Item 1. Business
General
Lincare Holdings Inc., together with its subsidiaries (“Lincare,” the “Company,” “we” or “our”), is one of the nation’s largest providers of oxygen and other respiratory therapy services to patients in the home. Our customers typically suffer from chronic obstructive pulmonary disease (“COPD”), such as emphysema, chronic bronchitis or asthma, and require supplemental oxygen or other respiratory therapy services in order to alleviate the symptoms and discomfort of respiratory dysfunction. Lincare currently serves approximately 700,000 customers in 48 states through 1,063 operating centers. Lincare Holdings Inc. was incorporated in Delaware in 1990. Our principal executive offices are located at 19387 U.S. Hwy 19 North, Clearwater, Florida 33764, and our telephone number is (727) 530-7700.
The Home Respiratory Market
We estimate that the home respiratory market (including home oxygen equipment and respiratory therapy services) represents in excess of $6.0 billion in annual sales. Growth in the home respiratory market is driven by increases in the number of persons afflicted with COPD, demographic factors that contribute to an increase in the proportion of the U.S. population over the age of 65 years, and the continued trend toward treatment of patients in the home as a lower cost alternative to the acute care setting.
Business Strategy
Our strategy is to increase our market share through internal growth and strategic business acquisitions. Lincare achieves internal growth in existing geographic markets through the addition of new customers and referral sources to our network of local operating centers. In addition, we expand into new geographic markets on a selective basis, either through acquisitions or by opening new operating centers, when we believe such expansion will enhance our business. In 2008, Lincare acquired three local and regional companies with operations in multiple states.
Revenue growth is dependent upon the overall growth rate of the home respiratory market and on our ability to increase market share through effective delivery of high quality equipment and services and selective business acquisitions. Continued cost containment efforts by government and private insurance reimbursement programs have created an increasingly competitive environment, accelerating consolidation trends within the home health care industry.
We will continue our focus on providing oxygen and other respiratory therapy services to patients in the home and to provide home medical equipment and other services where we believe such services will enhance our primary business. In 2008, oxygen and other respiratory therapy services accounted for approximately 92% of Lincare’s net revenues.
Products and Services of Lincare
Lincare primarily provides oxygen and other respiratory therapy services to patients in the home. We also provide a variety of durable medical equipment (“DME”) and home infusion therapies in certain geographic markets. When a physician, hospital discharge planner, or other source refers a patient to one of our operating centers, our customer representative obtains the necessary medical and insurance coverage information and assignment of benefits to Lincare, and coordinates the delivery of patient care. The prescribed therapy is delivered by one of our service representatives or clinicians at the customer’s home, where instruction and training are provided to the customer and the customer’s family regarding appropriate equipment use and maintenance and compliance with the prescribed therapy. Following the initial setup, our service representatives and/or clinicians make periodic visits to the customer’s home, the frequency of which is dictated by the type of therapy prescribed and physician orders. All services and equipment provided by Lincare are coordinated with
the prescribing physician. During the period that we provide services and equipment for a customer, the customer remains under the physician’s care and medical supervision. We employ respiratory therapists, nurses and other qualified clinicians to perform certain training and other functions in connection with our services. Clinicians are licensed where required by applicable law.
The principal products and services provided by Lincare are:
Home Oxygen Equipment. The major types of oxygen delivery equipment are oxygen concentrators and liquid oxygen systems. Each method of delivery has different characteristics that make it more or less suitable to specific customer applications.
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Oxygen concentrators are stationary units that provide a continuous flow of oxygen by filtering ordinary room air. Customers most commonly use concentrators as their primary source of stationary oxygen. These systems are often supplemented with portable gaseous oxygen cylinders or liquid oxygen systems to meet the ambulatory or emergency needs of the customer.
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Liquid oxygen systems are thermally insulated containers of liquid oxygen, generally consisting of a stationary unit and a portable unit, which are most commonly used by customers with significant ambulatory requirements.
Other Respiratory Therapy. Other respiratory therapy services offered by Lincare include the following:
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Nebulizers and associated respiratory medications provide aerosol therapy for customers suffering from COPD and asthma.
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Continuous positive airway pressure devices maintain open airways in customers suffering from obstructive sleep apnea by providing airflow at prescribed pressures during sleep.
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Non-invasive ventilation provides nocturnal ventilatory support for customers with neuromuscular disease and COPD. This therapy improves daytime function and decreases incidence of acute illness.
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Ventilators support respiratory function in severe cases of respiratory failure where the customer can no longer sustain the mechanics of breathing without the assistance of a machine.
Home Infusion Therapy. In certain geographic markets, Lincare provides a variety of home infusion therapies, including parenteral nutrition, intravenous antibiotic therapy, enteral nutrition, chemotherapy, dobutamine infusions, immunoglobulin (IVIG) therapy, continuous pain management and central catheter management.
Lincare also supplies home medical equipment, such as hospital beds, wheelchairs and other supplies that may be required by our customers.
Company Operations
Management. We maintain a decentralized approach to management of our local business operations. Decentralization of managerial decision-making enables our operating centers to respond promptly and effectively to local market demands and opportunities. We believe that the personalized nature of customer requirements and referral relationships characteristic of the home health care business mandate that we maintain a localized operating structure.
Each of our operating centers is managed by a center manager who is responsible and accountable for the operating and financial performance of the center. Service and marketing functions are performed at the local operating level, while strategic development, financial control and operating policies are administered at the corporate level. Reporting mechanisms are in place at the operating center level to monitor performance and ensure field accountability.
A team of area managers directly supervises individual operating center managers, serving as an additional mechanism for assessing and improving performance of our operations. Lincare’s operating centers are served by regional billing centers, which control all of our billing and reimbursement functions.
MIS Systems. We believe that our proprietary management information systems are one of our key competitive advantages. The systems provide management with critical information on a timely basis to measure and evaluate performance levels company-wide. Management reviews monthly reports, including revenues and profitability by individual center, accounts receivable and cash collection performance, equipment controls and utilization, customer activity and manpower trends. We have an in-house staff of computer programmers, which enables us to continually enhance our computer systems in order to provide timely financial and operational information and to respond promptly to changes in reimbursement regulations and policies.
Our billing system has both manual and computerized functions and processes that are designed to maintain the integrity of revenue and accounts receivable. Third-party payors, such as Medicare, that can accommodate electronic claims submission are billed electronically on a daily basis from our central computer system. Paper claims and invoices are generated and billed to various state Medicaid agencies, commercial payors and individual customers when electronic billing is unavailable. Electronic billing expedites the billing process and generally allows us to receive payment more quickly. The medical billing process requires the collection of various paper documents from customers and referral sources. Information such as customer demographics, insurance coverage and verification, prescriptions from physicians, delivery receipts, billing authorizations and assignments of benefits to Lincare, is gathered at the local operating centers and forwarded to our regional billing offices for review and manual input into our billing system. Item codes within the system representing specific products supplied to customers are matched against the Healthcare Common Procedure Coding System (“HCPCS”) for verification and accuracy of billing codes. Price tables within the system containing expected allowable payment amounts are maintained and updated by the regional billing offices based on published Medicare and Medicaid fee schedules and bulletins, as well as contracts and supplier notifications from private insurance companies.
Accounts Receivable Management. We derive a substantial majority of our revenue from reimbursement by third-party payors. We accept assignment of insurance benefits from customers and, in most instances, invoice and collect payments directly from Medicare, Medicaid and private insurance carriers, as well as from customers under co-insurance provisions. The following table sets forth, for the periods indicated, the percentage of our revenues derived from different types of payors.
Third-party reimbursement is a complicated process that involves submission of claims to multiple payors, each having its own specific claim requirements. To operate effectively in this environment, we have designed and implemented a proprietary computer system to decrease the time required for the submission and processing of third-party claims. Our systems are capable of tailoring the submission of claims to the specifications of individual payors. Our in-house information system capabilities also enable reimbursement or regulatory changes to be adjusted quickly. These features serve to decrease the processing time of claims for payment resulting in more rapid collection of accounts receivable.
It is our policy to verify insurance benefits with the responsible third-party payor before or within 48 hours of delivery of products to customers. Medicare beneficiaries provide our service representatives with a Medicare identification card containing the beneficiary’s Health Identification Control Number (“HICN”) at the time of
customer setup and delivery. The existence of an HICN indicates the beneficiary’s eligibility to receive benefits under the Medicare program for covered services. Medicare benefits are not separately verified with the applicable Medicare intermediaries.
Medicare and most other government and commercial payors that provide coverage to Lincare’s customers include a 20 percent co-payment provision in addition to a nominal deductible. Co-payments are generally not collected at the time of service and are invoiced to the customer or applicable secondary payor (supplemental providers of insurance coverage) on a monthly billing cycle as products are provided. A majority of our customers maintain, or are entitled to, secondary or supplemental insurance benefits providing “gap” coverage of this co-payment amount. In the event coverage is denied by the third-party payor, the customer may ultimately be responsible for all services rendered by Lincare.
Sales and Marketing
Favorable trends affecting the U.S. population and home health care have created an environment that has produced increasing demand for the services provided by Lincare. The average age of the American population is increasing and, as a person ages, more health care services are generally required. Further, well-documented changes occurring in the health care industry show a trend toward home care rather than institutional care as a matter of patient preference and cost containment.
Sales activities are generally carried out by our full-time sales representatives located at our local operating centers with assistance from our center managers. In addition to communicating the high quality of our equipment and services, our sales representatives are trained to provide information concerning the benefits of home respiratory care. Sales representatives are often licensed respiratory therapists who are highly knowledgeable in the provision of supplemental oxygen and other respiratory therapies.
Lincare primarily acquires new customers through referrals. Our principal sources of referrals are physicians, hospital discharge planners, prepaid health plans and clinical case managers. Our sales representatives maintain continual contact with these medical professionals.
Lincare’s referral sources recognize our reputation for providing high-quality equipment and service and have historically provided a steady flow of customers. While we view our referral sources as fundamental to our business, no single referral source accounts for more than one percent of our revenues. Lincare has approximately 700,000 active customers, and the loss of any single referral source, customer or group of customers would not materially impact our business.
Lincare has received accreditation from the Community Health Accreditation Program. Accreditation by a national accrediting body represents a marketing benefit to our operating centers and provides for a recognized quality assurance program. Home medical equipment providers are required to be accredited by an authorized accrediting organization in order to participate in Medicare and many private insurance plans.
Acquisitions
In each of 2008 and 2007, we acquired certain operating assets of three companies with operations in multiple states, resulting in the addition of three new operating centers in 2008 and one new operating center in 2007. The aggregate purchase prices for these acquisitions were $29.3 million and $6.0 million in 2008 and 2007, respectively.
Quality Control
We are committed to providing consistently high-quality products and services. Our quality control procedures and training programs are designed to promote greater responsiveness and sensitivity to individual
customer needs and to assure the highest level of quality and convenience to the customer and the referring physician. Licensed respiratory therapists, registered nurses and other clinicians provide professional health care support to our customers and assist in our sales and marketing efforts.
Suppliers
We purchase oxygen and other respiratory equipment from a variety of suppliers. We are not dependent upon any single supplier and believe that our product needs can be met by an adequate number of qualified manufacturers.
Competition
The home respiratory market is a fragmented and highly competitive industry that is served by Lincare, other national providers, and, by our estimates, over 2,000 regional and local providers.
Home respiratory companies compete primarily on the basis of service, not pricing, since reimbursement levels are established by fee schedules promulgated by Medicare and Medicaid or by the individual determinations of private insurance companies. Furthermore, marketing efforts by home respiratory companies are typically directed toward referral sources that generally do not share financial responsibility for the payment of services provided to customers. The relationships between a home respiratory company and its customers and referral sources are highly personal. There is no compelling incentive for either physicians or the patients to alter the relationship, so long as the home respiratory company is providing responsive, professional and high-quality service.
Medicare Reimbursement
As a provider of home oxygen and other respiratory therapy services to the home health care market, we participate in Medicare Part B, the Supplementary Medical Insurance Program, which was established by the Social Security Act of 1965. Providers of home oxygen and other respiratory therapy services have historically been heavily dependent on Medicare reimbursement due to the high proportion of elderly persons suffering from respiratory disease. Durable medical equipment (“DME”), including oxygen equipment, is traditionally reimbursed by Medicare based on fixed fee schedules.
Recent legislation, including 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. MIPPA delays for up to 18 months 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 institutes 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 contains provisions that will negatively impact reimbursement for oxygen equipment beginning in 2009 and negatively impacted reimbursement for DME items subject to capped rental payments beginning in 2007. MMA significantly reduced reimbursement for inhalation drug therapies beginning in 2005, reduced payment amounts for five categories of DME, including oxygen, beginning in 2005, froze payment amounts for other covered DME items through 2007, established a competitive bidding program for DME, and implemented quality standards and accreditation requirements for DME suppliers. These legislative provisions, when fully implemented, will materially and adversely affect our business, financial condition, operating results and cash flows.
The SCHIP Extension Act, which became law on December 29, 2007, reduced Medicare reimbursement amounts for covered Part B drugs, including inhalation drugs that we provide, beginning April 1, 2008. The
SCHIP Extension Act required the Centers for Medicare and Medicaid Services (“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. The SCHIP Extension Act also specifically lowered reimbursement for the inhalation drug albuterol. Based on the payment rates published quarterly by CMS for inhalation drugs dispensed in 2008, we estimate that our reimbursement for such drugs was reduced by approximately $72.6 million in 2008. We can not determine whether quarterly updates in ASP pricing data will continue to result in ongoing reductions in payment rates for inhalation drugs, or what impact such payment reductions could have on our business in the future.
On February 1, 2006, Congress passed the DRA legislation which contains provisions that impacted reimbursement for oxygen equipment and DME. DRA changes the reimbursement methodology for oxygen equipment from continuous monthly payment for as long as the equipment is in use by a Medicare beneficiary, which includes payment for oxygen contents, 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 will continue to be made for the period of medical need beyond the 36th month. Additionally, payment for routine maintenance and service of the oxygen equipment, limited to 30 minutes of labor, will 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.
The DRA oxygen provisions and related regulations represent a fundamental change in the Medicare payment system for oxygen. These provisions are complex and are expected to result in profound changes in the provider-customer relationship for oxygen equipment and related services. CMS has published initial claims submission and processing guidelines for providers and Medicare administrative contractors, however, final claims filing and payment instructions are still being developed by CMS.
The financial impact to the Company of the oxygen capped rental regulations will be dependent upon a number of variables, including (i) the number of Medicare oxygen customers reaching 36 months of continuous service, (ii) the number of customers receiving reimbursable oxygen contents beyond the 36-month rental period and the coverage and billing requirements established by CMS for suppliers to receive payment for such oxygen contents, (iii) the ultimate duration of therapy for customers on service beyond 36 months, (iv) the incidence of customers with equipment deemed to be beyond its useful life that may be eligible for new equipment and therefore a new rental period, and the coverage and billing requirements established by CMS for suppliers to receive payment for the period, (v) payment amounts and coverage guidelines established by CMS to reimburse suppliers for maintenance of oxygen equipment, and (vi) the extent to which other government and private payors attempt to adopt new oxygen payment rules similar to those now in effect under Medicare. The Company continues to evaluate these factors in order to determine the expected impact of the regulations, which we believe will have a material adverse effect on our revenues, operating income, cash flows and financial position in 2009 and beyond. The Company has developed a preliminary estimate of the potential reduction in our revenues and operating income in 2009 resulting from the oxygen capped rental regulations of between $130 million and $145 million. The assumptions used to develop this estimate are highly dependent upon the variables listed above, as well as other factors that we may be unable to anticipate. This estimate may be unreliable and subject to change as more information becomes available to the Company.
DRA also changed the reimbursement methodology for items of DME in the capped rental payment category, including but not limited to such items as continuous positive airway pressure (“CPAP”) devices, certain respiratory assist devices, nebulizers, hospital beds and wheelchairs. For such items of DME, payment may not extend over a period of continuous use of longer than 13 months. On the first day that begins after the 13th continuous month during which payment is made for the item, the supplier must transfer title of the item to the beneficiary. Additional payments for maintenance and service of the item are made for parts and labor not
covered by a supplier’s or manufacturer’s warranty. The DME capped rental provisions contained in DRA applied to items furnished for which the first rental month occurred on or after January 1, 2006. Accordingly, the first month in which the new payment methodology impacted our net revenues was February 2007.
On January 26, 2006, CMS announced a final rule revising the payment classification of certain respiratory assist devices (“RADs”). RADs with a backup rate feature were reclassified as capped rental DME items effective April 1, 2006, whereby payments to providers of such devices cease after the 13th continuous month of rental. Prior to the rule, providers were paid a continuous monthly rental amount over the entire period of medical necessity. In cases where Medicare beneficiaries received the item prior to April 1, 2006, only the rental payments for months after the effective date count toward the 13-month cap. Accordingly, the first month in which the new payment methodology impacted our net revenues was May 2007. We estimate that the capped rental changes to DME and RADs reduced our net revenues by approximately $11.4 million in 2007 and by an additional $11.3 million in 2008.
