 2003, nor did it have existing arrangements that required changes in accounting treatment.

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13.

OTHER CURRENT LIABILITIES

Other current liabilities as of September 30, 2003 were comprised of amounts as follows:

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ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 including, without limitation, statements containing the words “believes,” “anticipates,” “intends,” “expects,” “estimates,” “projects,” “may,” “plan,” “will,” “likely,” “could” and words of similar import. Such statements include statements concerning the Company’s Approved Plan (as defined in Note 3 to the interim condensed consolidated financial statements), other effects and consequences of the Bankruptcy Filing (as defined in Note 3 to the interim condensed consolidated financial statements), forecasts upon which the Approved Plan is based, business strategy, the ability to satisfy interest expense and principal repayment obligations, operations, cost savings initiatives, industry, economic performance, financial condition, liquidity and capital resources, adoption of, or changes in, accounting policies and practices, existing government regulations and changes in, or the failure to comply with, governmental regulations, legislative proposals for healthcare reform, the ability to enter into strategic alliances and arrangements with managed care providers on an acceptable basis, and changes in reimbursement policies. Such statements are not guarantees of future performance and are subject to various risks and uncertainties. The Company’s actual results may differ materially from the results discussed in such forward-looking statements because of a number of factors, including those identified in the “Risk Factors” section and elsewhere in this Quarterly Report on Form 10-Q. The forward-looking statements are made as of the date of this Quarterly Report on Form 10-Q and the Company does not undertake to update the forward-looking statements or to update the reasons that actual results could differ from those projected in the forward-looking statements.

General

The Company provides home health care services and products to patients through its 288 centers in 35 states. These services and products are primarily paid for by Medicare, Medicaid and other third-party payors. The Company has three principal services or product lines: home respiratory services, home infusion services and home medical equipment and supplies. Home respiratory services include oxygen systems, nebulizers, aerosol medications and home ventilators and are provided primarily to patients with severe and chronic pulmonary diseases. Home infusion services are used to administer nutrients, antibiotics and other medications to patients with medical conditions such as neurological impairments, infectious diseases or cancer. The Company also sells and rents a variety of home medical equipment and supplies, including wheelchairs, hospital beds and ambulatory aids.

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The following table sets forth the percentage of the Company’s revenues represented by each line of business for the periods presented:

Prior to 1998, the Company had significantly expanded its operations through a combination of home health care acquisitions and joint ventures and strategic alliances with integrated health care delivery systems. In 1998, the Company purposefully slowed its acquisition activity compared to prior years to focus on existing operations. Since 1998, the Company has not acquired any home health care businesses or developed any new joint ventures other than converting several of its previously owned 50% joint ventures to wholly-owned operations during 1999 and 2000. In March 2002, the Company sold substantially all of the assets of an infusion center for $1.3 million in cash and used the proceeds to pay down the Bank Credit Facility.

On July 31, 2002, American HomePatient, Inc. and 24 of its subsidiaries (collectively, the “Debtors”) filed voluntary petitions for relief to reorganize under Chapter 11 of the U.S. Bankruptcy Code (the “Bankruptcy Filing”) in the United States Bankruptcy Court for the Middle District of Tennessee (the “Bankruptcy Court”). On July 1, 2003, the Company’s plan of reorganization, which had previously been approved by the Bankruptcy Court (the “Approved Plan”), became effective and the Company successfully emerged from bankruptcy protection. See Note 3 to the interim condensed consolidated financial statements “Proceedings Under Chapter 11 of the Bankruptcy Code” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.”

The Company’s strategy for 2003 is to maintain a diversified offering of home health care services reflective of its current business mix. Respiratory services will remain a primary focus along with home medical equipment rental and enteral nutrition products and services.

Government Regulation

     General. The Company, as a participant in the health care industry, is subject to extensive federal, state and local regulation. In addition to the False Claims Act and other federal and state anti-kickback and self-referral laws applicable to all of the Company’s operations (discussed more fully below), the operations of the Company’s home health care centers are subject to federal laws covering the repackaging and dispensing of drugs (including oxygen) and regulating interstate motor-carrier transportation. Such centers also are subject to state laws (most notably licensing and controlled substances registration) governing pharmacies, nursing services and certain types of home health agency activities.

