10-K 1 a20111231-10k.htm ANNUAL REPORT FOR THE FISCAL YEAR ENDED DECEMBER 31, 2011 2011.12.31. - 10K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________________________________________________
FORM 10-K
_______________________________________________________________
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2011
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number 000-50940
_______________________________________________________________
ROTECH HEALTHCARE INC.
(Exact name of registrant as specified in its charter)
_______________________________________________________________
Delaware
 
030408870
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
2600 Technology Drive, Suite 300, Orlando, Florida
 
32804
(Address of principal executive offices)
 
(Zip Code)
(407) 822-4600
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.0001 par value per share, OTCBB
______________________________________________________________
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  ý
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer  ¨
  
Accelerated Filer  x
Non-Accelerated Filer  ¨
  
Smaller Reporting Company  ¨
(Do not check if a smaller reporting company)
  
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.):    Yes  ¨    No  ý
As of June 30, 2011, the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold was $113,134,454 based on the closing sale price of $4.65 on such date as quoted on the OTC Bulletin Board.
As of March 5, 2012, the registrant had 25,907,310 shares of common stock outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE: The information called for by Part III, to the extent not provided therein or elsewhere in this report, is incorporated by reference to the Definitive Proxy Statement for the 2012 Annual Meeting of Stockholders of the registrant which will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 2011.

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INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This report contains certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and the provisions of section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act) and section 27A of the Securities Act of 1933, as amended. These forward-looking statements include all statements regarding the intent, belief or current expectations regarding the matters discussed in this report and all statements which are not statements of historical fact. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” “projects,” “may,” “will,” “could,” “should,” “would,” variations of such words and similar expressions are intended to identify such forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties, contingencies and other factors that could cause results, performance or achievements to differ materially from those stated in this report. For more information about the nature of forward-looking statements and risks that could affect our future results and the disclosure provided in this Annual Report, please see Part I, Item 1A, Risk Factors and Exhibit 99.1, Forward-Looking Statements, which is incorporated herein by reference.


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PART I
As used herein, unless otherwise specified or the context otherwise requires, references to the “Company”, “we”, “our” and “us” refer to the business and operations of Rotech Healthcare Inc. and its subsidiaries.

ITEM 1.
BUSINESS
We are one of the largest providers of home medical equipment and related products and services in the United States, with a comprehensive offering of oxygen, and other respiratory therapy equipment and services. We provide equipment and services in 48 states through approximately 425 operating locations located primarily in non-urban markets. We provide our equipment and services principally to older patients with breathing disorders, most typically associated with chronic obstructive pulmonary diseases (COPD). COPD is a group of diseases of the lungs in which the airways become narrowed. This leads to a limitation of the flow of air to and from the lungs causing shortness of breath. COPD is the fourth most common cause of death in the US. The two main forms of COPD are chronic bronchitis and emphysema.
Our Service Lines
Oxygen and Other Respiratory Therapy Equipment and Services
Rentals and sales of oxygen and other respiratory therapy equipment and services represent 87.5% of our net revenues for the year ended December 31, 2011.
Patients in need of oxygen and other respiratory therapy equipment and services typically suffer from breathing disorders, such as COPD, obstructive sleep apnea and other cardiopulmonary disorders. Individuals diagnosed with COPD or similar diseases are often elderly and generally will require treatment for the rest of their lives. The majority of our oxygen and other respiratory therapy equipment is rented and reimbursed on a monthly basis.
Patients are generally referred to us by their physician or a hospital discharge planner. Upon receipt of a referral, our local customer service representative obtains the necessary medical and insurance coverage information, and assignment of benefits, and coordinates equipment delivery. Equipment delivery and setup is performed in the patient’s home by one of our patient service technicians or clinicians who then provides instruction and training to the patient and the patient’s family regarding appropriate equipment use and maintenance, and compliance with the prescribed therapy. Following the initial delivery and setup, our patient service technicians and/or clinicians make periodic visits to the patient’s home, the frequency of which is dictated by the type of therapy prescribed and physician orders. All services and equipment are coordinated with the prescribing physician and, during the period that we provide services and equipment for a patient, the patient remains under the physician’s care and medical supervision. Respiratory therapy is monitored by licensed respiratory therapists and other clinical staff as prescribed by physicians and in accordance with applicable state laws. We provide 24-hour on-call coverage to our patients through a centralized after-hours call center.
The following oxygen delivery systems are used in various combinations to meet our patient’s needs. Each system and combination has different characteristics that make it more or less suitable to specific patient applications.
Oxygen Concentrator
  