On December 8, 2003, MMA was signed into law. The MMA legislation contains provisions that directly impact reimbursement for the primary respiratory and other DME products provided by Lincare. Among other things, MMA:
(1) Significantly reduced reimbursement for inhalation drug therapies. Historically, prescription drug coverage under Medicare has been limited to drugs furnished incident to a physician’s services and certain self-administered drugs, including inhalation drug therapies. Prior to MMA, Medicare reimbursement for covered drugs, including the inhalation drugs that we provide, was limited to 95 percent of the published average wholesale price (“AWP”) for the drug. MMA established new payment limits and procedures for drugs reimbursed under Medicare Part B. Beginning in 2005, inhalation drugs furnished to Medicare beneficiaries are reimbursed at 106 percent of the volume-weighted average selling price (“ASP”) of the drug, as determined from data provided each quarter by drug manufacturers under a specific formula described in MMA. Implementation of the ASP-based reimbursement formula has resulted in dramatic reductions in payment rates for inhalation drugs since 2005.
(2) Established a competitive acquisition program for DME that was expected to commence in 2008, but was subsequently delayed by further legislation. MMA instructs CMS to establish and implement programs under which competitive acquisition areas will be established throughout the United States for contract award purposes 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 ten of the largest metropolitan statistical areas (“MSAs”) in the first year, 80 of the largest MSAs in the following year, and additional areas thereafter.
For each competitive acquisition area, CMS is to conduct a competition under which providers will submit bids to supply certain covered items of DME. Successful bidders will be expected to meet certain program quality standards in order to be awarded a contract and only successful bidders can supply the covered items to Medicare beneficiaries in the acquisition area. The applicable contract award prices are expected to be less than would be paid under current Medicare fee schedules and contracts will be re-bid at least every three years. CMS will be required to award contracts to multiple entities submitting bids in each area for an item or service, but will have the authority to limit the number of contractors in a competitive acquisition area to the number needed to meet projected demand. CMS may use competitive bid pricing information to adjust the payment amounts otherwise in effect for an area that is not a competitive acquisition area.
CMS concluded the bidding process for the first round of MSAs in September 2007. On March 20, 2008, CMS completed the bid evaluation process and announced the payment amounts that would have taken effect in the ten competitive bidding areas beginning July 1, 2008. Contracts to provide products within the competitive bid areas were awarded to selected suppliers and took effect on July 1, 2008. On July 15, 2008, Congress enacted the MIPPA legislation which retroactively delayed the implementation
of competitive bidding for up to 18 months and reduced Medicare prices nationwide by 9.5% beginning in 2009 for the product categories, including oxygen, that were initially included in competitive bidding. As a result of the delay, CMS cancelled all contract awards retroactively to June 30, 2008.
On January 16, 2009, CMS published its interim final rule for competitive bidding which outlines the process for rebidding the first round of competitive bidding in 2009. The bidding will apply to nine of the original ten MSAs in round one and will be expanded to additional MSAs in 2011. A competition for a national mail order competitive bidding program may occur after 2010. It is unclear at this time when contracts would be awarded under the program and the respective effective dates of the contracts. We will continue to monitor developments regarding the implementation of the competitive bidding program. 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.
The 9.5% reduction in Medicare payment rates imposed by the MIPPA legislation for the product categories, including oxygen, that were initially included in competitive bidding took effect on January 1, 2009. In addition to the 9.5% reduction, CMS 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. We estimate that these price reductions, in aggregate, will reduce our net revenues and operating income by approximately $110 million in 2009.
Federal and state budgetary and other cost-containment pressures will continue to impact the home respiratory care industry. We can not predict whether new federal and state budgetary proposals will be adopted or the effect, if any, such proposals would have on our business.
Government Regulation
The federal government and all states in which we currently operate regulate various aspects of our business. In particular, our operating centers are subject to federal laws regulating interstate motor-carrier transportation and covering the repackaging of oxygen. State laws also govern, among other things, pharmacies, nursing services, distribution of medical equipment and certain types of home health activities 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.
As a health care supplier, Lincare 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 and other regulations, regional health insurance carriers often conduct audits and request customer records and other documents to support 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.
Numerous federal and state laws and regulations, including the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”), govern the collection, dissemination, 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, congressional action or otherwise, could have a significant effect on the manner in which we handle health care related data and communicate with payors, and the cost of complying with these standards could be significant. If we do not comply with existing or new laws and regulations related to patient health information, we could be subject to criminal or civil sanctions.
Health care is an area of rapid regulatory change. Changes in the laws and regulations and new interpretations of existing laws and regulations may affect permissible activities, the relative costs associated with doing business, and reimbursement amounts paid by federal, state and other third-party payors. We can not predict the future of federal, state and local regulation or legislation, including Medicare and Medicaid statutes and regulations. Future legislative and regulatory changes could have a material adverse impact on us.
Employees
As of December 31, 2008, we had 9,957 employees. None of our employees are covered by collective bargaining agreements. We believe that the relations between our management and employees are good.
Environmental Matters
We believe that we are currently in compliance, in all material respects, with applicable federal, state and local statutes and ordinances regulating the discharge of hazardous materials into the environment. We do not believe we will be required to expend any material amounts in order to remain in compliance with these laws and regulations or that such compliance will materially affect our capital expenditures, earnings or competitive position.
Available Information
We maintain an Internet website at http://www.lincare.com. Information contained therein is not incorporated by reference into this annual report, and information contained in the website should not be considered part of this annual report. We make available free of charge through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. We make these reports available on our website as soon as reasonably practicable after such reports are filed with, or furnished to, the Securities and Exchange Commission (the “SEC”).
Materials filed by us with the SEC are also available to the public to read and copy at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. We are an electronic filer with the SEC. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including us, at http://www.sec.gov.
Item 1A.
Item 1A. Risk Factors
Forward-Looking Statements
Statements in this annual 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 Lincare as of the date hereof and Lincare assumes no obligation to update any such forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause Lincare’s 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 Lincare’s ability to attain these estimates include potential reductions in reimbursement rates by government and third party payors, changes in reimbursement policies, the demand for Lincare’s products and services, the availability of appropriate acquisition candidates and Lincare’s ability to
successfully complete and integrate acquisitions, efficient operations of Lincare’s existing and future operating facilities, regulation and/or regulatory action affecting Lincare or its business, economic and competitive conditions, access to borrowed and/or equity capital on favorable terms and other risks described below.
In developing our forward-looking statements, we have made certain assumptions relating to reimbursement rates and policies, internal growth and acquisitions and the outcome of various legal and regulatory proceedings. If the assumptions we use differ materially from what actually occurs, then actual results could vary significantly from the performance projected in the forward-looking statements. We are under no duty to update any of the forward-looking statements after the date of this report.
Certain Risk Factors Relating to the Company’s Business
We operate in a rapidly changing environment that involves a number of risks. The following discussion highlights some of these risks and others are discussed elsewhere in this report. These and other risks could materially and adversely affect our business, financial condition, operating results and cash flows.
A MAJORITY OF OUR CUSTOMERS HAVE PRIMARY HEALTH COVERAGE UNDER MEDICARE PART B, AND RECENTLY ENACTED AND FUTURE CHANGES IN THE REIMBURSEMENT RATES OR PAYMENT METHODOLOGIES UNDER THE MEDICARE PROGRAM COULD MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS.
As a provider of home oxygen and other respiratory 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 68 percent of our customers have primary coverage under Medicare Part B. There are increasing pressures on Medicare to control health care costs and to reduce or limit reimbursement rates for home medical equipment and services. Medicare reimbursement is subject to statutory and regulatory changes, retroactive rate adjustments, administrative and executive orders and governmental funding restrictions, all of which could materially decrease payments to us for the services and equipment we provide.
Recent legislation and coverage policy revisions, including 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. MIPPA delays for up to 18 months 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 institutes 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 contains provisions that will negatively impact reimbursement for oxygen equipment beginning in 2009 and negatively impacted reimbursement for DME items subject to capped rental payments beginning in 2007. MMA significantly reduced reimbursement for inhalation drug therapies beginning in 2005, reduced payment amounts for five categories of DME, including oxygen, beginning in 2005, froze payment amounts for other covered DME items through 2007, established a competitive acquisition program for DME and implemented quality standards and accreditation requirements for DME suppliers. These legislative provisions, when fully implemented, will materially and adversely affect our business, financial condition, operating results and cash flows. See “MEDICARE REIMBURSEMENT” for a full discussion of the MIPPA, SCHIP Extension Act, DRA and MMA provisions.
A SIGNIFICANT PERCENTAGE OF OUR BUSINESS IS DERIVED FROM THE SALE AND RENTAL OF MEDICARE-COVERED OXYGEN AND DME ITEMS, AND RECENT LEGISLATIVE ACTS IMPOSE SUBSTANTIAL CHANGES IN THE MEDICARE PAYMENT METHODOLOGIES AND REDUCTIONS IN THE MEDICARE PAYMENT AMOUNTS FOR THESE ITEMS.
DRA changes the reimbursement methodology for oxygen equipment from continuous monthly payment for as long as the equipment is in use by a Medicare beneficiary, which includes payment for oxygen contents, 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 will continue to be made for the period of medical need beyond the 36th month. Additionally, payment for routine maintenance and service of the oxygen equipment, limited to 30 minutes of labor, will 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.
The DRA oxygen provisions and related regulations represent a fundamental change in the Medicare payment system for oxygen. These provisions are complex, and are expected to result in profound changes in the provider-customer relationship for oxygen equipment and related services. CMS has published initial claims submission and processing guidelines for providers and Medicare administrative contractors, however, final claims filing and payment instructions are still being developed by CMS.
The financial impact to the Company of the oxygen capped rental regulations will be dependent upon a number of variables, including (i) the number of Medicare oxygen customers reaching 36 months of continuous service, (ii) the number of customers receiving reimbursable oxygen contents beyond the 36-month rental period and the coverage and billing requirements established by CMS for suppliers to receive payment for such oxygen contents, (iii) the ultimate duration of therapy for customers on service beyond 36 months, (iv) the incidence of customers with equipment deemed to be beyond its useful life that may be eligible for new equipment and therefore a new rental episode, and the coverage and billing requirements established by CMS for suppliers to receive payment for the period, (v) payment amounts and coverage guidelines established by CMS to reimburse suppliers for maintenance of oxygen equipment, and (vi) the extent to which other government and private payors attempt to adopt new oxygen payment rules similar to those now in effect under Medicare. The Company continues to evaluate these factors in order to determine the expected impact of the regulations, which we believe will have a material adverse effect on our revenues, operating income, cash flows and financial position in 2009 and beyond. The Company has developed a preliminary estimate of the potential reduction in our revenues and operating income in 2009 resulting from the oxygen capped rental regulations of between $130 million and $145 million. The assumptions used to develop this estimate are highly dependent upon the variables listed above, as well as other factors that we may be unable to anticipate. This estimate may be unreliable and subject to change as more information becomes available to the Company.
DRA also changed the reimbursement methodology for items of DME in the capped rental payment category, including but not limited to such items as continuous positive airway pressure (“CPAP”) devices, certain respiratory assist devices, nebulizers, hospital beds and wheelchairs. For such items of DME, payment may not extend over a period of continuous use of longer than 13 months. On the first day that begins after the 13th continuous month during which payment is made for the item, the supplier must transfer title of the item to the beneficiary. Additional payments for maintenance and service of the item are made for parts and labor not covered by a supplier’s or manufacturer’s warranty. The DME capped rental provisions contained in DRA applied to items furnished for which the first rental month occurred on or after January 1, 2006. Accordingly, the first month in which the new payment methodology impacted our net revenues was February 2007.
On January 26, 2006, CMS announced a final rule revising the payment classification of certain respiratory assist devices (“RADs”). RADs with a backup rate feature were reclassified as capped rental DME items
effective April 1, 2006, whereby payments to providers of such devices cease after the 13th continuous month of rental. Prior to the rule, providers were paid a continuous monthly rental amount over the entire period of medical necessity. In cases where Medicare beneficiaries received the item prior to April 1, 2006, only the rental payments for months after the effective date count toward the 13-month cap. Accordingly, the first month in which the new payment methodology impacted our net revenues was May 2007. We estimate that the capped rental changes to DME and RADs reduced our net revenues by approximately $11.4 million in 2007 and by an additional $11.3 million in 2008.
On July 15, 2008, Congress enacted the MIPPA legislation which contains provisions that reduce 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%, thereby reducing the monthly payment rate from $199.28 in 2008 to $175.79 in 2009. We estimate that these price reductions, in aggregate, will reduce our net revenues and operating income by approximately $110 million in 2009.
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. The SCHIP Extension Act also specifically lowered reimbursement for the inhalation drug albuterol. Based on the payment rates published quarterly by CMS for inhalation drugs dispensed in 2008, we estimate that our reimbursement for such drugs was reduced by approximately $72.6 million in 2008. We can not determine whether quarterly updates in ASP pricing data will continue to result in ongoing reductions in payment rates for inhalation drugs, or what impact such payment reductions could have on our business in the future.
RECENT 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 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 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 contract award purposes 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 ten of the largest MSAs in the first year, 80 of the largest MSAs in the following year, and additional areas thereafter.
For each competitive acquisition area, CMS is to conduct a competition under which providers will submit bids to supply certain covered items of DME. Successful bidders will be expected to meet certain program quality standards in order to be awarded a contract and only successful bidders can supply the covered items to Medicare beneficiaries in the acquisition area. The applicable contract award prices are expected to be less than would be paid under current Medicare fee schedules, and contracts will be re-bid at least every three years. CMS will be required to award contracts to multiple entities submitting bids in each area for an item or service, but will have the authority to limit the number of contractors in a competitive acquisition area to the number needed to meet projected demand. CMS may use competitive bid pricing information to adjust the payment amounts otherwise in effect for an area that is not a competitive acquisition area.
CMS concluded the bidding process for the first round of MSAs in September 2007. On March 20, 2008, CMS completed the bid evaluation process and announced the payment amounts that would have taken effect in the ten competitive bidding areas beginning July 1, 2008. Contracts to provide products within the competitive bid areas were awarded to selected suppliers and took effect on July 1, 2008. On July 15, 2008, Congress enacted the MIPPA legislation which retroactively delayed the implementation of competitive bidding for up to 18 months and reduced Medicare prices nationwide by 9.5% beginning in 2009 for the product categories, including oxygen, that were initially included in competitive bidding. As a result of the delay, CMS cancelled all contract awards retroactively to June 30, 2008.
On January 16, 2009, CMS published its interim final rule for competitive bidding which outlines the process for rebidding the first round of competitive bidding in 2009. The bidding will apply to nine of the original ten MSAs in round one and will be expanded to additional MSAs in 2011. A competition for a national mail order competitive bidding program may occur after 2010. It is unclear at this time when contracts would be awarded under the program and the respective effective dates of the contracts. We will continue to monitor developments regarding the implementation of the competitive bidding program. 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.
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 6% of our customers are eligible for primary Medicaid benefits, and State Medicaid programs fund approximately 13% 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 24% of our customers and approximately 33% 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-insurance provisions. Approximately 47% of our revenues are derived from Medicare, 33% from private insurance carriers, 13% 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 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 AND STATE 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 RESULTS OF OPERATIONS.
The federal government and all states in which we operate regulate many aspects of our business. In particular, our operating centers are subject to federal laws that regulate the repackaging of drugs (including oxygen) and interstate motor-carrier transportation. Our operations also are subject to state laws governing, among other things, pharmacies, nursing services, distribution of medical equipment and certain types of home health activities. Certain of our employees are subject to state laws and regulations governing the ethics and professional practices of respiratory therapy, pharmacy and nursing.
As a health care supplier, we are subject to extensive government regulation, including numerous laws directed at preventing fraud and abuse and laws regulating reimbursement under various government programs. The marketing, billing, documenting and other practices of health care companies are all subject to government scrutiny. To ensure compliance with Medicare and other regulations, regional carriers often conduct audits and request customer records and other documents to support our claims for payment. Similarly, government agencies periodically open investigations and obtain information from health care providers pursuant to 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.
Health care is an area of rapid regulatory change. Changes in the law and new interpretations of existing laws may affect permissible activities, the costs associated with doing business, and reimbursement amounts paid by federal, state and other third-party payors. We can not predict the future of federal, state and local regulation or legislation, including Medicare and Medicaid statutes and regulations, or possible changes in national health care policies. Future legislation and regulatory changes could have a material adverse effect on our business.
WE ARE SUBJECT TO A CORPORATE INTEGRITY AGREEMENT WITH THE OFFICE OF INSPECTOR GENERAL, AND IF WE FAIL TO COMPLY WITH THE TERMS OF THE CORPORATE INTEGRITY AGREEMENT, WE COULD SUFFER SEVERE CRIMINAL, CIVIL OR ADMINISTRATIVE SANCTIONS.
We are subject to a five-year corporate integrity agreement with the Office of Inspector General that began in May 2006. Violations of the terms of the corporate integrity agreement could result in severe criminal, civil and administrative penalties and sanctions, including disqualification from Medicare and other reimbursement programs.
COMPLIANCE WITH REGULATIONS UNDER THE FEDERAL HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996 AND RELATED RULES, OR HIPAA, RELATING TO THE TRANSMISSION AND PRIVACY OF HEALTH INFORMATION COULD IMPOSE ADDITIONAL SIGNIFICANT COSTS ON OUR OPERATIONS.