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The Company’s operations are also subject to a series of laws and regulations dating back to the Omnibus Budget Reconciliation Act of 1987 (“OBRA 1987”) which apply to the Company’s operation. Periodic changes have occurred from time to time since the enactment of OBRA 1987, including reimbursement reductions and changes to payment rules.

The Federal False Claims Act imposes civil liability on individuals or entities that submit false or fraudulent claims to the government for payment. False Claims Act penalties for violations can include sanctions, including civil monetary penalties. As a provider of services under the federal reimbursement programs such as Medicare, Medicaid and TRICARE (formerly CHAMPUS), the Company is subject to the anti-kickback statute, also known as the “fraud and abuse law.” This law prohibits any bribe, kickback, rebate or remuneration of any kind in return for, or as an inducement for, the referral of patients for government-reimbursed health care services. The Company may also be affected by the federal physician self-referral prohibition, known as the “Stark Law,” which, with certain exceptions, prohibits physicians from referring patients to entities with which they have a financial relationship. Many states in which the Company operates have adopted similar self-referral laws, as well as laws that prohibit certain direct or indirect payments or fee-splitting arrangements between health care providers, under the theory that such arrangements are designed to induce or to encourage the referral of patients to a particular provider. In many states, these laws apply to services reimbursed by all payor sources.

In 1996, the Health Insurance Portability and Accountability Act (“HIPAA”) introduced a new category of federal criminal health care fraud offenses. If a violation of a federal criminal law relates to a health care benefit, then an individual is guilty of committing a Federal Health Care Offense. The specific offenses are: health care fraud; theft or embezzlement; false statements, obstruction of an investigation; and money laundering. These crimes can apply to claims submitted not only to government reimbursement programs such as Medicare, Medicaid and TRICARE, but to any third-party payor, and carry penalties including fines and imprisonment. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Factors, HIPAA Compliance” for further discussion.

HIPAA mandates an extensive set of regulations to protect the privacy of individually identifiable health information. The regulations consist of three sets of standards, each with a different date for required compliance: (1) Privacy Standards have a compliance date of April 14, 2003; (2) Transactions and Code Sets Standards required compliance by October 16, 2002 except as extended by one year to October 16, 2003 for providers that filed a compliance extension form by October 15, 2002; and (3) recently published Security Standards that have an implementation date of April 21, 2005. The Company has filed its compliance extension form and is actively pursuing its strategies toward compliance with the final Privacy Standards and Transaction and Code Sets Standards.

Implementation of mandated HIPAA Transaction and Code Sets did result in a disruption of cash as a result of a higher than anticipated rate of electronic claim rejections from Medicare. These rejections caused a disruption in both August and September cash collections. The Company believes most of the problems have been corrected and processes have been put in place to identify rejections and promptly resubmit claims to avoid further disruptions. CMS has also granted an extension to the October 16, 2003 deadline and will allow providers to continue to submit claims electronically in “old” formats as long as they continue to make good faith efforts to comply with

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HIPAA requirements. This extension will allow us to continue to submit non-standard formatted claims electronically to payors who will not be compliant as of October 16, 2003.

The Company must follow strict requirements with paperwork and billing. As required by law, it is Company policy that certain service charges (as defined by Medicare) falling under Medicare Part B are confirmed with a Certificate for Medical Necessity (“CMN”) signed by a physician. In January 1999, the Office of Inspector General of the Department of Health and Human Services (“OIG”) published a draft Model Compliance Plan for the Durable Medical Equipment, Prosthetics, Orthotics and Supply Industry. The OIG has stressed the importance for all health care providers to have an effective compliance plan. The Company has created and implemented a compliance program, which it believes meets the elements of the OIG’s Model Plan for the industry. As part of its compliance program, the Company performs internal audits of the adequacy of billing documentation. The Company’s policy is to voluntarily refund to the government any reimbursements previously received for claims with insufficient documentation that are identified in this process and that cannot be corrected. The Company periodically reviews and updates its policies and procedures in an effort to comply with applicable laws and regulations; however, certain proceedings have been and may in the future be commenced against the Company alleging violations of applicable laws governing the operation of the Company’s business and its billing practices.

