proposed rule, CMS sought comments that would assist the agency in setting an appropriate dispensing fee that reflects the costs of the shipping, handling, compounding and other pharmacy activities required to furnish inhalation drug therapy to Medicare beneficiaries.  The GAO is directed under MMA to conduct a study to examine the adequacy of reimbursement for inhalation drug therapy under the Medicare program and submit the results of the study in a report to Congress within one year of the effective date of MMA. On October 13, 2004, the GAO released a report entitled “Appropriate Dispensing Fee Needed for Suppliers of Inhalation Therapy Drugs,” recommending that the Administrator of CMS evaluate the costs of dispensing inhalation therapy drugs and modify the dispensing fee, if warranted, to ensure that the fee appropriately accounts for the costs necessary to dispense the drugs.  The CMS Administrator, in his October 8, 2004 comment letter to the GAO, agreed with the GAO’s recommendation and concluded that after reviewing the comments to CMS’s proposed rule and the information from the GAO report and other public sources, a reasonable range for a 2005 dispensing fee is $55.00 to $64.00 per month. 

          On Novermber 3, 2004, CMS issued its final rule, CMS-1429-FC, which establishes a monthly dispensing fee of $57.00 per customer for inhalation drug therapy. The rule also establishes an alternative dispensing fee of $80.00 per customer when dispensed in 90-day increments. Payment rates for inhalation drugs will be updated quarterly based on the manufacturer ASP calculated for the most recent calendar quarter for which data are available. Manufacturer ASP submissions are due to CMS not later than 30 days after the last day of each calendar quarter. Inhalation drug payment rates in the first quarter of 2005 will therefore be based on ASP data from the third quarter of 2004, which are not yet available. ASP data for the second quarter of 2004 have been published by CMS and indicates substantially reduced payment rates for inhalation drugs. For example, the payment rates for the two most prevalent inhalation drugs, albuterol sulfate and ipratropium bromide, based on the second quarter ASP data would be reduced from $0.39 and $2.82 per milligram to $0.05 and $0.46, respectively, representing reductions of 84% to 87%.  Medicare-covered inhalation drugs account for approximately one quarter of our net revenues.  While Lincare continues to evaluate the impact of the final rule on its business, Lincare expects to be able to continue to provide inhalation drugs to Medicare beneficiaries in 2005. The final rule states that CMS intends to revisit the payment amount for the dispensing fee next year and proceed through notice and comment rulemaking in order to establish an appropriate dispensing fee for 2006. Lincare can not determine the outcome of any future rulemaking by CMS nor the impact that such rulemaking might have on its ability to continue to provide inhalation drugs beyond 2005.  Such payment adjustments could have a material adverse effect on our financial position and operating results.

RECENT REGULATORY CHANGES SUBJECT THE MEDICARE REIMBURSEMENT RATES FOR OUR EQUIPMENT AND SERVICES TO POTENTIAL DISCRETIONARY ADJUSTMENT BY THE CENTERS FOR MEDICARE AND MEDICAID SERVICES (“CMS”), WHICH COULD REDUCE OUR REVENUES, NET INCOME AND CASH FLOWS.

          In February 2003, a final rule governing CMS’ Inherent Reasonableness, or IR, authority became effective. The IR rule establishes a process for adjusting fee schedule amounts for Medicare Part B services when existing payment amounts are determined to be either grossly excessive or deficient. The rule describes the factors that CMS or its contractors will consider in making such determinations and the procedures that will be followed in establishing new payment amounts. To date, no payment adjustments have occurred or been proposed as a result of the IR rule.

          The effectiveness of the IR rule itself does not trigger payment adjustments for any items or services. Nevertheless, the IR rule puts in place a process that could eventually have a significant impact on Medicare payments for our equipment and services. We can not predict whether or when CMS will exercise its IR authority with respect to our equipment and services. Such payment adjustments, if implemented, could reduce our revenues, net income and cash flows.

RECENT LEGISLATION ESTABLISHING A COMPETITIVE BIDDING PROCESS UNDER MEDICARE COULD REDUCE OUR REVENUES, NET INCOME AND CASH FLOWS.

          MMA instructs the Secretary to establish and implement programs under which competitive acquisition areas are established throughout the United States for contract award purposes for the furnishing of competitively priced items of DME, including oxygen equipment. The program would be implemented in phases such that competition under the program occurs in 10 of the largest MSAs in 2007, 80 of the largest MSAs in 2009, and additional areas after 2009. Items selected for competitive acquisition may be phased in first among the highest cost and highest volume items and services or those items and services that the Secretary determines have the largest savings potential. In carrying out such programs, the Secretary may exempt rural areas and areas with low-population density within urban areas that are not competitive, unless there is a significant national market through mail order for a particular item or service.

          For each competitive acquisition area, the Secretary would conduct a competition under which providers would submit bids to supply certain covered items of DME. Successful bidders would be expected to meet certain program quality standards in order to be awarded a contract and only successful bidders could supply the covered

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