Numerous federal and state laws and regulations, including HIPAA, govern the collection, dissemination, use and confidentiality of patient-identifiable health information. HIPAA requires us to comply with standards for the use and disclosure of health information within our company and with third parties. HIPAA also includes 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. Each set of HIPAA regulations 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.
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. New health information standards, whether implemented pursuant to HIPAA 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 are 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.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
Lincare owns its headquarters facility located in Clearwater, Florida and two of its 1,063 operating center locations. Lincare’s other 1,061 operating center locations are leased from unrelated third parties. Each operating center is a combination warehouse and office, with warehouse space generally comprising about half of the facility. Warehouse space is used for storage of adequate supplies of equipment and accessories necessary to conduct our business. We also lease 32 separate billing office locations from unrelated third parties.
Item 3.
Item 3. Legal Proceedings
As a health care provider, 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 and other regulations, regional carriers often conduct audits and request patient records and other documents to support claims submitted by Lincare for payment of services rendered to customers. Similarly, government agencies periodically open investigations and obtain information from health care providers pursuant to 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.
From time to time, the Company receives inquiries from various government agencies requesting customer records and other documents. It has been the Company’s policy to cooperate with all such requests for information. However, the Company can provide 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. We are a defendant in certain qui tam proceedings. The government has declined to intervene for purposes other than dismissal in all unsealed qui tam actions of which we are aware and we are vigorously defending these suits.
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 such inquiries and vigorously defend any administrative complaints. The Company can provide no assurances as to the duration or outcome of these inquiries and/or complaints.
We are also involved in certain other claims and legal actions arising in the ordinary course of our business. The ultimate disposition of all such matters is not currently expected to have a material adverse impact on our financial position, results of operations or liquidity.
We are subject to a five-year corporate integrity agreement with the Office of Inspector General that began in May 2006. Violations of the corporate integrity agreement can result in severe criminal, civil and administrative penalties and sanctions, including disqualification from Medicare and other reimbursement programs.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of our stockholders during the fourth quarter of 2008.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the NASDAQ Global Market under the symbol LNCR. The following table sets forth the high and low sales prices as reported by NASDAQ for the periods indicated.
As of January 31, 2009, there were approximately 346 holders of record of the 74,393,068 outstanding shares of Lincare common stock. The closing price of Lincare common stock on January 30, 2009, was $24.05 per share, as reported on the NASDAQ Global Market.
We have not paid any cash dividends on our capital stock and do not anticipate paying cash dividends in the foreseeable future. It is the present intention of our Board of Directors to retain all earnings in order to support the future growth of our business and, from time to time, when authorized by our Board of Directors, to repurchase our common stock on the open market.
Performance Graph
The following graph shows changes over the last five years in the value of $100 invested in Lincare’s common stock, the NASDAQ Health Services Stocks Index, and the NASDAQ Stock Market (U.S.) Index. The value of each investment is based on share price appreciation, with reinvestment of all dividends. The investments are assumed to have occurred at the beginning of the period presented.
The performance graph shall not be deemed incorporated by reference by any general statement incorporating by reference this annual report into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that we specifically incorporate this information by reference, and shall not otherwise be deemed filed under such acts.
ISSUER PURCHASES OF EQUITY SECURITIES
During the year ended December 31, 2008, the Company repurchased approximately 1.0 million shares of its common stock at a cost of approximately $35.2 million. There were no repurchases of our common stock by the Company during the fourth quarter of 2008.
On February 14, 2006, the Board 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. On January 23, 2007 and October 23, 2007, the Board approved modifications to the formula to increase the ratio of net debt to cash flow to allow additional share repurchases. As of December 31, 2008, $335.7 million of common stock was eligible for repurchase in accordance with the formula.
The following table sets forth information as of the end of fiscal year 2008 with respect to compensation plans under which equity securities are authorized for issuance.
Securities Authorized for Issuance Under Equity Compensation Plans
(1) Includes 8.3 million shares that are reserved for issuance under various stock option plans and 0.9 million shares that were issued under the Company’s Restricted Stock program.
Item 6.
Item 6. Selected Financial Data
The selected consolidated financial data presented below the caption “Statements of Operations Data” for the years ended December 31, 2008, 2007, 2006, 2005, and 2004, and the caption “Balance Sheet Data” as of December 31, 2008, 2007, 2006, 2005 and 2004 are derived from our consolidated financial statements audited by KPMG LLP, an independent registered public accounting firm.
The data set forth below are qualified by reference to, and should be read in conjunction with, the consolidated financial statements and accompanying notes, Management’s Discussion and Analysis of Financial Condition and Results of Operations and Certain Risk Factors Relating to the Company’s Business included in this report.
(1) Figures reflect the application of the “if converted” method of accounting for our 3.0% convertible debentures in accordance with EITF Issue No. 04-8, effective for reporting periods ending after December 15, 2004. The debentures were redeemed in full at par value in the amount of $275.0 million on June 15, 2008, pursuant to a notice of redemption.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
We continue to pursue a strategy of increasing market share in existing and surrounding geographic markets through internal growth and selective acquisition of local and regional companies. In addition, we will continue to expand into new geographic markets on a selective basis, either through acquisition or by opening new operating centers, when we believe it will enhance our business. Our focus remains primarily on oxygen and other respiratory therapy services, which represent approximately 92% of our revenues.
Critical Accounting Policies
The consolidated financial statements include the accounts of Lincare Holdings Inc. and its subsidiaries. We have made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles.
Critical accounting policies are those we believe are both most important to the portrayal of our financial condition and operating results and require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Judgments and uncertainties affecting the application of those policies may result in materially different amounts being reported under different conditions or using different assumptions. We consider the following policies to be most critical in understanding the judgments that are involved in preparing our consolidated financial statements.
Revenue Recognition and Accounts Receivable
Our revenues are recognized on an accrual basis in the period in which services and related products are provided to customers and are recorded at net realizable amounts estimated to be paid by customers and third-party payors. Insurance benefits are assigned to the Company and, accordingly, the Company bills on behalf of its customers. The Company’s billing system contains payor-specific price tables that reflect the fee schedule amounts in effect or contractually agreed upon by various government and commercial payors for each item of equipment or supply provided to a customer. The Company has established an allowance to account for sales adjustments that result from differences between the payment amount received and the expected realizable amount. Actual adjustments that result from differences between the payment amount received and the expected realizable amount are recorded against the allowance for sales adjustments and are typically identified and ultimately recorded at the point of cash application or when otherwise determined pursuant to the Company’s collection procedures. We report revenues in our financial statements net of such adjustments.
Certain items provided by the Company are reimbursed under rental arrangements that generally provide for fixed monthly payments established by fee schedules for as long as the patient is using the equipment and medical necessity continues (subject to capped rental arrangements which limit the rental payment periods in some instances and which may result in a transfer of title to the patient at the end of the rental payment period). Once initial delivery of rental equipment is made to the patient, a monthly billing cycle is established based on the initial date of delivery. The Company recognizes rental arrangement revenues ratably over the monthly service period and defers revenue for the portion of the monthly bill that is unearned in accordance with SFAS No. 13, “Accounting for Leases.” No separate payment is earned from the initial equipment delivery and setup process. During the rental period, we are responsible for servicing the equipment and providing routine maintenance, if necessary.
Our revenue recognition policy is consistent with the criteria set forth in Staff Accounting Bulletin 104- Revenue Recognition (“SAB 104”) for determining when revenue is realized or realizable and earned. We recognize revenue in accordance with the requirements of SAB 104 that:
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persuasive evidence of an arrangement exists;
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delivery has occurred;
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the seller’s price to the buyer is fixed or determinable; and
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collectibility is reasonably assured.
Due to the nature of the industry and the reimbursement environment in which we operate, certain estimates are required to record net revenues and accounts receivable at their net realizable values at the time products and/or services are provided. Inherent in these estimates is the risk that they will have to be revised or updated as additional information becomes available. Specifically, the complexity of many third-party billing arrangements and the uncertainty of reimbursement amounts for certain services from certain payors may result in adjustments to amounts originally recorded. Such adjustments are typically identified and recorded at the point of cash application, claim denial or account review.
Included in accounts receivable are earned but unbilled receivables. Unbilled accounts receivable represent charges for equipment and supplies delivered to customers for which invoices have not yet been generated by the billing system. Prior to the delivery of equipment and supplies to customers, we perform certain certification and approval procedures to ensure collection is reasonably assured and that unbilled accounts receivable are recorded at net amounts expected to be paid by customers and third-party payors. Billing delays, 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, interim transactions occurring between cycle billing dates established for each customer within the billing system and business acquisitions awaiting assignment of new provider enrollment identification numbers. In the event that a third-party payor does not accept the claim for payment, the customer is ultimately responsible.
We perform analyses to evaluate the net realizable value of accounts receivable. Specifically, we consider historical realization data, accounts receivable aging trends, other operating trends and relevant business conditions. Because of continuing changes in the health care industry and third-party reimbursement, it is possible that our estimates could change, which could have a material impact on our operations and cash flows.
Bad Debt Expense, Sales Adjustments and Related Allowances for Uncollectible Accounts Receivable
Accounts receivable are reported net of allowances for sales adjustments and uncollectible accounts. The majority of our accounts receivable are due from Medicare, Medicaid and private insurance carriers, as well as from customers under co-insurance provisions. Third-party reimbursement is a complicated process that involves submission of claims to multiple payors, each having its own claims requirements. In some cases, the ultimate collection of accounts receivable subsequent to the service dates may not be known for several months. Bad debt is recorded as an operating expense and consists of billed charges that are ultimately deemed uncollectible due to the customer’s or third-party payor’s inability or refusal to pay. We record bad debt expense based on a percentage of revenue using historical Company-specific data. The percentage and amounts used to record bad debt expense and the allowance for doubtful accounts are supported by various methods, including current and historical cash collections, bad debt write-offs, and aging of accounts receivable. Our proprietary management information systems are utilized to provide this data in order to assess bad debts. In the event that collection results of existing accounts receivable are not consistent with historical experience, there may be a need to increase our allowances for doubtful accounts, which may materially impact our financial position or results of operations. The Company has established an allowance to account for sales adjustments that result from differences between the payment amounts received from customers and third-party payors and the expected realizable amounts. Actual adjustments that result from such differences are recorded against the allowance for sales adjustments and are typically identified and ultimately recorded at the point of cash application or when otherwise determined pursuant to the Company’s collection procedures. We report revenues in our financial statements net of such adjustments.
Business Acquisition Accounting
The Financial Accounting Standards Board’s Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets,” provide
guidance on the application of generally accepted accounting principles for business acquisitions. We apply the purchase method of accounting for business acquisitions, and use available cash from operations, borrowings under our revolving credit agreement and the assumption of certain liabilities as the consideration for business acquisitions. We allocate the purchase price of our business acquisitions based on the fair market value of identifiable tangible and intangible assets. The difference between the total cost of the acquisition and the sum of the fair values of acquired tangible and identifiable intangible assets less liabilities is recorded as goodwill.
Goodwill and Other Intangible Assets
We have recorded intangible assets, including goodwill and customer and contract relationships, in connection with business acquisitions. Estimated useful lives of amortizable intangible assets are determined by management based on an assessment of the period over which the asset is expected to contribute to future cash flows. The allocation of amortizable intangible assets impacts the amounts allocable to goodwill.
In accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” we perform a goodwill impairment test using a two-step method on an annual basis or whenever events or circumstances indicate that the carrying value may not be recoverable. The recoverability of goodwill is measured at the reporting unit level.
The first step of the impairment analysis compares the Company’s fair value to its net book value to determine if there is an indicator of impairment. If the assessment in the first step indicates impairment then the Company performs step two. The second step compares the implied fair value of goodwill to its carrying amount in a manner similar to a purchase price allocation for a business combination. If the carrying amount of goodwill exceeds its implied fair value, an impairment loss is recognized equal to that excess.
In determining fair value, SFAS No. 142 allows for the use of several valuation methodologies, although it states quoted market prices are the best evidence of fair value. The Company calculates its fair value using two different approaches. The first approach utilizes the closing market price of its common stock at the annual impairment testing date and the number of shares of common stock outstanding on that date.
The second approach utilizes a discounted cash flow projection which is based on assumptions that are consistent with the Company’s best estimates of future growth and the strategic plan used to manage the underlying business. Factors requiring significant judgment include the future cash flows, growth rates, discount factors and tax rates, amongst other considerations. Changes in economic and operating conditions impacting these assumptions could result in goodwill impairment in future periods.
We completed the annual impairment test during the third quarter of 2008 and determined that no impairment existed as of the date of the impairment test. No recent events or circumstances have occurred to indicate that impairment may exist.
Long-Lived Assets
In accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we review property, plant and equipment and amortizable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of property, plant and equipment is measured by comparing its carrying value to the undiscounted projected future cash flows that the asset(s) are expected to generate. If the carrying amount of an asset is not recoverable, we recognize an impairment loss based on the excess of the carrying amount of the long-lived asset over its respective fair value, which is generally determined as the present value of estimated future cash flows or at the appraised value. The impairment analysis is based on significant assumptions of future results made by management, including revenue and cash flow projections. Circumstances that may lead to impairment of property, plant and equipment include a significant decrease in the market price of a long-lived
asset, a significant adverse change in the extent or manner in which a long-lived asset is being used or in its physical condition and a significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset including an adverse action or assessment by a regulator. We performed a recoverability test during the fourth quarter of 2008 in consideration of certain regulatory changes affecting Medicare reimbursement in 2009 and beyond and determined the carrying value of our long-lived assets are recoverable from undiscounted projected future cash flows.
Contingencies
We are involved in certain claims and legal matters arising in the ordinary course of business. The Financial Accounting Standards Board’s Statement of Financial Accounting Standards (“SFAS”) No. 5, “Accounting for Contingencies,” provides guidance on the application of generally accepted accounting principles related to contingencies. We evaluate and record liabilities for contingencies based on known claims and legal actions when it is probable a liability has been incurred and the liability can be reasonably estimated.
Results of Operations
Net Revenues
The following table sets forth for the periods indicated a summary of our net revenues by product category:
Net revenues for the year ended December 31, 2008 increased by $68.6 million, an increase of 4.3% above net revenues for 2007. The 4.3% increase in net revenues in 2008 was comprised of 9.1% internal growth and 0.3% acquisition growth, partially offset by $80.9 million of Medicare price reductions taking effect in 2008 (see “Medicare Reimbursement”). Net revenues for the year ended December 31, 2007 increased by $186.2 million, an increase of 13.2% above net revenues for 2006. The 13.2% increase in net revenues in 2007 was comprised of 11.3% internal growth and 3.5% acquisition growth partially offset by $22.3 million of Medicare price reductions taking effect in 2007. The internal growth in net revenues is attributable to underlying growth in the market for our products and increased market share resulting primarily from our reputation for high quality equipment and customer service. Growth in net revenues from acquisitions is attributable to the effects of acquisitions of local and regional companies and is estimated based on the contribution to net revenues for the four quarters following such acquisitions. During 2008 and 2007, we completed the acquisition of three businesses with annual revenues of approximately $13.3 million and three businesses with annual revenues of approximately $4.3 million, respectively.
The contribution of oxygen and other respiratory therapy products to our net revenues was 91.7%, 92.1% and 91.9%, respectively, for the years ended December 31, 2008, 2007 and 2006. Our strategy is to focus on the provision of oxygen and other respiratory therapy services to patients in the home and to provide home medical equipment and other services where we believe such services will enhance our core respiratory business.
Cost of Goods and Services
Cost of goods and services as a percentage of net revenues was 24.1% for the year ended December 31, 2008, 24.4% for the year ended December 31, 2007 and 22.4% for the year ended December 31, 2006. Cost of goods and services increased by $10.9 million, or 2.8%, in 2008 and $73.8 million, or 23.3% in 2007. The increase in cost of
goods and services in 2008 is attributable primarily to higher oxygen costs related to an increase in the number of oxygen customers on service and higher costs of CPAP supplies and accessories due to growth in our sleep therapy product lines. We also experienced an increase in enteral nutrition and infusion therapy costs associated with higher customer volumes. The increase in cost of goods and services in 2007 is attributable primarily to an increase in drug purchasing costs due to a product mix shift away from compounded to higher cost commercially-available products in our inhalation drug business as a result of a determination by CMS to eliminate Medicare coverage of compounded medications as of July 1, 2007. Also contributing to higher cost of goods and services in 2007 were increased sales of medical supplies and nutritional products to pediatric customers associated with our acquisition of the business of a pediatric respiratory provider in the fourth quarter of 2006.
Cost of goods and services includes the cost of equipment (excluding depreciation of $83.1 million, $82.6 million and $68.6 million in 2008, 2007 and 2006, 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 $47.5 million, $48.8 million and $49.2 million in 2008, 2007 and 2006, respectively. Included in cost of goods and services for the year ended December 31, 2008 are salary and related expenses of pharmacists and pharmacy technicians of $11.7 million. Such salary and related expenses for the years ended December 31, 2007 and 2006 were $10.5 million and $10.3 million, respectively.