The Balanced Budget Act of 1997 introduced several government initiatives which are either in the planning or implementation stages and which, when fully implemented, could have a material adverse impact on reimbursement for products and services provided by the Company. These initiatives include: (i) Prospective Payment System (“PPS”) requirements for skilled nursing facilities and PPS for home health agencies, which do not affect the Company directly but could affect the Company’s contractual relationships with such entities; (ii) deadlines (as yet undetermined) for obtaining Medicare and Medicaid surety bonds for home health agencies and DME suppliers; and (iii) pilot projects in Polk County, Florida and San Antonio, Texas which were effective between October 1, 1999 and September 30, 2002, and February 1, 2001 and December 31, 2002, respectively, to determine the efficacy of competitive bidding for certain durable medical equipment (“DME”), under which Medicare reimbursements for certain items were reduced between 3.6% to 34% from the then current Medicare fee schedules (the Company participated to some extent in both pilot projects). At expiration, the DME items reverted to normal Medicare fees and procedures, although the Bush administration has announced that it intends to expand competitive bidding on a national basis, building on these two pilot projects that yielded savings to Medicare. The United States House of Representatives recently passed a bill that includes provisions for a national competitive bidding program for durable medical equipment, including home oxygen equipment. The United States Senate recently passed a bill that includes provisions for a seven year freeze in the consumer price index (“CPI”) update for durable medical equipment and off-the-shelf orthotics. The Company cannot predict at this time the outcome of proposed legislation related to a national competitive bidding program or the financial impact of such a program on the Company’s business, if it should become law.

In April 2003, the OIG issued a special advisory bulletin addressing certain contractual arrangements that would not be included in a “safe harbor” as defined under the federal anti-kickback statutes. This bulletin specifically focuses on contractual arrangements where a health care provider in one line of business expands into a related health care business by contracting with an existing provider of a related item or service. The Company is a party to several

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contracts that could potentially be impacted by this special advisory bulletin. Management is in the process of assessing its compliance with the provisions of this bulletin and has not determined the financial impact, if any, of complying with these provisions.

The Company is also subject to state laws governing Medicaid, professional training, licensure, financial relationships with physicians and the dispensing and storage of pharmaceuticals. The facilities operated by the Company must comply with all applicable laws, regulations and licensing standards and many of the Company’s employees must maintain licenses to provide some of the services offered by the Company. Additionally, certain of the Company’s employees are subject to state laws and regulations governing the professional practice of respiratory therapy, pharmacy and nursing.

Information about individuals and other health care providers who have been sanctioned or excluded from participation in government reimbursement programs is readily available on the Internet, and all health care providers, including the Company, are held responsible for carefully screening entities and individuals they employ or do business with, to avoid contracting with an excluded provider. The entity cannot bill government programs for services or supplies provided by an excluded provider, and the federal government may also impose sanctions, including financial penalties, on companies that contract with excluded providers.

Health care law is an area of extensive and dynamic regulatory oversight. Changes in laws or regulations or new interpretations of existing laws or regulations can have a dramatic effect on permissible activities, the relative costs associated with doing business, and the amount and availability of reimbursement from government and other third-party payors. There can be no assurance that federal, state or local governments will not impose additional standards or change existing standards or interpretations.

In August 2003, the Centers for Medicare & Medicaid Services (CMS) issued a proposed rule change that would revise current payment methodology for Part B covered drugs and biologicals. Nebulizer drugs are included in Part B covered drugs. CMS proposes to select a payment methodology based on four different payment approaches. The Company cannot predict at this time the payment approach that will be selected by CMS and therefore cannot predict the outcome of the proposed rule on the Company’s business.

In September 2003, the Office of Inspector General (“OIG”) published a notice of proposed rulemaking that would amend the OIG exclusion regulations addressing excessive claims by including definitions for the terms “substantially in excess” and “usual charges.” Under the proposed rule, providers and suppliers that charge Medicare 120% more than they charge other payors for certain services can be excluded from the Medicare program. Should the proposed rule become effective, there most likely will be some financial impact on the Company’s business but the Company cannot predict the scope of the impact at this time.