Operating and Other Expenses
Operating expenses as a percentage of net revenues for the years ended December 31, 2008, 2007 and 2006 were 23.8%, 22.9% and 23.5%, respectively. Operating expenses in 2008 and 2007 increased by $30.7 million, or 8.4%, and $33.1 million, or 10.0%, respectively, when compared with the prior year periods. The increase in operating expenses in 2008 is attributable to higher payroll and related expenses from employee headcount increases, partially offset by gains in productivity, and significantly higher vehicle and related expenses caused primarily by higher fuel prices. The increase in operating expenses in 2007 resulted from higher payroll and related expenses, partially attributable to the acquisition of a business at the end of 2006, and an increase in rent and other facility expenses due to expansion in the number of operating centers.
The Company manages over 1,000 operating centers from which customers are provided equipment, supplies and services. An operating center averages approximately seven to eight employees and is typically comprised of a center manager, two customer service representatives (referred to as “CSR’s”-telephone intake, scheduling, documentation), two or three service representatives (referred to as “Service Reps”-delivery, maintenance and retrieval of equipment and delivery of disposables), a respiratory therapist (non-reimbursable and discretionary clinical follow-up with the customer and communication to the prescribing physician) and a sales representative (marketing calls to local physicians and other referral sources).
The Company includes in operating expenses the costs incurred at the Company’s operating centers for certain service personnel (center manager, CSR’s 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 years ended December 31, 2008, 2007 and 2006 within these major categories were as follows:
Included in operating expenses during the year ended December 31, 2008 are salary and related expenses for Service Reps in the amount of $108.9 million. Such salary and related expenses for the years ended December 31, 2007 and 2006 were $100.0 million and $91.2 million, respectively.
Selling, general and administrative expenses (“SG&A”) as a percentage of net revenues for the years ended December 31, 2008, 2007 and 2006, were 19.6%, 19.9%, and 20.7%, respectively. SG&A expenses in 2008 increased by $9.2 million, or 2.9%, compared with the prior year period. Contributing to the increase in SG&A expenses in 2008 were higher payroll costs included in selling and field administration and higher stock-based compensation expense, partially offset by cost controls at our corporate administration and billing office locations and lower advertising expenses. SG&A expenses in 2007 increased by $26.1 million, or 8.9%, compared with the prior year period. Contributing to the increase in SG&A expenses in 2007 were higher payroll costs included in selling expenses and higher liability insurance expenses, partially offset by cost controls at our administrative, field overhead and billing office locations and lower stock-based compensation expense.
SG&A expenses include costs related to sales and marketing activities, clinical respiratory services, corporate overhead and other business support functions. Included in SG&A during the year ended December 31, 2008 are salary and related expenses of $238.4 million. These salary and related expenses include the cost of the Company’s respiratory therapists in the amount of $66.4 million during 2008. The Company’s respiratory therapists generally provide non-reimbursable and discretionary clinical follow-up with the customer and communication, as appropriate, to the prescribing physician with respect to the customer’s plan of care. The Company includes the salaries and related expenses of its respiratory therapist personnel (licensed respiratory therapists or, in some cases, registered nurses) in SG&A because it believes that these personnel enhance the Company’s business relative to its competitors that do not employ respiratory therapists. Included in SG&A during the years ended December 31, 2007 and 2006 are salary and related expenses of $226.2 million and $207.9 million, respectively. These salary and related expenses include the cost of the Company’s respiratory therapists in the amount of $63.0 million and $54.0 million during the respective years.
Bad debt expense as a percentage of net revenues was 1.5% for the years ended December 31, 2008, 2007 and 2006. Days sales outstanding (“DSO”) were 38 days at December 31, 2008, compared with 43 days and 42 days at December 31, 2007 and 2006, respectively. While we have achieved consistent results in managing bad debt expense over the past three years, the general economic climate and business acquisition activities may contribute to an increase in our bad debt expense in the future. The collection of deductible balances and co-payment amounts due directly from customers may be negatively affected by weakening economic conditions in the U.S. The integration of acquired companies into our regional billing and collections offices may temporarily disrupt collections, increasing the amount of accounts receivable written off as uncollectible.
Depreciation and amortization expense as a percentage of net revenues was 7.1% for the year ended December 31, 2008 compared with 7.3% and 7.2% for the years ended December 31, 2007 and 2006, respectively. Included in depreciation and amortization expense in the year ended December 31, 2008 is depreciation of medical equipment of $83.1 million and depreciation of other property and equipment of $34.3 million. Included in depreciation and amortization expense in the years ended December 31, 2007 and 2006 is depreciation of medical equipment of $82.6 million and $68.6 million, respectively, and depreciation of other property and equipment of $33.4 million and $31.9 million, respectively.
During 2008, we amortized $0.1 million of intangible assets compared with $0.3 million in 2007 and $1.5 million in 2006. Our net intangible assets were $1.2 billion as of December 31, 2008. Of this total, $0.3 million (consisting of various covenants not-to-compete) is being amortized over periods of one to seven years, $2.0 million (consisting of customer contracts and relationships) is being amortized over a period of 11 years and the remainder represents goodwill.
Operating Income
As shown in the table below, operating income for the years ended December 31, 2008 and 2007 increased $15.5 million and $36.1 million, respectively, when compared to the prior year periods. The increases in operating income in 2008 and 2007 are attributable primarily to revenue growth from increases in customer volumes partially offset by Medicare price reductions impacting the respective periods and by higher costs and expenses as noted above.
Other Income (Expense)
Interest expense for the year ended December 31, 2008 was $23.9 million, compared to $26.5 million and $9.9 million for the years ended December 31, 2007 and 2006, respectively. Interest expense in 2008 was lower than interest expense in 2007 due to the redemption of our $275.0 million of 3.0% convertible debentures in June 2008. Interest expense in 2007 was higher than interest expense in 2006 due to the placement of $550.0 million of 2.75% convertible senior debentures in the fourth quarter of 2007 and higher average balances outstanding under our revolving credit facility. Included in interest expense is amortization of debt issuance costs of $2.7 million, $5.7 million and $1.0 million in 2008, 2007 and 2006, respectively.
Other income (expense) during the year ended December 31, 2008 included a gain of $10.8 million from the recognition of the UBS Put Option offset by an equivalent $10.8 million unrealized loss recorded on the auction rate securities from UBS due to a reclassification of these securities from available-for-sale to trading (see “Liquidity and Capital Resources” and Note 2 to the Consolidated Financial Statements).
Income Taxes
Our income tax expense, deferred tax assets and liabilities and reserves for uncertain tax positions reflect management’s best assessment of estimated future taxes to be paid. We are subject to income taxes at both the federal and numerous state and local jurisdictions.
Deferred income taxes arise from temporary differences between the tax and financial statement recognition of revenue and expense. In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise we consider all available positive and negative evidence.
As of December 31, 2008 we had state income tax net operating loss carryforwards of $2.8 million. We believe that it is more likely than not that the benefit from certain state net operating loss carryforwards will not be realized. In recognition of this risk, we have provided a valuation allowance of $0.1 million on the deferred tax assets relating to these state net operating loss carryforwards.
The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our national operations.
In July 2006, the FASB issued Financial Interpretation (“FIN”) 48, “Accounting for Uncertainty in Income Taxes,” which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS 109, “Accounting for Income Taxes.” FIN 48 provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits. This interpretation also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We adopted FIN 48 effective January 1, 2007.
We recognize tax liabilities in accordance with FIN 48 and we adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which they are determined.
Our effective income tax rate was 37.8% for the year ended December 31, 2008 compared with 37.3% for the years ended December 31, 2007 and 2006, respectively.
Acquisitions
In 2008, the Company acquired certain operating assets of three companies resulting in the addition of three new operating centers. The aggregate cost of these acquisitions was $29.3 million and was allocated to acquired assets as follows: $0.5 million to current assets, $1.3 million to property and equipment, $2.0 million to separately identifiable intangible assets and $25.5 million to goodwill.
In 2007, the Company acquired certain operating assets of three companies resulting in the addition of one new operating center. The aggregate cost of these acquisitions was $6.0 million and was allocated to acquired assets as follows: $0.3 million to current assets, $0.1 million to property and equipment, and $5.6 million to goodwill.
Liquidity and Capital Resources
Our primary sources of liquidity have been internally generated funds from operations, borrowings under credit facilities and proceeds from equity and debt transactions. We have used these funds to meet our capital requirements, which consist primarily of operating costs, capital expenditures, acquisitions, debt service and share repurchases.
At December 31, 2008, our working capital was $119.4 million. At December 31, 2007, our current liabilities exceeded our current assets by $72.3 million, resulting in negative working capital. The working capital deficit in 2007 was primarily attributable to the reclassification of our $275.0 million principal amount of 3.0% Convertible Senior Debentures (the “Debentures”) to a current liability due to the right of the holders to put the securities to us for cash within one year of the December 31, 2007 balance sheet. The Debentures were redeemed in full on June 15, 2008. A significant portion of our assets consists of accounts receivable from third party payors that are responsible for payment for the equipment and services we provide. Our DSO was 38 days as of December 31, 2008 and 43 days as of December 31, 2007. We measure our DSO by dividing our net accounts receivable at the balance sheet date by the product of our latest quarterly net revenues times four, multiplied by 360 days.
Net cash provided by operating activities was $439.1 million for the year ended December 31, 2008, compared with $406.2 million for the year ended December 31, 2007 and $328.7 million for the year ended December 31, 2006. Net cash used in investing and financing activities was $418.1 million, $379.5 million and $312.2 million for the years ended December 31, 2008, 2007 and 2006, respectively. Activity in the year ended December 31, 2008 included our investment of $22.0 million in business acquisitions, net investment in property and equipment of $124.2 million, payments of debt of $452.0 million and $35.2 million in payments to repurchase our common stock, offset by proceeds of $165.0 million from the issuance of debt and proceeds of $11.4 million from the exercise of stock options and issuance of common shares.
As of December 31, 2008, our principal sources of liquidity consisted of approximately $72.7 million of cash and cash equivalents and $363.0 million available under our revolving credit agreement. The revolving credit agreement, dated December 1, 2006, makes available to us up to $390.0 million over a five-year period, subject to certain terms and conditions set forth in the agreement. As of December 31, 2008, there were $27.0 million of standby letters of credit issued under the credit facility.
At December 31, 2008, the Company held $60.4 million of auction rate securities. These securities are variable-rate debt instruments with contractual maturities between the years 2020 and 2041 with interest rates that reset every seven or 35 days pursuant to a bidding process as determined by the underlying security indentures. Under the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” the investments are classified as trading securities and are carried at fair value, with any realized and unrealized gains and losses included in other income and expense.
During the first quarter of 2008, the Company reclassified all of its investments in auction rate securities from short-term to long-term investments. Of the auction rate securities held as of December 31, 2008, $60.4 million are secured by pools of student loans guaranteed by state-designated guaranty agencies or monoline insurers or reinsured by the United States government. All of the auction rate securities held by the Company are senior obligations under the applicable indentures authorizing the issuance of such securities. Recent turmoil in the credit markets has resulted in widespread failures to attract demand for such securities at the periodic auction dates occurring subsequent to December 31, 2007. As of December 31, 2008, all of the securities held by the Company continued to experience auction failures, resulting in our continuing to hold such securities.
All of the auction rate securities owned by the Company were purchased from UBS Financial Services, Inc., a subsidiary of UBS AG (“UBS”), and are held, for the benefit of the Company, by UBS. On August 8, 2008, UBS announced a settlement in principle with the Securities and Exchange Commission, the New York Attorney General and other state regulatory agencies to restore liquidity to remaining clients who hold auction rate securities. In November 2008, the Company accepted an offer (the “UBS Put Option”) from UBS to sell to it at par value all of the Company’s remaining auction rate securities in accordance with the terms of the settlement agreement. Under the settlement agreement, the Company will be able to redeem all of its auction rate securities at par during a two-year time period beginning June 30, 2010, while UBS may purchase all or some of the auction rate securities at par from the Company at any time through July 2, 2012. Pursuant to the Company’s acceptance of the offer, UBS purchased a portion of the Company’s then outstanding holdings of auction rate securities at par on November 6, 2008 in the amount of $32.5 million. The Company elected to measure the UBS Put Option under the fair value option of SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115”, and recorded other income of approximately $10.8 million before income taxes, and recorded a corresponding long term investment. The Company valued the UBS Put Option using a discounted cash flow approach that takes into account certain estimates for interest rates and the timing and amount of expected future cash flows, adjusted for any bearer risk associated with UBS’s financial ability to repurchase the ARS beginning June 30, 2010. These assumptions are volatile and subject to change as the underlying sources of these assumptions and market conditions change. Simultaneously, the Company transferred these auction rate securities from available-for-sale to trading securities. As a result of this transfer, the Company recognized an unrealized loss recorded to other expense of approximately $10.8 million before income taxes. The recording of the UBS Put Option and the recognition of the unrealized loss resulted in no net impact to the consolidated statements of operations for the three and twelve month periods ended December 31, 2008. The Company anticipates that any future changes in the fair value of the UBS Put Option will be offset by the changes in the fair value of the related auction rate securities with no material net impact to the consolidated statements of operations. The UBS Put Option will continue to be measured at fair value until the earlier of its maturity or exercise.
We will continue to monitor credit market conditions to assess the liquidity of our investments and access to external sources of capital. Due to our ability to access our cash and cash equivalents, amounts available under our revolving credit facility, and our expected operating cash flows, we believe that we have adequate liquidity available to meet our obligations.
On February 14, 2006, our Board of Directors authorized a share repurchase plan whereby the Company may repurchase from time to time, on the open market or in privately negotiated transactions, shares of the Company’s common stock in amounts determined pursuant to a formula (the “share repurchase formula”) that takes into account both the ratio of the Company’s net debt to cash flow and its available cash resources and
borrowing availability. On January 23, 2007 and October 23, 2007, our Board of Directors approved modifications to the share repurchase formula to increase the ratio of debt to cash flow to allow additional share repurchases. During the year ended December 31, 2008, the Company repurchased and retired 1,009,250 shares for $35.2 million pursuant to the repurchase plan. As of December 31, 2008, $335.7 million of the Company’s common stock was eligible for repurchase in accordance with the amended formula.
On October 31, 2007, we completed the sale of $275.0 million principal amount (including exercise of a $25.0 million over-allotment option) of convertible senior debentures due 2037-Series A (the “Series A Debentures”) and $275.0 million principal amount (including exercise of a $25.0 million over-allotment option) of convertible senior debentures due 2037-Series B (the “Series B Debentures” and together with the Series A Debentures, the “Series Debentures”) in a private placement. The Series Debentures pay interest semi-annually at a rate of 2.75% per annum. The Series Debentures are unsecured and unsubordinated obligations and will be convertible under specified circumstances based upon a base conversion rate, which, under certain circumstances, will be increased pursuant to a formula that is subject to a maximum conversion rate. Upon conversion, holders of the Series Debentures will receive cash up to the principal amount, and any excess conversion value will be delivered in shares of our common stock or in a combination of cash and shares of common stock, at our option. The initial base conversion rate for the Debentures is 19.5044 shares of common stock per $1,000 principal amount of Series Debentures, equivalent to an initial base conversion price of approximately $51.27 per share. In addition, if at the time of conversion the applicable price of our common stock exceeds the base conversion price, holders of the Series A Debentures and Series B Debentures will receive an additional number of shares of common stock per $1,000 principal amount of the Debentures, as determined pursuant to a specified formula. We will have the right to redeem the Series A Debentures and the Series B Debentures at any time after November 1, 2012 and November 1, 2014, respectively. Holders of the Series Debentures will have the right to require us to repurchase for cash all or some of their Series Debentures upon the occurrence of certain fundamental change transactions or on November 1, 2012, 2017, 2022, 2027 and 2032 in the case of the Series A Debentures and November 1, 2014, 2017, 2022, 2027 and 2032 in the case of the Series B Debentures.
In May 2008, the Financial Accounting Standards Board (“FASB”) issued FSP APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement).” FSP APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. Upon adoption, the debt component of such instrument would be recognized by measuring the fair value of a similar liability that does not have an associated equity component. The equity component of such instrument would be recognized as the difference between the proceeds from the issuance of the note and the fair value of the liability component. The FSP requires accretion of the resultant debt discount (equal to the proceeds allocated to the equity component) over the expected life of the debt.
We have 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, we have estimated that instruments similar to the Series A and B notes 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. To the extent that the initial proceeds of the instruments exceed the fair value of the liability components as estimated in the preceding sentence, we will recognize an equity component. As a result, we estimate that, upon adoption, approximately $47.4 million and $67.2 million of the carrying value of the Company’s Series A and B convertible notes will be reclassified to equity as of the October 31, 2007 issuance date. These amounts represent the equity components of the proceeds from the notes. We will also recognize debt discounts equal to the equity components which will be accreted to interest expense over the respective 5 and 7-year terms of the first put option dates specified in the indentures underlying the notes. The accreted interest plus the cash interest payments based on the stated coupon rates will result in interest cost being recognized in the income statement that will reflect the interest rates on similar instruments without a conversion option.
Debt issuance costs (which are amortized to interest expense) do not include issuance costs allocated to the equity component (which are recorded as a reduction of the proceeds allocated to the equity component by means of a credit to additional paid in capital). The basis of the liability component in accordance with the FSP and the liability in accordance with tax accounting will result in a deferred tax liability recorded at initial recognition which will reduce additional paid in capital. The initial deferred tax liability will be equal to the initial debt discount times the Company’s tax rate. The deferred tax liability will subsequently be amortized out of additional paid in capital as the debt discount is amortized. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company will adopt FSP APB 14-1 beginning in the first quarter of fiscal 2009, and this standard must be applied on a retrospective basis.
Accordingly, we estimate that the pre-tax increase in non-cash interest expense to be recognized on our consolidated financial statements using our estimated comparable straight debt borrowing rates at the date of issuance of the Series Debentures would be as follows (in thousands):
(1) These interest costs are related solely to the amortization of the debt discount. Debt issuance costs are not considered in this calculation.
In June 2003, we completed the sale of $275.0 million aggregate principal amount of 3.0% Convertible Senior Debentures due 2033 (the “Debentures”) in a private placement. The Debentures were convertible into shares of our common stock based on a conversion rate of 18.7515 shares for each $1,000 principal amount of Debentures. Interest on the Debentures was payable at the rate of 3.0% per annum on June 15 and December 15 of each year. On June 15, 2008, we redeemed all of the outstanding Debentures at par pursuant to a notice of redemption. We funded the redemption with $110.0 million of available cash and $165.0 million of borrowings under our revolving credit facility. The entire amount of the borrowings under the credit facility were paid down from operating cash flow by the end of 2008.
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 the next year.
Accounts Receivable: The Company maintains payor-specific price tables in its billing system that reflect the fee schedule amounts statutorily in effect or contractually agreed upon by various government and commercial payors for each item of equipment or supply provided to a customer. Due to the nature of the health care industry and the reimbursement environment in which Lincare operates, situations can occur where expected payment amounts are not established by fee schedules or contracted rates, and estimates are required to record revenues and accounts receivable at their net realizable values. Inherent in these estimates is the risk that revenues and accounts receivable will have to be revised or updated as additional information becomes available. Contractual adjustments to revenues and accounts receivable can result from price differences between allowed
charges and amounts initially recognized as revenue due to incorrect price tables or subsequently negotiated payment rates. Actual adjustments that result from differences between the payment amount received and the expected realizable amount are recorded against the allowance for sales adjustments and are typically identified and ultimately recorded at the point of cash application or account review. We report revenues in our financial statements net of such adjustments. Accounts receivable are reported net of allowances for sales adjustments and uncollectible accounts. Bad debt is recorded as an operating expense and consists of billed charges that are ultimately deemed uncollectible due to the customer’s or third-party payor’s inability or refusal to pay.
The Company’s payor mix is highly concentrated among Medicare, Medicaid and other government third-party payors and contracted private insurance or commercial payors. Government payment rates are determined according to published fee schedules established pursuant to statute, law or other regulatory processes and commercial payment rates are based on contractual line item pricing as reflected in the respective contracts. Fee schedule updates have historically occurred on a prospective basis and have been made available to the Company in advance of the effective date of a change in reimbursement rates. The Company’s proprietary billing system has features that allow the Company to timely update payor price tables within the system as changes occur in order to accurately record revenues and accounts receivable at their expected realizable values. Additional systems and manual controls and processes are used by management to evaluate the accuracy of these recorded amounts. Based on the Company’s experience, it is unlikely that a change in estimate of unsettled amounts from third party payors would have a material adverse impact on its financial position or results of operations.
Accounts receivable balance concentrations by major payor category as of December 31, 2008 and December 31, 2007 were as follows:
Aged accounts receivable balances by major payor category as of December 31, 2008 and December 31, 2007 were as follows:
The Company operates 34 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 December 31, 2008 and 2007, there were 1,361 and 1,322 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 the Company’s 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 the Company can access to determine the status of individual claims. The Company has benefited from the increasing availability of electronic funds transfers from payors, which now account for approximately 71% of all payments received. The Company believes that its collection procedures contribute to its accounts receivable days sales outstanding (“DSO”) and bad debt expense being among the lowest in its industry, according to published industry data and public filings of some of its competitors.
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.
The Company does 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.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
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 bank credit facility and Series Debentures, as well as contractual lease payments for facility, vehicle, and equipment leases and deferred acquisition obligations. The following table presents, in aggregate, scheduled payments under our contractual obligations (in thousands):
(1) Amounts include the Series Debentures due 2037. The Series A Debentures are redeemable by us on or after November 1, 2012, and may be put to us for repurchase on November 1, 2012, 2017, 2022, 2027 and 2032. The Series A Debentures are shown in the table as scheduled for repurchase in 2012 as a result of the put feature. The Series B Debentures are redeemable by us on or after November 1, 2014, and may be put to us for repurchase on November 1, 2014, 2017, 2022, 2027 and 2032.
(2) The Company had gross unrecognized tax benefits, including interest and penalties, of $11.9 million of which we anticipate payment settlement of $0.8 million during 2009. We are unable to determine a reasonable estimate of the payment settlement date or the settlement amount for the remaining balance of $11.1 million in unrecognized tax benefits.
New Accounting Standards
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. The provisions of SFAS No. 157 were effective as of the beginning of the 2008 calendar year. The adoption of SFAS No. 157 did not have a material impact on our financial condition, results of operations or cash flows.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115”. On January 1, 2008 the Company adopted SFAS No. 159 which permits companies to choose to measure certain financial assets and liabilities at fair value (the “fair value option”). The fair value election is irrevocable and may generally be made on an instrument-by-instrument basis, even if a company has similar instruments that it elects not to fair value. At the adoption date, unrealized gains and losses on existing items for which fair value has been elected are reported as a cumulative adjustment to beginning retained earnings. The Company chose not to elect the fair value option for its financial assets and liabilities existing on January 1, 2008, and did not elect the fair value option for any financial assets and liabilities transacted during the twelve months ended December 31, 2008, except for a put option related to the Company’s auction rate securities that was recorded in conjunction with a settlement agreement with one if its investment firms, as more fully described in “Liquidity and Capital Resources” and in Note 2 to the consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” which replaces SFAS No. 141. SFAS No. 141(R) requires an acquirer in a business combination to recognize the assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. It also requires the recognition of assets acquired and liabilities assumed arising from certain contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. The provisions of SFAS No. 141(R) are effective as of the beginning of the 2009 calendar year. The Company is currently evaluating the potential future impact of this standard on its financial condition, results of operations and cash flows.
In February 2008, the FASB issued FSP FAS 157-2, “Effective Date of FASB Statement No. 157,” which delays the effective date of FASB Statement No. 157, “Fair Value Measurements,” to calendar years beginning January 1, 2009. The scope of the proposed deferral applies to all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). We do not expect the adoption of FSP FAS 157-2 to have a material impact on our financial condition, results of operations or cash flows.
In May 2008, the FASB issued FSP APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement).” FSP APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. Upon adoption, the debt component of such instrument would be recognized by measuring the fair value of a similar liability that does not have an associated equity component. The equity component of such instrument would be recognized as the difference between the proceeds from the issuance of the note and the fair value of the liability component. The FSP requires accretion of the resultant debt discount (equal to the proceeds allocated to the equity component) over the expected life of the debt.
FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company will adopt FSP APB 14-1 beginning in the first quarter of fiscal 2009, and this standard must be applied on a retrospective basis. For a full discussion of the impact to the Company’s consolidated financial statements, please refer to “Liquidity and Capital Resources” and to Note 1(v) to the consolidated financial statements.
In October 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a Financial Asset in a Market That Is Not Active,” which clarifies the application of FASB Statement No. 157, “Fair Value Measurements”, in an inactive market and provides an illustrative example to demonstrate how the fair value of a financial asset is determined when the market for that financial asset is inactive. Key existing principles of Statement 157 illustrated in the example include (a) fair value represents the price at which an orderly transaction would take place between market participants; even if there is little or no market activity for an asset at the measurement date, the objective of determining fair value remains the same, (b) in determining fair value, the use of management’s internal assumptions concerning future cash flows discounted at an appropriate risk-adjusted interest rate is acceptable when relevant observable market data do not exist, (c) broker quotes may properly be included as an input when measuring fair value (but such quotes are not necessarily determinative if an active market for the financial asset does not exist). The provisions of FSP FAS 157-3 are effective upon issuance. The adoption of FSP FAS 157-3 did not have a material impact on our financial condition, results of operations or cash flows.
Inflation
We currently do not anticipate any material increases in the near term in either the cost of supplies or operating expenses due to inflation. With reductions in reimbursement by government and private medical insurance programs and pressure to contain the costs of such programs, we bear the risk that reimbursement rates set by such programs will not keep pace with inflation.
Segment Information
We follow Financial Accounting Standards Board Statement of Financial Accounting Standards (“SFAS”) No. 131, “Disclosures about Segments of an Enterprise and Related Information.” SFAS No. 131 utilizes the “management” approach for determining reportable segments. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of our reportable segments. We maintain a decentralized approach to management of our local business operations. Decentralization of managerial decision-making enables our operating centers to respond promptly and effectively to local market demands and opportunities. We provide home health care equipment and services through 1,063 operating centers in 48 states. We view each operating center as a distinct part of a single “operating segment,” as each operating center generally provides the same products to customers. As a result, all of our operating centers are aggregated into one reportable segment.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The fair values of our debt instruments are subject to change as a result of changes in market prices or interest rates. We estimate potential changes in the fair value of interest rate sensitive financial instruments based on a hypothetical increase in interest rates. Our use of this methodology to quantify the market risk of such instruments should not be construed as an endorsement of its accuracy or the accuracy of the related assumptions. The quantitative information about market risk is necessarily limited because it does not take into account anticipated operating and financial transactions.
The following table sets forth the estimated fair value of our long-term obligations (and current portions thereof) and our estimate of the impact from a 10 percent increase in interest rates on the fair value of such obligations and the associated change in annual interest expense.
Market Risk Sensitive Instruments-Interest Rate Sensitivity
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements required by this item are listed in Item 15(a)(1) and are submitted at the end of this Annual Report on Form 10-K. The supplementary data required by this item is included on page S-1. The financial statements and supplementary data are herein incorporated by reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures.
The Company has conducted an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the fiscal year covered by this Annual Report on Form 10-K. Based on its evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company is recorded, processed, summarized and reported within the required time periods.
(b) Management’s Annual Report on Internal Control Over Financial Reporting
Lincare’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). The Company’s internal control system was designed to provide reasonable assurance to management and the board of directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the underlying policies or procedures may deteriorate. Under the supervision and with the participation of management, including Lincare’s Chief Executive Officer and Chief Financial Officer, Lincare conducted an evaluation of the effectiveness of its internal control over financial reporting as of December 31, 2008 based on the framework in Internal Control- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
In conducting Lincare’s evaluation of the effectiveness of its internal control over financial reporting, Lincare has excluded the business and assets acquired in December 2008 from Meridian Healthcare Group, Inc. and its wholly owned subsidiaries. This acquisition constituted approximately 1.0% of total assets as of December 31, 2008 and less than 0.1% of total net revenues and net income for the year then ended.
Based on Lincare’s evaluation under the framework in Internal Control-Integrated Framework, management concluded that internal control over financial reporting was effective as of December 31, 2008.
Lincare’s registered public accounting firm, KPMG LLP, has issued an attestation report on Lincare’s internal control over financial reporting.
(c) Changes in Internal Control Over Financial Reporting
There has been no change in Lincare’s internal control over financial reporting during the fourth fiscal quarter ended December 31, 2008 that has materially affected, or is reasonably likely to materially affect, Lincare’s internal control over financial reporting.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Lincare Holdings Inc.:
We have audited Lincare Holdings Inc. and subsidiaries (Company) internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)”. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting (Item 9A(b)). Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
As indicated in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting excluded the internal controls of the business acquired from Meridian Healthcare Group Inc., which is included in the 2008 consolidated financial statements of the Company and constituted approximately 1% of total assets as of December 31, 2008 and less than 0.1% of total revenues and net earnings for the year then ended. Our audit of internal control over financial reporting of Lincare Holdings Inc. also excluded an evaluation of the internal control over financial reporting of the business referred to above.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2008, and our report dated February 25, 2009 expressed an unqualified opinion on those consolidated financial statements.
(s) KPMG LLP
Tampa, Florida
February 25, 2009
Certified Public Accountants
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers, and Corporate Governance
Directors, Executive Officers, Promoters and Control Persons
Information required to be furnished by Item 401 of Regulation S-K of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), will be included in the definitive proxy statement for the Annual Meeting of Stockholders to be held on May 11, 2009, and is herein incorporated by reference.
Audit Committee
The Company has a standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. Additional information regarding the Audit Committee will be included in the definitive proxy statement for the Annual Meeting of Stockholders to be held on May 11, 2009, and is herein incorporated by reference.
Audit Committee Financial Expert
The Board of Directors has designated William F. Miller, III as the “Audit Committee Financial Expert” as defined by Item 407(d)(5)(ii) of Regulation S-K of the Exchange Act and has determined that he is independent as defined in the listing standards applicable to the Company.
Compliance with Section 16(a) of the Exchange Act
Information required to be furnished by Item 405 of Regulation S-K will be included in the definitive proxy statement for the Annual Meeting of Stockholders to be held on May 11, 2009, and is herein incorporated by reference.
Code of Ethics
The Company has adopted a code of business conduct and ethics that applies to its directors and officers (including its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions) as well as its employees. Copies of the Company’s code of ethics are available without charge upon written request directed to Corporate Secretary, Lincare Holdings Inc., 19387 U.S. 19 North, Clearwater, Florida 33764.
Nominating Committee
Information required to be furnished by Item 407(c)(3) of Regulation S-K will be included in the definitive proxy statement for the Annual Meeting of Stockholders to be held on May 11, 2009, and is herein incorporated by reference.
Item 11.
Item 11. Executive Compensation
Information required to be furnished by Item 402 of Regulation S-K and paragraphs (e)(4) and (e)(5) of Item 407 of Regulation S-K regarding executive compensation will be included in the definitive proxy statement for the Annual Meeting of Stockholders to be held on May 11, 2009, and is herein incorporated by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information required to be furnished by Item 201(d) of Regulation S-K and by Item 403 of Regulation S-K will be included in the definitive proxy statement for the Annual Meeting of Stockholders to be held on May 11, 2009, and is herein incorporated by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information required to be furnished by Item 404 of Regulation S-K and Item 407(a) of Regulation S-K will be included in the definitive proxy statement for the Annual Meeting of Stockholders to be held on May 11, 2009, and is herein incorporated by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
Information required to be furnished by Item 9(e) of Schedule 14A will be included in the definitive proxy statement for the Annual Meeting of Stockholders to be held on May 11, 2009, and is herein incorporated by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) (1) The following consolidated financial statements of Lincare Holdings Inc. and subsidiaries are filed as part of this Form 10-K starting at page:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets-December 31, 2008 and 2007
Consolidated Statements of Operations-Years ended December 31, 2008, 2007 and 2006
Consolidated Statements of Stockholders’ Equity-Years ended December 31, 2008, 2007 and 2006
Consolidated Statements of Cash Flows-Years ended December 31, 2008, 2007 and 2006
Notes to Consolidated Financial Statements
(2) The following consolidated financial statement schedule of Lincare Holdings Inc. and subsidiaries is included in this Form 10-K at page S-1:
Schedule II-Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting regulations of the SEC are not required under the related instructions or are inapplicable, and therefore have been omitted.
(3) Exhibits included or incorporated herein:
See Exhibit Index.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Date: February 25, 2009
/S/ PAUL G. GABOS
Paul G. Gabos
Secretary, Chief Financial Officer and
Principal Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Lincare Holdings Inc.:
We have audited the accompanying consolidated balance sheets of Lincare Holdings Inc. and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2008. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule on page S-1. These consolidated financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and this financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Lincare Holdings Inc. and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Note 10 to the consolidated financial statements, the Company changed its method of quantifying errors in 2006.
As discussed in Note 1(m) to the consolidated financial statements, effective January 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes.
As discussed in Note 1(v) to the consolidated financial statements, effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Lincare Holdings Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)”), and our report dated February 25, 2009 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ KPMG LLP
Tampa, Florida
February 25, 2009
Certified Public Accountants
LINCARE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2008 and 2007
See accompanying notes to consolidated financial statements.
LINCARE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2008, 2007 and 2006
See accompanying notes to consolidated financial statements.
LINCARE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Years Ended December 31, 2008, 2007 and 2006
See accompanying notes to consolidated financial statements.
LINCARE HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2008, 2007 and 2006
See accompanying notes to consolidated financial statements.
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(1) Description of Business and Summary of Significant Accounting Policies
(a) Description of Business
Lincare Holdings Inc. and subsidiaries (the “Company”) provides oxygen, respiratory therapy services, 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. The Company’s equipment and supplies are readily available and the Company is not dependent on a single supplier or even a few suppliers.
(b) Use of Estimates
Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with U.S. generally accepted accounting principles. Actual results could differ from those estimates. It is at least reasonably possible that a change in those estimates will occur in the near term.