In September 2003, the OIG approved Operation Wheeler-Dealer, which will subject power wheelchairs and power operated vehicles to more intense scrutiny to assure the Medicare beneficiaries receiving these products do in fact have medical necessity. The result of Operation Wheeler-Dealer is an expected increase in the number of post-payment and pre-payment Medicare audits.

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     Enforcement Activities. In recent years, various state and federal regulatory agencies have stepped up investigative and enforcement activities with respect to the health care industry, and many health care providers, including the Company and other durable medical equipment suppliers, have received subpoenas and other requests for information in connection with their business operations and practices. From time to time, the Company also receives notices and subpoenas from various government agencies concerning plans to audit the Company, or requesting information regarding certain aspects of the Company’s business. The Company cooperates with the various agencies in responding to such subpoenas and requests. The Company expects to incur additional legal expenses in the future in connection with existing and future investigations.

The government has broad authority and discretion in enforcing applicable laws and regulations; therefore, the scope and outcome of any such investigations, inquiries, or legal actions cannot be predicted. There can be no assurance that federal, state or local governments will not impose additional regulations upon the Company’s current activities nor that the Company’s past activities will not be found to have violated some of the governing laws and regulations. Any such regulatory changes or findings of violations of laws could adversely affect the Company’s business and financial position, and could even result in the exclusion of the Company from participating in Medicare, Medicaid, and other government reimbursement programs.

     Legal Proceedings. On June 11, 2001, a settlement agreement (the “Government Settlement”) was entered among the Company, the United States of America, acting through the United States Department of Justice (“DOJ”) and on behalf of the OIG and the TRICARE Management Activity, and a former Company employee, as relator. The Government Settlement was approved by the United States District Court for the Western District of Kentucky, the court in which the relator’s false claim action was filed. The Government Settlement covers alleged improprieties by the Company during the period from January 1, 1995 through December 31, 1998, including allegedly improper billing activities and allegedly improper remuneration to and contracts with physicians, hospitals and other healthcare providers. Pursuant to the Government Settlement, the Company made an initial payment of $3,000,000 in the second quarter of 2001 and agreed to make additional payments in the principal amount of $4,000,000, together with interest on this amount, in installments due at various times until March 2006. The Company also paid the relator’s attorneys fees and expenses. Pursuant to the Approved Plan, the amounts owed pursuant to the Government Settlement will be paid in full in accordance with the Government Settlement. The Company has accrued $4,358,000 for its remaining obligations pursuant to the Government Settlement.

     Other Claims and Litigation. Other than the Government Settlement, all other claims and litigation described below are disputed by the Company. To the extent the Bankruptcy Court ultimately determines that any of the parties has a valid claim pursuant to the Approved Plan, such claim will be paid as a general unsecured claim.

The relator in the false claim action giving rise to the Government Settlement also asserted in his amended complaint that the Company discriminated against him because of his reports of alleged wrong-doing to the government. The relator filed a claim in the Company’s bankruptcy proceeding. The Company has objected to that claim.

The Company also was named as a defendant in two other False Claims Act cases filed prior to the Company’s bankruptcy. In each of those cases, the DOJ declined to intervene and both cases were

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subsequently dismissed in March 2001. The first of these cases, United States ex rel. Kirk S. Corsello v. Lincare, et al. (N.D. Ga.), was dismissed with prejudice on motion of the Company on March 9, 2001. The appeal of that dismissal was argued in November 2001; however, in December 2001 the Court of Appeals for the Eleventh Circuit dismissed the appeal on jurisdictional grounds and returned the case to the trial court. In January 2002, one of the other defendants filed a Motion for Reconsideration with the Court of Appeals, and the Court of Appeals denied the motion on July 10, 2002. On August 5, 2002 the Company filed a Notice of Bankruptcy which stayed the proceedings as to the Company. The other case, United States ex rel. Alan D. Hutchison v. Respironics, et al. (S.D. NY and N.D. Ga.), was dismissed without prejudice on Mr. Hutchison’s own motion on March 22, 2001. To the best of the Company’s knowledge, neither Corsello or Hutchison filed a claim in the Company’s bankruptcy.