(c) Basis of Presentation
The consolidated financial statements include the accounts of Lincare Holdings Inc. and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Certain immaterial amounts in the prior years’ financial statements have been reclassified to conform to the current year presentation.
(d) Revenue Recognition
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 estimated 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 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 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 in accordance with SFAS No. 13, “Accounting for Leases.” 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’s revenue recognition policy is consistent with the criteria set forth in Staff Accounting Bulletin 104-Revenue Recognition (“SAB 104”) for determining when revenue is realized or realizable and earned. The Company recognizes revenue in accordance with the requirements of SAB 104 that:
•
persuasive evidence of an arrangement exists;
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(1) Description of Business and Summary of Significant Accounting Policies (Continued)
•
delivery has occurred;
•
the seller’s price to the buyer is fixed or determinable; and
•
collectibility is reasonably assured.
Due to the nature of the industry and the reimbursement environment in which the Company operates, certain estimates are required to record net revenues and accounts receivable at their net realizable values at the time products are provided. Inherent in these estimates is the risk that they will have to be revised or updated as additional information becomes available. Specifically, the complexity of many third-party billing arrangements and the uncertainty of reimbursement amounts for certain services from certain payors may result in adjustments to amounts originally recorded. Such adjustments are typically identified and recorded 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 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 ultimately be responsible. 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.
The Company accounts for taxes imposed on revenue producing transactions by government authorities on a net basis.
(e) Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all short-term investments with an original maturity of less than three months to be cash equivalents.
(f) Investments
At December 31, 2008, the Company held $60.4 million of auction rate securities. These securities are variable-rate debt instruments with contractual maturities between the years 2020 and 2041 with interest rates that reset every seven or 35 days pursuant to a bidding process as determined by the underlying security
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(1) Description of Business and Summary of Significant Accounting Policies (Continued)
indentures. Under the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” the investments are classified as trading securities and are carried at fair value, with any realized and unrealized gains and losses included in other income and expense.
During the first quarter of 2008, the Company reclassified all of its investments in auction rate securities from short-term to long-term investments. Of the auction rate securities held as of December 31, 2008, $60.4 million are secured by pools of student loans guaranteed by state-designated guaranty agencies or monoline insurers or reinsured by the United States government. All of the auction rate securities held by the Company are senior obligations under the applicable indentures authorizing the issuance of such securities. Recent turmoil in the credit markets has resulted in widespread failures to attract demand for such securities at the periodic auction dates occurring subsequent to December 31, 2007. As of December 31, 2008, all of the securities held by the Company continued to experience auction failures, resulting in our continuing to hold such securities.
All of the auction rate securities owned by the Company were purchased from UBS Financial Services, Inc., a subsidiary of UBS AG (“UBS”), and are held, for the benefit of the Company, by UBS. On August 8, 2008, UBS announced a settlement in principle with the Securities and Exchange Commission, the New York Attorney General and other state regulatory agencies to restore liquidity to remaining clients who hold auction rate securities. In November 2008, the Company accepted an offer (the “UBS Put Option”) from UBS to sell to it at par value all of the Company’s remaining auction rate securities in accordance with the terms of the settlement agreement. Under the settlement agreement, the Company will be able to redeem all of its auction rate securities at par during a two-year time period beginning June 30, 2010, while UBS may purchase all or some of the auction rate securities at par from the Company at any time through July 2, 2012. Pursuant to the Company’s acceptance of the offer, UBS purchased a portion of the Company’s then outstanding holdings of auction rate securities at par on November 6, 2008 in the amount of $32.5 million. The Company elected to measure the UBS Put Option under the fair value option of SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115”, and recorded other income of approximately $10.8 million before income taxes, and recorded a corresponding long term investment. The Company valued the UBS Put Option using a discounted cash flow approach that takes into account certain estimates for interest rates and the timing and amount of expected future cash flows, adjusted for any bearer risk associated with UBS’s financial ability to repurchase the ARS beginning June 30, 2010. These assumptions are volatile and subject to change as the underlying sources of these assumptions and market conditions change. Simultaneously, the Company transferred these auction rate securities from available-for-sale to trading securities. As a result of this transfer, the Company recognized an unrealized loss recorded to other expense of approximately $10.8 million before income taxes. The recording of the UBS Put Option and the recognition of the unrealized loss resulted in no net impact to the consolidated statements of operations for the three and twelve month periods ended December 31, 2008. The Company anticipates that any future changes in the fair value of the UBS Put Option will be offset by the changes in the fair value of the related auction rate securities with no material net impact to the consolidated statements of operations. The UBS Put Option will continue to be measured at fair value until the earlier of its maturity or exercise.
The Company will continue to monitor credit market conditions to assess the liquidity of its investments. Due to the Company’s ability to access its cash and cash equivalents, amounts available under its revolving credit facility, and its expected operating cash flows, the Company believes that it has adequate liquidity available to meet its obligations.
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(1) Description of Business and Summary of Significant Accounting Policies (Continued)
(g) Financial Instruments
The Company believes the book value of its cash equivalents, short-term and long-term investments, accounts receivable, income taxes receivable, accounts payable and accrued expenses approximate fair value. The Company utilizes Level 3 fair value measurements to value its investments. The book value of the Company’s revolving credit agreement and deferred acquisition obligations approximate their fair value as the applicable interest rates approximate rates at which similar types of borrowing arrangements could be currently obtained by the Company. The fair value of the Company’s 2.75% Series A Debentures due 2037 and 2.75% Series B Debentures due 2037 are estimated based on several standard market variables including the Company’s stock price, yield to put/call through conversion and yield to maturity. The estimated fair values of the Series A and Series B Debentures at December 31, 2008 were $230,802,000 and $213,309,250, respectively, and $290,482,500 and $288,337,500, respectively, at December 31, 2007.
(h) Inventories
Inventories, consisting of equipment, supplies and replacement parts, are stated at the lower of cost or market value. Cost is determined using the first-in, first-out (FIFO) method. Inventories are charged to cost of goods and services in the period in which products and related services are provided to customers.
(i) Property and Equipment
Property and equipment is stated at cost. Depreciation on property and equipment is calculated using the straight-line method, including the half year convention, over the estimated useful lives of the assets as set forth in the table below.
Building and improvements
1 year to 39 years
Medical rental equipment
1.5 years to 11 years
Other equipment and furniture
3 years to 25 years
Leasehold improvements are amortized using the straight-line method over the lesser of the lease term or estimated useful life of the asset. Amortization of leasehold improvements is included with depreciation expense.
(j) Goodwill
Goodwill results from the excess of cost over identifiable net assets of acquired businesses.
In accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” the Company performs a goodwill impairment test using a two-step method on an annual basis or whenever events or circumstances indicate that the carrying value may not be recoverable. The recoverability of goodwill is measured at the reporting unit level.
The first step of the impairment analysis compares the Company’s fair value to its net book value to determine if there is an indicator of impairment. If the assessment in the first step indicates impairment then the Company performs step two. The second step compares the implied fair value of goodwill to its carrying amount in a manner similar to a purchase price allocation for a business combination. If the carrying amount of goodwill exceeds its implied fair value, an impairment loss is recognized equal to that excess.
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(1) Description of Business and Summary of Significant Accounting Policies (Continued)
In determining fair value, SFAS No. 142 allows for the use of several valuation methodologies, although it states quoted market prices are the best evidence of fair value. The Company calculates its fair value using two different approaches. The first approach utilizes the closing market price of its common stock at the annual impairment testing date and the number of shares of common stock outstanding on that date.
The second approach utilizes a discounted cash flow projection which is based on assumptions that are consistent with the Company’s best estimates of future growth and the strategic plan used to manage the underlying business. Factors requiring significant judgment include the future cash flows, growth rates, discount factors and tax rates, amongst other considerations. Changes in economic and operating conditions impacting these assumptions could result in goodwill impairment in future periods.
The Company completed the annual impairment test during the third quarter of 2008 and determined that no impairment existed as of the date of the impairment test. No recent events or circumstances have occurred to indicate that impairment may exist.
(k) Other Assets
Other assets principally include capitalized costs of borrowing which are being amortized over the term of the respective debt on the effective interest method.
(l) Impairment or Disposal of Long-Lived Assets
In accordance with FASB Statement No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets,” long-lived assets, such as property, plant, and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposal group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet.
(m) Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the enactment date.
Valuation allowances are established when necessary to reduce deferred tax assets to amounts that the Company believes are more likely than not to be recovered. The Company evaluated its deferred tax assets
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(1) Description of Business and Summary of Significant Accounting Policies (Continued)
quarterly to determine whether adjustments to its valuation allowance are appropriate. In making its evaluation, the Company relies on its recent history of pre-tax earnings, estimated timing of future deductions and benefits represented by the deferred tax assets and its forecast of future earnings, the latter two of which involve the exercise of significant judgment.
Beginning with the adoption of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”, (“FIN 48”) as of January 1, 2007, the Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. Prior to the adoption of FIN 48, the Company recognized the effect of income tax positions only if such positions were probable of being sustained.
The Company recognizes interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying consolidated statements of operations. Accrued interest and penalty are included within the related tax liability line in the consolidated balance sheet.
(n) Advertising Costs
Advertising costs are charged to expense as incurred and are included in selling expenses.
(o) Cost of Goods and Services
Cost of goods and services includes the cost of equipment (excluding depreciation of $83.1 million, $82.6 million and $68.7 million in 2008, 2007 and 2006, 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 $47.5 million, $48.8 million and $49.2 million in 2008, 2007 and 2006, respectively. Included in cost of goods and services are salary and related expenses of pharmacists and pharmacy technicians of $11.7 million, $10.5 million and $10.3 million in 2008, 2007 and 2006, respectively.
(p) Operating Expenses
The Company manages over 1,000 operating centers from which customers are provided equipment, supplies and services. An operating center averages approximately seven to eight employees and is typically comprised of a center manager, two customer service representatives (referred to as “CSR’s”-telephone intake, scheduling, documentation), two or three service representatives (referred to as “Service Reps”-delivery, maintenance and retrieval of equipment and delivery of disposables), a respiratory therapist (non-reimbursable and discretionary clinical follow-up with the customer and communication to the prescribing physician) and a sales representative (marketing calls to local physicians and other referral sources).
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(1) Description of Business and Summary of Significant Accounting Policies (Continued)
The Company includes in operating expenses the costs incurred at the Company’s operating centers for certain service personnel (center manager, CSR’s 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 years ended December 31, 2008, 2007 and 2006 within these major categories were as follows:
Included in operating expenses during the year ended December 31, 2008 are salary and related expenses for Service Reps in the amount of $108.9 million. Such salary and related expenses for the years ended December 31, 2007 and 2006 were $100.0 million and $91.2 million, respectively.
(q) Lease Commitments
The Company leases office space, vehicles and equipment under non-cancelable operating leases, which expire at various dates through 2014. The Company’s operating leases generally have one to four year terms and may have renewal options. The Company records rent expense and amortization of leasehold improvements on a straight-line basis over the initial term of the lease and the Company does not negotiate rent holidays, rent concessions or leasehold improvements in its office leases.
The lease period is determined as the original lease term without renewals, unless and until the exercise of lease renewal options is reasonably assured.
(r) 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 years ended December 31, 2008, 2007 and 2006 are salary and related expenses of $238.4 million, $226.2 million and $207.9 million, respectively. These salary and related expenses include the cost of the Company’s respiratory therapists in the amount of $66.4 million, $63.0 million and $54.0 million during the respective periods. The Company’s respiratory therapists generally provide non-reimbursable and discretionary clinical follow-up with the customer and communication, as appropriate, to the prescribing physician with respect to the customer’s plan of care. The Company includes the salaries and related expenses of its respiratory therapist personnel (licensed respiratory therapists or, in some cases, registered nurses) in SG&A because it believes that these personnel enhance the Company’s business relative to its competitors that do not employ respiratory therapists.
(s) Employee Benefit Plans
The Company has a defined contribution plan covering substantially all employees subject to specific plan requirements. The Company has also sponsored an employee stock purchase plan that enabled eligible employees
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(1) Description of Business and Summary of Significant Accounting Policies (Continued)
to purchase shares of the Company’s common stock at the lower of 85 percent of the fair market value of the Company’s stock price on: (i) the last day of the offering period; or (ii) the last day of the prior offering period. Employees were able to elect to have up to 10% of their base salary withheld on an after-tax basis. Under the employee stock purchase plan, 1.2 million shares were authorized for issuance. To date, 543,160 shares have been issued under this authorization. During 2008, the Company issued 56,508 shares at an average price of $23.07; during 2007, the Company issued 43,767 shares at an average price of $31.22; and during 2006, the Company issued 41,973 shares at an average price of $32.36 per share. In years prior to 2005, the Company funded its employee stock purchase plan using treasury shares. In 2005, the Company began funding its employee stock purchase plan by issuing new common shares. Due to the expiration of the term of the plan, the board of directors has approved, subject to shareholder approval, a new employee stock purchase plan that will permit eligible employees to purchase shares on substantially the same terms as provided under the prior plan and reserves 700,000 shares for issuance under the plan (without carrying forward unissued shares under the prior plan). See Note 12 to the Consolidated Financial Statements for a full description of the Company’s stock compensation expense.
(t) Stock Plans
The Company has multiple stock-based employee compensation plans, which are described more fully in Note 12 below.
Effective January 1, 2006, the Company adopted SFAS No. 123R, “Share Based Payment,” using the modified prospective transition method. Under the modified prospective transition method, fair value accounting and recognition provisions of SFAS No. 123R are applied to stock-based awards granted or modified subsequent to the date of adoption and prior periods presented are not restated. In addition, for awards granted prior to the effective date, the unvested portion of the awards are recognized in periods subsequent to the effective adoption date based on the grant date fair value determined for pro forma disclosure purposes under SFAS No. 123.
Refer to Note 12-Stock Plans for additional disclosures regarding the Company’s stock compensation programs.
(u) Segment Information
The Company provides home health care equipment and services through 1,063 operating centers in 48 states. The Company’s operating centers exhibit similar long-term financial performance and have similar economic characteristics, having similar products and services, types of customers and methods used to distribute their products and services. The Company believes it meets the criteria for aggregating its operating segments into a single reporting segment based on the provisions of SFAS No. 131.
(v) New Accounting Standards
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. The provisions of SFAS No. 157 were effective as of the beginning of the 2008 calendar year. The adoption of SFAS No. 157 did not have a material impact on the Company’s financial condition, results of operations or cash flows.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115”. On January 1, 2008 the Company
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(1) Description of Business and Summary of Significant Accounting Policies (Continued)
adopted SFAS No. 159 which permits companies to choose to measure certain financial assets and liabilities at fair value (the “fair value option”). The fair value election is irrevocable and may generally be made on an instrument-by-instrument basis, even if a company has similar instruments that it elects not to fair value. At the adoption date, unrealized gains and losses on existing items for which fair value has been elected are reported as a cumulative adjustment to beginning retained earnings. The Company chose not to elect the fair value option for its financial assets and liabilities existing on January 1, 2008, and did not elect the fair value option for any financial assets and liabilities transacted during the twelve months ended December 31, 2008, except for a put option related to the Company’s auction rate securities that was recorded in conjunction with a settlement agreement with one if its investment firms, as more fully described in Note 2 to the consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” which replaces SFAS No. 141. SFAS No. 141(R) requires an acquirer in a business combination to recognize the assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. It also requires the recognition of assets acquired and liabilities assumed arising from certain contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. The provisions of SFAS No. 141(R) are effective as of the beginning of the 2009 calendar year. The Company is currently evaluating the potential future impact of this standard on its financial condition, results of operations and cash flows.
In February 2008, the FASB issued FSP FAS 157-2, “Effective Date of FASB Statement No. 157,” which delays the effective date of FASB Statement No. 157, “Fair Value Measurements,” to calendar years beginning January 1, 2009. The scope of the proposed deferral applies to all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The Company does not expect the adoption of FSP FAS 157-2 to have a material impact on its financial condition, results of operations or cash flows.
In May 2008, the FASB issued FSP APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement).” FSP APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. Upon adoption, the debt component of such instrument would be recognized by measuring the fair value of a similar liability that does not have an associated equity component. The equity component of such instrument would be recognized as the difference between the proceeds from the issuance of the note and the fair value of the liability component. The FSP requires accretion of the resultant debt discount (equal to the proceeds allocated to the equity component) over the expected life of the debt.
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 has estimated that instruments similar to the Series A and B notes 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. To the extent that the initial proceeds of the instruments exceed the estimated fair value of the liability components, the Company will recognize an equity component. As a result, the Company estimates that, upon adoption, approximately $47.4 million and $67.2 million of the carrying value of the Company’s Series A and B convertible notes will be reclassified to equity as
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(1) Description of Business and Summary of Significant Accounting Policies (Continued)
of the October 31, 2007 issuance date. These amounts represent the equity components of the proceeds from the notes. The Company will also recognize debt discounts equal to the equity components which will be accreted to interest expense over the respective 5 and 7-year terms of the first put option dates specified in the indentures underlying the notes. The accreted interest plus the cash interest payments based on the stated coupon rates will result in interest cost being recognized in the consolidated statements of operations that will reflect the interest rates on similar instruments without a conversion option.