Prior to the Company’s Bankruptcy Filing, the Company was informed that the United States was investigating its conduct during periods after December 31, 1998, and the Company believes that this investigation was prompted by another qui tam complaint against the Company under the False Claims Act. The Company has not seen a complaint in this action and, to the Company’s knowledge, no claim was filed against the Company in the Chapter 11 proceedings by the United States or any party purporting to act on its behalf for any amounts other than those owed pursuant to the Government Settlement.

There can be no assurances as to the final outcome of any pending False Claims Act lawsuits. Possible outcomes include, among other things, the repayment of reimbursements previously received by the Company related to billed claims that are found to be improper, the imposition of fines or penalties, and the suspension or exclusion of the Company from participation in the Medicare, Medicaid and other government reimbursement programs. Other than the $4,358,000 accrued liability discussed above which relates to the Government Settlement, the Company has not recorded any reserves related to the unsettled government investigations. In the unlikely event that the Company were to lose the pending false claim lawsuits or be subject to future settlements, such amounts could have a material adverse effect on the Company’s financial position or results of operations.

Medicare Reimbursement for Oxygen Therapy Services

The Medicare reimbursement rate for oxygen related services was reduced by 25% beginning January 1, 1998 as a result of the Balanced Budget Act of 1997 with an additional reduction of 5% beginning January 1, 1999. The reimbursement rate for certain drugs and biologicals covered under Medicare was also reduced by 5% beginning January 1, 1998. The Company is one of the nation’s largest providers of home oxygen services to patients, many of whom are Medicare recipients, and is therefore significantly affected by this legislation. Medicare oxygen reimbursements account for a significant part of the Company’s on-going revenues. In January 2001, federal legislation was signed into law that provided for a one-time increase, beginning July 1, 2001, in Medicare reimbursement rates for home medical equipment, excluding oxygen related services, based on the consumer price index (“CPI”). There have been no significant increases since this law was passed. Medicare also has the option of developing fee schedules for parenteral and enteral nutrition and home dialysis supplies and equipment, although currently there is no timetable for the development or implementation of such fee schedules. Following promulgation of a final rule, effective February 11, 2003, CMS also has “inherent reasonableness” authority to modify payment rates for all Medicare Part B items and services by as much as 15% per year without industry consultation,

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publication or public comment, if the rates are determined to be “grossly excessive” or “grossly deficient.” Therefore, the Company cannot be certain that additional reimbursement reductions for oxygen therapy services or other services and products provided by the Company will not occur. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Government Regulation.”

Critical Accounting Policies

Management’s Discussion and Analysis of Financial Condition and Results of Operations are based upon the Company’s consolidated financial statements. The preparation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. On an on-going basis, management evaluates its critical accounting policies and estimates.

A “critical accounting policy” is one which is both important to the understanding of the financial condition and results of operations of the Company and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Management believes the following accounting policies fit this definition:

     Revenue Recognition and Allowance for Doubtful Accounts. The Company provides credit for a substantial part of its non third-party reimbursed revenues and continually monitors the credit-worthiness and collectibility of amounts due from its patients. Approximately 61% of the Company’s year to date 2003 revenues are derived from participation in Medicare and state Medicaid programs. Amounts paid under these programs are generally based upon a fixed rate. Revenues are recorded at the expected reimbursement rates when the services are provided, merchandise delivered or equipment rented to patients. Although amounts earned under the Medicare and Medicaid programs are subject to review by such third-party payors, subsequent adjustments to reimbursements as a result of such reviews are historically insignificant as these reimbursements are based on fixed fee schedules. In the opinion of management, adequate provision has been made for any adjustment that may result from such reviews. Any differences between estimated settlements and final determinations are reflected in operations in the year finalized.

Sales and related services revenues include all product sales to patients and are derived from the provision of infusion therapies, the sale of home health care equipment and supplies, the sale of aerosol medications and respiratory therapy equipment and supplies, and services related to the delivery of these products. Sales revenues are recognized at the time of delivery and are billed using fixed fee schedules based upon the type of product and the payor. Rentals and other patient revenues are derived from the rental of home health care equipment, enteral pumps and equipment related to the provision of respiratory therapy. All rentals of equipment are provided by the Company on a month-to-month basis and are billed using fixed monthly fee schedules based upon the type of rental and the payor. The fixed monthly fee encompasses the rental of the product as well as the delivery and the set-up and instruction by the product technician.

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The Company recognizes revenues at the time services are performed. As such, a portion of patient receivables consists of unbilled receivables for which the Company has not obtained all of the necessary medical documentation, but has provided the service or equipment. The Company calculates its allowance for doubtful accounts based upon the type of receivable (billed or unbilled) as well as the age of the receivable. As a receivable balance ages, an increasingly larger allowance is recorded for the receivable. All billed receivables over one year old and all unbilled receivables over 180 days old are fully reserved. Management believes that the recorded allowance for doubtful accounts is adequate and that historical collections substantiate the percentages used in the allowance valuation process. However, the Company is subject to further loss to the extent uncollectible receivables exceed its allowance for doubtful accounts. If the Company were to experience a deterioration in the aging of its accounts receivable due to disruptions or a slow down in cash collections, the Company’s allowance for doubtful accounts and bad debt expense would likely increase from current levels. Conversely, an improvement in the Company’s cash collection trends and in its receivable aging would likely result in a decrease in both the allowance for doubtful accounts and bad debt expense.

The Company’s allowance for doubtful accounts totaled approximately $19.6 million and $23.0 million as of September 30, 2003 and December 31, 2002, respectively.

     Inventory Valuation and Cost of Sales Recognition. Inventories represent goods and supplies and are priced at the lower of cost (on a first-in, first-out basis) or market value. The Company recognizes cost of sales and relieves inventory on an interim basis based upon the type of product sold and payor mix, and performs physical counts of inventory at each center on an annual basis. Any resulting adjustment from these physical counts is charged to cost of sales.

     Rental Equipment Valuation. Rental equipment is rented to patients for use in their homes and is depreciated over the equipment’s estimated useful life. On an annual basis, the Company performs physical counts of rental equipment at each center and reconciles all recorded rental assets to internal billing reports. Any resulting adjustment for unlocated or obsolete equipment is charged to rental equipment depreciation expense. Since rental equipment is maintained in the patient’s home, the Company is subject to loss resulting from lost equipment as well as losses for outdated or obsolete equipment. Management records a valuation allowance for its estimate lost, broken, or obsolete rental equipment based upon historical adjustment amounts and believes the recorded rental allowance is adequate. The Company is subject to loss for unrecorded adjustments in excess of its recorded rental equipment valuation allowance. The Company’s rental equipment reserves totaled $0.9 million at September 30, 2003 and December 31, 2002.

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     Valuation of Long-lived Assets. In accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), management evaluates long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Management utilizes estimated undiscounted future cash flows to determine if an impairment exists. When this analysis indicates an impairment exists, the amount of loss is determined based upon a comparison of estimated fair value with the carrying value of the asset. While management believes that the estimates of future cash flows are reasonable, different assumptions regarding such cash flows could materially affect the evaluations.

     Valuation of Goodwill and Other Intangible Assets. Goodwill represents the excess of cost over the fair value of net assets acquired. In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”). The Company was required to adopt the provisions of this statement effective January 1, 2002. SFAS No. 142 requires that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives no longer be amortized. Instead, goodwill and intangible assets with indefinite lives are required to be tested for impairment on an annual basis and when an event occurs or circumstances change such that it is reasonably possible that an impairment may exist. The Company selected September 30 as its annual testing date. There was no additional impairment recognized in 2002 or as a result of the Company’s annual impairment testing in September 2003.

Upon adoption of SFAS No. 142, goodwill was tested for impairment by comparing the fair value of goodwill to the carrying value of goodwill. The fair value was determined using a combination of analyses which included discounted cash flow calculations, market multiples and other market information. Key assumptions used in these estimates include projected operating results, discount rates and peer market multiples. The implied fair value of goodwill did not support the carrying value of goodwill primarily due to the Company’s highly leveraged capital structure, which resulted in impairment of $68.5 million. This impairment charge was recorded as a cumulative effect of change in accounting principle in the first quarter of 2002. There was no tax effect on the impairment loss due to the fact that the majority of the related goodwill was non-tax deductible and because of the Company’s federal net operating loss position.