Debt issuance costs (which are amortized to interest expense) do not include issuance costs allocated to the equity component (which are recorded as a reduction of the proceeds allocated to the equity component by means of a credit to additional paid in capital). The basis of the liability component in accordance with the FSP and the liability in accordance with tax accounting will result in a deferred tax liability recorded at initial recognition which will reduce additional paid in capital. The initial deferred tax liability will be equal to the initial debt discount times the Company’s tax rate. The deferred tax liability will subsequently be amortized out of additional paid in capital as the debt discount is amortized. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company will adopt FSP APB 14-1 beginning in the first quarter of fiscal 2009, and this standard must be applied on a retrospective basis.
Accordingly, the Company estimates that the pre-tax increase in non-cash interest expense to be recognized in its consolidated financial statements using its estimated comparable straight debt borrowing rates at the date of issuance of the Series Debentures would be as follows (in thousands):
(1) These interest costs are related solely to the amortization of the debt discount. Debt issuance costs are not considered in this calculation.
In October 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a Financial Asset in a Market That Is Not Active,” which clarifies the application of FASB Statement No. 157, “Fair Value Measurements”, in an inactive market and provides an illustrative example to demonstrate how the fair value of a financial asset is determined when the market for that financial asset is inactive. Key existing principles of Statement 157 illustrated in the example include (a) fair value represents the price at which an orderly transaction would take place between market participants; even if there is little or no market activity for an asset at the measurement date, the objective of determining fair value remains the same, (b) in determining fair value, the use of management's internal assumptions concerning future cash flows discounted at an appropriate risk-adjusted interest rate is acceptable when relevant observable market data do not exist, (c) broker quotes may properly be included as an input when measuring fair value (but such quotes are not necessarily determinative if an active market for the financial asset does not exist). The provisions of FSP FAS 157-3 are effective upon issuance. The adoption of FSP FAS 157-3 did not have a material impact on our financial condition, results of operations or cash flows.
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(1) Description of Business and Summary of Significant Accounting Policies (Continued)
(w) Contingencies
The Company is involved in certain claims and legal matters arising in the ordinary course of its business. The Company uses Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies,” as guidance on the application of generally accepted accounting principles related to contingencies. The Company evaluates and records liabilities for contingencies based on known claims and legal actions when it is probable a liability has been incurred and the liability can be reasonably estimated.
(x) Concentration of Credit Risk
The Company’s revenues are generated through locations in 48 states. The Company generally does not require collateral or other security in extending credit to its 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 customers. Included in the Company’s net revenues is reimbursement from government sources under Medicare, Medicaid and other federally funded programs, which aggregated approximately 60% of net revenues in 2008, 64% of net revenues in 2007, and 67% of net revenues in 2006.
(y) Comprehensive Income
SFAS No. 130, “Reporting Comprehensive Income”, establishes standards for the reporting and display of comprehensive income and its components in the Company’s consolidated financial statements. The objective of SFAS No. 130 is to report a measure (comprehensive income (loss)) of all changes in equity of an enterprise that result from transactions and other economic events in a period other than transactions with owners.
The Company’s comprehensive income is the same as reported net income for all periods presented.
(2) Fair Value Measurements
Under SFAS No. 157, “Fair Value Measurements”, 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. SFAS No. 157 also establishes a hierarchy for inputs 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.
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(2) Fair Value Measurements (Continued)
- Level 3-Valuations based on inputs that are unobservable and significant to the overall fair value measurement.
The Company utilizes Level 3 fair value measurements to value its long term investments in auction rate securities (“ARS”) consisting of securities collateralized by student loans, and a related put option.
In November 2008, the Company entered into an agreement (the “Agreement”) with UBS AG (“UBS”), the parent company of the investment firm that sold the Company its holdings of auction rate securities having a par value of approximately $60.4 million at December 31, 2008. By entering into the Agreement, the Company (1) received the right (“UBS Put Option”) to sell these auction rate securities back to UBS at par, at its sole discretion, anytime during the period from June 30, 2010 through July 2, 2012, and (2) gave UBS the right to purchase these auction rate securities or sell them on the Company’s behalf at par anytime after the execution of the Agreement through July 2, 2012. The Company elected to measure the UBS Put Option under the fair value option of SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115”, and recorded other income of approximately $10.8 million before income taxes, and recorded a corresponding long term investment. The Company valued the UBS Put Option using a discounted cash flow approach that takes into account certain estimates for interest rates and the timing and amount of expected future cash flows, adjusted for any bearer risk associated with UBS’s financial ability to repurchase the ARS beginning June 30, 2010. These assumptions are volatile and subject to change as the underlying sources of these assumptions and market conditions change. Simultaneously, the Company transferred these auction rate securities from available-for-sale to trading securities. As a result of this transfer, the Company recognized an unrealized loss recorded to other expense of approximately $10.8 million before income taxes. The recording of the UBS Put Option and the recognition of the unrealized loss resulted in no net impact to the consolidated statements of operations for the three and twelve month periods ended December 31, 2008. The Company anticipates that any future changes in the fair value of the UBS Put Option will be offset by the changes in the fair value of the related auction rate securities with no material net impact to the consolidated statements of operations. The UBS Put Option will continue to be measured at fair value utilizing Level 3 inputs until the earlier of its maturity or exercise.
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, SFAS No. 157 requires that an asset or liability be 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 during periods of market dislocation, such as the recent illiquidity in the auction rate securities market. 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.
SFAS No. 157 requires that the valuation techniques used by the Company must be consistent with at least one of the three possible approaches: the market approach, income approach and/or cost approach. The
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(2) Fair Value Measurements (Continued)
Company’s Level 3 valuations of auction rate securities are based on the income approach, specifically, discounted cash flow analyses which utilize significant inputs based on the Company’s estimates and assumptions. Inputs include current coupon rates and expected maturity dates.
The following table presents the valuation of the Company’s financial assets as of December 31, 2008, measured at fair value on a recurring basis by the input levels prescribed by SFAS No. 157:
The following table presents the changes in the Company’s financial assets that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3):
(3) Investments
At December 31, 2008, the Company held $60.4 million of auction rate securities. These securities are variable-rate debt instruments with contractual maturities between the years 2020 and 2041 with interest rates that reset every seven or 35 days pursuant to a bidding process as determined by the underlying security indentures. Under the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” the investments are classified as trading securities and are carried at fair value, with any realized and unrealized gains and losses included in other income and expense.
During the first quarter of 2008, the Company reclassified all of its investments in auction rate securities from short-term to long-term investments. Of the auction rate securities held as of December 31, 2008, $60.4 million are secured by pools of student loans guaranteed by state-designated guaranty agencies or monoline insurers or reinsured by the United States government. All of the auction rate securities held by the Company are senior obligations under the applicable indentures authorizing the issuance of such securities. Recent turmoil in the credit
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(3) Investments (Continued)
markets has resulted in widespread failures to attract demand for such securities at the periodic auction dates occurring subsequent to December 31, 2007. As of December 31, 2008, all of the securities held by the Company continued to experience auction failures, resulting in it continuing to hold such securities.
All of the auction rate securities owned by the Company were purchased from UBS Financial Services, Inc., a subsidiary of UBS AG (“UBS”), and are held for the benefit of the Company by UBS. On August 8, 2008, UBS announced a settlement in principle with the Securities and Exchange Commission, the New York Attorney General and other state regulatory agencies to restore liquidity to remaining clients who hold auction rate securities. In November 2008, the Company accepted an offer (the “UBS Put Option”) from UBS to sell to it at par value all of the Company’s remaining auction rate securities in accordance with the terms of the settlement agreement. Under the settlement agreement, the Company will be able to redeem all of its auction rate securities at par during a two-year time period beginning June 30, 2010, while UBS may purchase all or some of the auction rate securities at par from the Company at any time through July 2, 2012. Pursuant to the Company’s acceptance of the offer, UBS purchased a portion of the Company’s then outstanding holdings of auction rate securities at par on November 6, 2008 in the amount of $32.5 million. The Company elected to measure the UBS Put Option under the fair value option of SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115”, and recorded other income of approximately $10.8 million before income taxes, and recorded a corresponding long term investment. The Company valued the UBS Put Option using a discounted cash flow approach that takes into account certain estimates for interest rates and the timing and amount of expected future cash flows, adjusted for any bearer risk associated with UBS’s financial ability to repurchase the ARS beginning June 30, 2010. These assumptions are volatile and subject to change as the underlying sources of these assumptions and market conditions change. Simultaneously, the Company transferred these auction rate securities from available-for-sale to trading securities. As a result of this transfer, the Company recognized an unrealized loss recorded to other expense of approximately $10.8 million before income taxes. The recording of the UBS Put Option and the recognition of the unrealized loss resulted in no net impact to the consolidated statements of operations for the three and twelve month periods ended December 31, 2008. The Company anticipates that any future changes in the fair value of the UBS Put Option will be offset by the changes in the fair value of the related auction rate securities with no material net impact to the consolidated statements of operations. The UBS Put Option will continue to be measured at fair value utilizing Level 3 inputs until the earlier of its maturity or exercise.
(4) Accounts Receivable, Net
Accounts receivable at December 31, 2008 and 2007 consist of:
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(5) Property and Equipment, Net
Property and equipment at December 31, 2008 and 2007 consist of:
Depreciation of medical rental equipment was approximately $83.1 million in 2008, $82.6 million in 2007 and $68.7 million in 2006. Accumulated depreciation of medical rental equipment at December 31, 2008 and 2007 was $545.1 million and $462.1 million, respectively.
(6) Leases
There were no new capital leases in 2008. The Company entered into a three-year capital lease in 2007 covering computer equipment with an outstanding balance of $0.2 million at December 31, 2008. The book value of the underlying equipment is included in Property and Equipment as follows:
Amortization of assets held under capital leases of $0.6 million, $1.0 million and $1.0 million in 2008, 2007 and 2006, respectively, is included with depreciation expense in the accompanying consolidated statements of operations.
The Company has noncancelable lease obligations, primarily for buildings, office equipment and vehicles, that expire over the next six years and may provide for renewal options for periods ranging from one year to three years and that require the Company to pay ancillary costs such as maintenance and insurance. The Company records rent expense and amortization of leasehold improvements on a straight-line basis over the initial term of the lease and the Company does not negotiate rent holidays, rent concessions or leasehold improvements in its office leases. Operating lease expense was approximately $52.0 million in 2008, $51.7 million in 2007 and $47.7 million in 2006. Future minimum lease payments under capital leases and noncancelable operating leases as of December 31, 2008, are as follows:
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(7) Long-Term Obligations
Long-term obligations at December 31, 2008 and 2007 consist of:
The Company’s current revolving credit agreement with several lenders and Bank of America N.A. as agent, dated December 1, 2006, permits the Company to borrow amounts up to $390.0 million under a five-year revolving credit facility. The five-year revolving credit facility contains a $60.0 million letter of credit sub-facility, which reduces the principal amount available under the five-year revolving credit facility by the amount of outstanding letters of credit on the sub-facility. As of December 31, 2008 and 2007, $0.0 million and $10.0 million, respectively, in borrowings were outstanding on the five-year credit facility and $27.0 million and $23.5 million, respectively, in standby letters of credit were issued as of those dates. The revolving five-year credit agreement has a maturity date of December 1, 2011. Upon entering into the five-year credit agreement, origination and other upfront fees and expenses of $1.0 million were paid and are being amortized over five years. In addition to the upfront fees, 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 0.10% and 0.175% 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 December 31, 2008 and 2007. 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
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(7) Long-Term Obligations (Continued)
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.
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 will pay interest semi-annually at a rate of 2.75% per annum. The Series Debentures are unsecured and unsubordinated obligations and will be convertible under specified circumstances based upon a base conversion rate, which, under certain circumstances, will be increased pursuant to a formula that is subject to a maximum conversion rate. Upon conversion, holders of the Series Debentures will receive cash up to the principal amount, and any excess conversion value will be delivered in shares of the Company’s common stock or in a combination of cash and shares of common stock, at the Company’s option. The initial base conversion rate for the Debentures is 19.5044 shares of common stock per $1,000 principal amount of Series Debentures, equivalent to an initial base conversion price of approximately $51.27 per share. In addition, if at the time of conversion the applicable price of 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.
In June 2003, we completed the sale of $275.0 million aggregate principal amount of 3.0% Convertible Senior Debentures due 2033 (the “Debentures”) in a private placement. The Debentures were convertible into shares of our common stock based on a conversion rate of 18.7515 shares for each $1,000 principal amount of Debentures. Interest on the Debentures was payable at the rate of 3.0% per annum on June 15 and December 15 of each year. On June 15, 2008, we redeemed all of the outstanding Debentures at par pursuant to a notice of redemption. We funded the redemption with $110.0 million of available cash and $165.0 million of borrowings under our revolving credit facility. The entire amount of the borrowings under the credit facility were paid down from operating cash flow by the end of 2008.
The aggregate maturities of long-term obligations for each of the five years subsequent to December 31, 2008 are as follows:
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(8) Income Taxes
The tax effects of temporary differences that account for significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2008 and 2007 are presented below:
At December 31, 2008 and December 31, 2007 the Company had state income tax net operating loss carryforwards of $2.8 million and $2.9 million, respectively. The Company believes that it is more likely than not that the benefit from certain state net operating loss carryforwards will not be realized. In recognition of this risk, the Company has provided a valuation allowance at December 31, 2008 and 2007 of $0.1 million and $0.7 million, respectively, on the deferred tax assets relating to these state net operating loss carryforwards. Such deferred tax assets expire between 2010 and 2029 as follows:
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(8) Income Taxes (Continued)
Income tax expense attributable to operations consists of:
Total income tax expense differs from the amounts computed by applying a U.S. federal income tax rate of 35% to income before income taxes as a result of the following:
The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”, on January 1, 2007. As of December 31, 2007 and December 31, 2008, respectively, the Company had gross unrecognized tax benefits, including interest and penalties, of $17.7 million and $11.9 million of which $12.0 million and $8.3 million, net of federal tax benefit, if recognized, would favorably affect the effective tax rate. The Company recognizes accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense. The gross amount provided for potential interest and penalties at December 31, 2008 totaled $2.0 million and $1.0 million, respectively.
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(8) Income Taxes (Continued)
A reconciliation of the beginning and ending balances of the Company’s gross liability for unrecognized tax benefits, excluding the related interest and penalties, at December 31, 2008 is a follows:
The Company conducts business nationally and, as a result, files U.S. federal income tax returns and returns in various state and local jurisdictions. In the normal course of business the Company is subject to examination by taxing authorities throughout the United States. With few exceptions, the Company is no longer subject to U.S. federal, state and local, income tax examinations for years before 2003.
The Company effectively settled an examination with a taxing jurisdiction for $5.4 million for which reserves had been provided in prior periods. The Company does not expect that the total amount of unrecognized tax positions will significantly increase or decrease in the next twelve months.
The Internal Revenue Service (“IRS”) has completed its examination of the Company’s U.S. income tax returns through 2007. The U.S. federal statute of limitations remains open for the year 2005 and onward. There are no material disputes for the open tax years.
The Company has been invited to participate in the IRS’s Compliance Assurance Program, or CAP, for the year 2007 and 2008. The year 2008 is currently under examination under the CAP program. The objective of CAP is to reduce taxpayer burden and uncertainty while assuring the IRS of the tax return’s accuracy prior to filing, thereby reducing or eliminating the need for post-filing examination.
(9) Other Current Liabilities
Other current liabilities at December 31, 2008 and 2007 consist of:
(10) Staff Accounting Bulletin No. 108 (SAB 108)
In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”).
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(10) Staff Accounting Bulletin No. 108 (SAB 108) (Continued)
SAB 108 addresses how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current-year financial statements. SAB 108 requires an entity to quantify misstatements using a balance sheet and income statement approach (the “dual approach”) and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. SAB 108 is effective for annual financial statements covering the first fiscal year ending after November 15, 2006.
Traditionally, there have been two methods available for quantifying the effects of misstatements in financial statements, the “roll-over” method and the “iron curtain” method. The roll-over method considers the impact of errors or misstatements on the current-year income statement, including the effect of reversing prior-year misstatements, but its use can result in the accumulation of misstatements in the balance sheet. The iron-curtain method, on the other hand, considers the effect of correcting the accumulation of prior and current year misstatements in the period ending balance sheet. Prior to the Company’s adoption of SAB 108, the Company applied the roll-over method in quantifying financial statement misstatements.
During the fourth quarter of 2006, the Company adopted the provisions of SAB 108 effective as of January 1, 2006. As permitted by SAB 108, the Company elected to record the effects of applying SAB 108 using the cumulative effect transition method, thereby recording the cumulative effect of initially applying the dual approach as adjustments to the carrying values of assets and liabilities with an offsetting adjustment recorded to the opening balance of retained earnings. The misstatements that were corrected are described below.
Certain items provided by the Company are reimbursed under rental arrangements that generally provide for fixed monthly payments 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). Once initial delivery of rental equipment is made to the patient, a monthly billing cycle is established based on the date of delivery. Monthly rental billings are generated in 30-day cycles so that each month’s billing falls on approximately the same day of the month as the initial billing. 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. In all accounting periods prior to the application of SAB 108 and in all instances where such rental arrangements occurred in the past, rental revenue was recognized on the cycle billing date for the full month’s billing amount.