     Self Insurance. Self-insurance accruals primarily represent managements’ loss estimate for self-insurance or large deductible risks associated with employee health insurance and workers’ compensation insurance. The Company is insured for workers’ compensation, but retains the first $250,000 of each claim. The Company is not maintaining annual aggregate stop loss coverage for claims made in 2003 and did not maintain annual aggregate stop loss coverage for claims made in 2002, as such coverage was not available. Judgments used in determining the accruals related to workers’ compensation include loss development factors, frequency of claims and severity of claims. The liability for estimated workers’ compensation claims totaled approximately $3.8 million and $3.3 million as of September 30, 2003 and December 31, 2002, respectively. The Company utilizes analyses prepared by its third-party administrator based on historical claims information to support the required reserve and related expense associated with workers’ compensation. The Company records claims expense by plan year based on the lesser of the aggregate stop loss (if applicable) or the developed losses as calculated by its third-party administrator.

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The Company is also self-insured for health insurance for substantially all employees for the first $150,000 on a per person, per year basis and maintains annual aggregate stop loss coverage. The health insurance policies are limited to maximum lifetime reimbursements of $2.0 million per person for 2003 and 2002. The estimated liability for health insurance claims totaled approximately $1.9 million and $1.8 million as of September 30, 2003 and December 31, 2002, respectively. The Company reviews health insurance trends and payment history and maintains a an accrual for incurred but not reported claims based upon its assessment of lag time in reporting and paying claims. Judgments include assessing historical paid claims, average lags between the claims’ incurred dates, reported dates and paid dates, the frequency of claims and the severity of claims.

The Company is required to maintain cash collateral accounts with the insurance companies related to its self-insurance obligations. The Company currently maintains cash collateral balances of $4.2 million related to its self-insured obligations, included in other assets.

Management continually analyzes its accrued liabilities for incurred but not reported claims, and for reported but not paid claims related to its self-insurance programs and believes these accruals to be adequate. However, significant judgment is involved in assessing these accruals, and the Company is at risk for differences between actual settlement amounts and recorded accruals, and any resulting adjustments are included in expense once a probable amount is known.

Results of Operations

The Company reports its revenues as follows: (i) sales and related services and (ii) rentals and other revenues. Sales and related services revenues are derived from the provision of infusion therapies, the sale of home health care equipment and supplies, the sale of aerosol and respiratory therapy equipment and supplies and services related to the delivery of these products. Rentals and other revenues are derived from the rental of home health care equipment, enteral pumps and equipment related to the provision of respiratory therapies. Cost of sales and related services includes the cost of equipment, drugs and related supplies sold to patients. Cost of rentals and other revenues includes the costs of oxygen and rental supplies, demurrage for leased oxygen tanks, rent expense for leased equipment, and rental equipment depreciation expense, and excludes delivery expenses and salaries associated with the rental set-up. Operating expenses include operating center labor costs, delivery expenses, division and area management expenses, selling costs, occupancy costs, billing center costs, bad debt expense, and other operating costs. General and administrative expenses include corporate and senior management expenses.

The majority of the Company’s hospital joint ventures are not consolidated for financial statement reporting purposes. Earnings from hospital joint ventures represent the Company’s equity in earnings from unconsolidated hospital joint ventures and management and administrative fees from unconsolidated hospital joint ventures.

     Sale of Assets of Center. In the quarter ended March 31, 2002, the Company recorded a pre-tax gain of $0.7 million related to the sale of the assets of an infusion business and nursing agency (collectively, the “Center”). Effective March 19, 2002, substantially all of the assets of the Center were sold for approximately $1.3 million in cash. During the nine months ended September 30, 2002 the Center generated approximately $1.9 million in total revenues. The proceeds of the sale were used to pay down debt under the Company’s Bank Credit Facility.

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