This accounting treatment resulted in an overstatement of revenue at each calendar month-end period. More appropriately, revenues recorded from rental arrangements should have been recognized ratably over the 30-day service period with a portion deferred for the amount of the monthly bill that is unearned at calendar month-end. The Company previously quantified these errors under the roll-over method and concluded that they were immaterial.
In its application of SAB 108, the Company corrected the errors resulting from its rental revenue recognition policies by deferring the unearned portion of rental revenues and establishing a deferred revenue liability on its balance sheet. The deferral of rental revenues also required an adjustment to deferred income taxes. In electing the cumulative effect transition method in applying SAB 108, the Company recorded cumulative adjustments to the carrying amounts of liabilities for deferred revenue and deferred income taxes by $34.4 million and $13.3 million, respectively, in its 2006 opening balance sheet and an offsetting adjustment to its opening balance of retained earnings in the amount of $21.1 million.
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(10) Staff Accounting Bulletin No. 108 (SAB 108) (Continued)
Pursuant to its application of SAB 108, the Company made additional adjustments to its 2006 opening balance sheet related to the recording of an allowance for sales adjustments against accounts receivable. The Company’s revenues are recorded at net realizable amounts estimated 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. Actual adjustments that result from differences between the payment amount received and the expected realizable amount 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 adjustments.
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 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 from certain payors may result in adjustments to amounts originally recorded.
The Company had historically reported revenues in its financial statements prior to the application of SAB 108 net of such sales adjustments at the time they were identified but did not report accounts receivable net of a specific allowance for estimates of such sales adjustments. The Company does, however, report accounts receivable net of allowances for uncollectible accounts (i.e., bad debt). 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.
In all accounting periods prior to the application of SAB 108 and in all instances where such sales adjustments were recorded in the past, the Company consistently applied this accounting treatment which resulted in the recording of sales adjustments related to prior period revenues against current period revenues that either overstated or understated net revenues within each financial statement period. More appropriately, an estimate of sales adjustments arising from differences between the payment amounts received and the expected realizable amounts should have been recorded at the time that revenues were recognized and an allowance recorded against accounts receivable for estimates of such sales adjustments. The Company previously quantified these errors under the roll-over method and concluded that they were immaterial.
In its application of SAB 108, the Company corrected the errors by establishing an allowance against accounts receivable for sales adjustments on its balance sheet. The recognition of such allowances also required an adjustment to deferred income taxes. In electing the cumulative effect transition method in applying SAB 108, the Company recorded cumulative adjustments to the carrying amounts of the allowance for doubtful accounts and deferred income taxes by $10.7 million and $4.2 million, respectively, in its 2006 opening balance sheet and an offsetting adjustment to its opening balance of retained earnings in the amount of $6.5 million.
The cumulative effect of correcting the financial statement misstatements in accordance with SAB 108 in 2006 was an increase in deferred revenue and the allowance for doubtful accounts of $34.4 million and $10.7 million, respectively, and reduced retained earnings of $27.6 million. Deferred income tax adjustments totaling $17.5 million were also recorded as part of the cumulative adjustment.
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(11) Stockholders’ Equity
During the fourth quarter of 2006, the Company adopted the provisions of SAB 108 (see Note 10) effective as of January 1, 2006. The related impact to stockholders’ equity was a $27.6 million reduction to retained earnings in the 2006 opening balance sheet.
The Company has 5,000,000 authorized shares of preferred stock, all of which are unissued. The Board of Directors has the authority to issue up to such number of shares of preferred stock in one or more series and to fix the rights, preferences, privileges, qualifications, limitations and restrictions thereof without any further vote or action by the stockholders but subject to restrictions imposed by the Company’s revolving credit agreement.
(12) Stock Plans
The Company issues stock options and other stock-based awards to key employees and directors under stock-based compensation plans. The Company also sponsors an employee stock purchase plan.
The Company uses the fair value accounting and recognition provisions of SFAS No. 123R for stock-based awards granted or modified. SFAS No. 123R requires cash flows resulting from excess tax benefits to be classified as a part of cash flows from financing activities. Excess tax benefits are realized tax benefits from tax deductions for exercised options in excess of the deferred tax asset attributable to stock compensation costs for such options. The Company realized excess tax benefits of $1.2 million, $5.0 million and $1.1 million for the years ended December 31, 2008, 2007 and 2006, respectively, these amounts have been classified as a financing cash inflow as well as an operating cash outflow. Additionally, $3.1 million, $12.4 million and $3.5 million have been included in the change in income taxes payable as an operating cash inflow for the years ended December 31, 2008, 2007 and 2006, respectively.
For the years ended December 31, 2008, 2007 and 2006, the Company recognized total stock-based compensation costs of $19.3 million, $18.0 million and $20.3 million, respectively, as well as related tax benefits of $7.0 million, $6.4 million and $6.6 million, respectively. All stock-based compensation costs are expensed using a graded method approach and are either classified within operating or selling, general and administrative expenses on the consolidated statements of operations. The Company recognized compensation costs of $12.8 million, $15.5 million and $17.4 million in 2008, 2007 and 2006, respectively.
Stock Options
The Company has six outstanding stock option plans that provide for the grant of options and other stock-based awards to officers, employees and directors. To date, stock options have been granted with an exercise price equal to the fair value of the stock at the date of grant. Stock options generally have eight to ten year expiration terms and generally vest over one to five years depending on the particular grant. As of December 31,
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(12) Stock Plans (Continued)
2008, approximately 2.9 million shares are available for future grant under the Company’s shareholder-approved stock plans. See table below for summary of individual plans.
The following table summarizes information about stock options outstanding under the plans at December 31, 2008:
The Company believes that the Black-Scholes valuation model provides a reasonable estimate of the fair value of the Company’s stock options, particularly in view of the absence of any market-based or performance-based vesting conditions attached to those stock options. The Black-Scholes option pricing model requires, among other things, an estimate of expected share price volatility. The Company considers the use of both historical and implied volatility assumptions in calculating the fair value of stock options issued. The Company did not grant any stock options in 2008. In estimating the fair value of stock options granted during 2006 and 2007, the Company used implied volatility derived from its publicly-traded options as the volatility input in the option valuation model. In using implied volatility, the Company considered SFAS No. 123R and the guidance provided in Staff Accounting Bulletin No. 107, “Share-Based Payment,” and determined that implied volatility provides the most reliable estimate of expected volatility. The expected option term is based on historical exercise and post-vesting termination patterns. The expected dividend yield is 0% as the Company has not paid any cash dividends on its capital stock and does not anticipate it will pay cash dividends in the foreseeable future. The risk-free interest rate is based on the U.S. Treasury yield curve at the time of the grant.
Following are the specific weighted average valuation assumptions for the stock options, where applicable, used for each respective period:
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(12) Stock Plans (Continued)
Stock option activity for the years ended December 31, 2006 through 2008 is summarized below:
Stock options outstanding at December 31, 2008, were 8,324,266. Of those stock options outstanding at December 31, 2008, 6,289,351 were exercisable at December 31, 2008 and 2,034,915 were unvested. Of the total stock options outstanding at December 31, 2008, 8,209,915 stock options are vested or expected to vest in the future, net of expected cancellations and forfeitures of 114,351. The intrinsic value of options exercised during the years ended December 31, 2008, 2007 and 2006, amounted to $8.6 million, $33.0 million and $8.6 million, respectively.
Restricted Stock
Under the 2004 Stock Plan, certain key employees may be granted restricted stock at nominal cost to them. Restricted stock is measured at fair value on the date of the grant, based on the number of shares granted and the quoted price of the Company’s common stock. Restricted stock vests upon the employees’ fulfillment of specified performance and/or service-based conditions. In September 2008, the Company granted 325,000 shares of restricted stock to certain key employees which will vest after two years, but may vest earlier if specific performance criteria are met. The performance criteria are based on achieving pre-determined EPS goals for a specific period. In September 2008, the Company granted 236,000 shares of restricted stock, which have service-based conditions, to certain other key employees. On May 17, 2007 and October 1, 2007, the Company granted 383,500 and 5,800 shares, respectively, of restricted stock which have service based conditions to certain employees. The restrictions lapse in from one to three year annual installments. During the years ended December 31, 2008, 2007 and 2006, the Company recognized $6.4 million, $2.6 million and $2.9 million, respectively, of stock-based compensation expense related to restricted stock.
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(12) Stock Plans (Continued)
A summary of the status of unvested restricted stock for the years ended December 31, 2006 through 2008 is presented below:
Employee Stock Purchase Plan
The Company’s Employee Stock Purchase Plan (“Stock Purchase Plan”) provides a means to encourage and assist employees in acquiring a stock ownership interest in Lincare. Payroll deductions are accumulated during each quarter and applied toward the purchase of stock on the last trading day of each quarter. The Stock Purchase Plan defines purchase price per share as 85% of the lower of the fair value of a share of common stock on the last trading day of the previous plan quarter, or the last trading day of the current plan quarter. The board of directors has approved, subject to shareholder approval, a new Stock Purchase Plan that will continue the terms of the existing Plan and provide for the issuance of up to 700,000 shares.
During the years ended December 31, 2008, 2007 and 2006, 56,508 shares, 43,767 shares and 41,973 shares, respectively, of common stock were purchased under the Stock Purchase Plan resulting in compensation cost of $0.4 million and $0.3 million and $0.3 million, respectively.
Total Stock-Based Compensation
The following weighted-average per share fair values were determined for stock-based compensation grants or employee stock purchases occurring during the years ended December 31, 2008, 2007 and 2006:
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(12) Stock Plans (Continued)
During the years ended December 31, 2008, 2007 and 2006, the Company received cash of $11.4 million, $41.1 million and $13.2 million, respectively, from employee stock purchases and exercises of stock options, and recognized related tax benefits of $3.1 million, $12.1 million and $3.2 million, respectively. There were no stock options settled for cash during the years ended December 31, 2008, 2007 and 2006.
As of December 31, 2008, the total remaining unrecognized compensation cost related to unvested stock options and restricted stock amounted to $9.1 million and $23.8 million, respectively, which will be amortized over the weighted-average remaining requisite service periods of 1.3 years and 1.8 years, respectively.
The total estimated fair value of stock options vested during 2008, 2007 and 2006 was $15.9 million, $11.0 million and $12.3 million, respectively. The total estimated fair value of restricted stock vested during 2008, 2007 and 2006 was $0.0 million, $2.9 million and $2.7 million, respectively.
The Company issues new shares of common stock to satisfy stock-based awards upon exercise.
(13) Net Revenues
Included in the Company’s net revenues is reimbursement from the federal government under Medicare, Medicaid and other federally funded programs, which aggregated approximately 60% of net revenues in 2008, 64% of net revenues in 2007, and 67% of net revenues in 2006, respectively.
The following table sets forth a summary of the Company’s net revenues by product category:
Included in net revenues are rental and sale items that comprise approximately 68.1% and 31.9% of total revenues in 2008, approximately 66.7% and 33.3% in 2007, and approximately 69.6% and 30.4% in 2006, respectively.
(14) Income Per Common Share
Basic income 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 income per common share reflects the potential dilution of securities that could share in earnings, including stock options and outstanding convertible debt. When the exercise of stock options is anti-dilutive, they are excluded from the calculation. For the year ended December 31, 2008, the number of excluded shares underlying anti-dilutive stock options and awards was 7,387,416. For the year ended December 31, 2007, the number of excluded shares underlying anti-dilutive stock options was 4,128,650. For the year ended December 31, 2006, the number of excluded shares underlying anti-dilutive stock options was 2,066,750.
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(14) Income Per Common Share (Continued)
In October 2004, the Emerging Issues Task Force (“EITF”) ratified the consensus on EITF Issue 04-8, “The Effect of Contingently Convertible Instruments on Diluted Earnings per Share,” that the impact of contingently convertible debt should be included in diluted earnings per share computations regardless of whether the market price conversion condition has been met. This provision is effective for all reporting periods presented and was applicable to the Company’s $275.0 million aggregate principal amount of 3.0% Convertible Senior Debentures. On June 15, 2008, the Company redeemed all of the outstanding 3.0% debentures at par pursuant to a notice of redemption. The Company’s outstanding $550.0 million of Series Debentures are not within the scope of EITF Issue 04-08.
A reconciliation of the numerators and the denominators of the basic and diluted income per common share computations is as follows:
(15) Business Combinations
The Company’s strategy is to increase its market share through internal growth and strategic acquisitions. Lincare achieves internal growth in existing geographic markets through the addition of new customers through referral sources to its network of local operating centers. In addition, the Company expands into new geographic markets on a selective basis, either through acquisitions or by opening new operating centers, when it believes such expansion will enhance its business.
The Company acquired certain assets of three businesses in 2008, three businesses in 2007 and 10 businesses in 2006. Consideration for the acquisitions generally included cash, deferred acquisition payments (unsecured non-interest bearing) and the assumption of certain liabilities.
Each acquisition during 2008, 2007 and 2006 was accounted for as a purchase. The results of operations of the acquired companies are included in the accompanying consolidated statements of operations since the respective dates of acquisition. Each of the acquired companies conducted operations similar to that of the Company. These allocations are inclusive of amounts not yet paid.
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(15) Business Combinations (Continued)
The total aggregate cost of the acquisitions described above was as follows:
The total aggregate purchase price of the acquisitions described above was allocated as follows:
The following unaudited pro forma supplemental information on the results of operations for the years ended December 31, 2008 and 2007 includes the 2008 acquisitions as if they had been combined at the beginning of 2007.
This unaudited pro forma financial information is not necessarily indicative of either the results of operations that would have occurred had the transactions been effected at the beginning of 2007 or of future results of operations of the combined companies.
(16) Contingencies
As a health care provider, 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 and other regulations, regional carriers often conduct audits and request patient records and other documents to support claims submitted by Lincare for payment of services rendered to customers. Similarly, government agencies periodically open investigations and obtain information from health care providers pursuant to legal process.
LINCARE HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008, 2007 and 2006
(16) Contingencies (Continued)
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.
From time to time, the Company receives inquiries from various government agencies requesting customer records and other documents. It has been the Company’s policy to cooperate with all such requests for information. 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. The Company is a defendant in certain qui tam proceedings. The government has declined to intervene in all unsealed qui tam actions of which the Company is aware and it is vigorously defending these suits.
The Company is also involved in certain other claims and legal actions in the ordinary course of its business. The ultimate disposition of all such matters is not expected to have a material adverse impact on its financial position, results of operations or liquidity.
(17) Quarterly Financial Data (Unaudited-see accompanying accountants’ report)
The following is a summary of quarterly financial results for the years ended December 31, 2008 and 2007:
SCHEDULE II
LINCARE HOLDINGS INC. AND SUBSIDIARIES
FINANCIAL STATEMENT SCHEDULE
VALUATION AND QUALIFYING ACCOUNTS
(1) To record net sales adjustments and allowances on business combinations.
(2) To record write-offs, net of recoveries.
(3) Includes SAB 108 adjustment to beginning balance of $10.7 million (see Note 10 within the Notes to Consolidated Financial Statements).
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INDEX OF EXHIBITS
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A Incorporated by reference to the Corresponding exhibit to the Registrant’s Registration Statement on Form S-1 (No. 33-44672).
B Incorporated by reference to the Registrant’s Form 10-K dated March 26, 1998.
C Incorporated by reference to the Registrant’s Form 10-Q dated August 12, 1998.
D Incorporated by reference to the Registrant’s Form 10-Q dated November 13, 2000.
E Incorporated by reference to the Registrant’s Form 10-K dated March 29, 2001.
F Incorporated by reference to the Registrant’s Form 10-K dated March 28, 2002.
G Incorporated by reference to the Registrant’s Form 10-Q dated May 13, 2002.
H Incorporated by reference to the Registrant’s Form 10-Q dated August 13, 2002.
I Incorporated by reference to the Registrant’s Form 8-K dated June 12, 2003.
J Incorporated by reference to the Registrant’s Form 10-Q dated August 14, 2003.
K Incorporated by reference to the Registrant’s Form DEF 14-A dated April 22, 2004.
L Incorporated by reference to the Registrant’s Form 10-Q dated November 9, 2004.
M Incorporated by reference to the Registrant’s Form 8-K dated November 18, 2004.
N Incorporated by reference to the Registrant’s Form 8-K dated December 16, 2004.
O Incorporated by reference to the Registrant’s Form 10-K dated March 16, 2005.
P Incorporated by reference to the Registrant’s Form 8-K dated April 26, 2005.
Q Incorporated by reference to the Registrant’s Form 8-K dated June 28, 2005.
R Incorporated by reference to the Registrant’s Form 8-K dated December 4, 2006.
S Incorporated by reference to the Registrant’s Form DEF 14-A dated April 5, 2007.
T Incorporated by reference to the Registrant’s Form 8-K dated November 6, 2007.
U Incorporated by reference to Registrant’s Form 8-K dated November 26, 2007.
V Incorporated by reference to the Registrant’s Form 8-K dated January 3, 2008.
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