A concentrator is a device that separates oxygen from room air. It is small, reliable and generally provides the least expensive supply of oxygen to the patient. The concentrator is not an ambulatory product. It stays in the room in which it is placed, and patients use different lengths of oxygen tubing to continue to receive oxygen while moving around.
Liquid Oxygen
  
Liquid oxygen is delivered to the patient’s home in a base unit that can be the primary source of oxygen while at home and can be used to fill a smaller portable unit when the patient leaves home. Conventional liquid oxygen vessels require no power source to operate, making it an appropriate choice for patients in areas with frequent power outages. Conventional liquid oxygen systems are quiet and have no major moving parts. When the conventional liquid oxygen base unit is used as the primary oxygen source, it needs to be refilled approximately every two weeks, depending on the patient’s consumption rate and liter flow.
High Pressure Oxygen Cylinders
  
Typically, cylinders of varying sizes are used as backup systems and for use when an oxygen concentrator patient travels outside the home.
Homefill System
  
A homefill system is used in conjunction with an oxygen concentrator. The homefill unit allows the patient to fill their own oxygen cylinders at home using oxygen generated by their oxygen concentrator.

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Portable Oxygen Concentrator
  
A portable oxygen concentrator works in the same way as a regular oxygen concentrator with the addition of a battery and AC/DC adapter. Portable concentrators are generally used for travel purposes and not as the primary oxygen system in the patient’s home.
In addition to home oxygen, we also provide other home respiratory therapy equipment and services to our patients, including:
CPAP Devices and Supplies
(continuous positive airway pressure)
  
CPAPs are primarily used for the home treatment of obstructive sleep apnea. Obstructive sleep apnea occurs when the upper airway becomes narrow as the muscles relax naturally during sleep. This reduces oxygen in the blood and causes arousal from sleep. The CPAP machine stops this phenomenon by delivering a stream of compressed air via a hose to a nasal pillow, nose mask or full-face mask, splinting the airway (keeping it open under air pressure) so that unobstructed breathing becomes possible, reducing and/or preventing apneas.
 
CPAPs include component parts and supplies which require routine replacement to ensure proper functioning of the CPAP device. The supplies include hoses, masks, filters, chin straps, pillows, cushions and humidification units. Hoses and masks accumulate exfoliated skin and particulate matter, and can develop mold, all of which may reduce the effectiveness of the unit or expose the patient to infection risk. Such parts need to be cleaned or replaced on a regular basis. Most units also employ some type of filtration, and the filters also require regular maintenance.
 
 
 
BiPAP Devices and Supplies
(bi-level positive airway pressure)
  
BiPAPs are likewise used for the home treatment of sleep apnea for patients who cannot tolerate use of a CPAP. With a BiPAP, air delivered through a mask can be set at one pressure for inhaling and another for exhaling. This makes a BiPAP much easier for users to adapt to, as they do not have to exhale against extra air pressure as they do with a CPAP. Because of these dual settings, BiPAP allows people to get more air in and out of the lungs without the natural muscular effort needed to do so. BiPAPs have been found to be especially useful for patients with congestive heart failure and lung disorders.
 
BiPAPs include the same component parts and supplies as a CPAP, which require routine replacement to ensure proper functioning.
 
 
NiPPV Devices and Supplies
(non-invasive positive pressure ventilator)
  
NiPPV refers to delivery of mechanically assisted or generated breaths without placement of an artificial airway, such as an endotracheal tube. In most cases, ventilation is delivered via a tightly fitting nasal mask.
 
NiPPVs include the same component parts and supplies as a CPAP and BiPAP, which require routine replacement to ensure proper functioning.
 
 
Nebulizer Devices and Medications
  
A nebulizer is a device used to administer medication to people in the form of a mist inhaled into the lungs. Nebulizer medications are distributed in unit dose vials. Typically patients with COPD are prescribed some combination of the following nebulizer medications: Albuterol, Ipratropium, Brovana®1, Perforomist®2and/or Budesonide. We manage our nebulizer medication business through our centralized pharmacy and call center operations in Murray, KY.
 
 
1 Brovana is a registered trademark of Sepracor Inc.
2 Perforomist is a registered trademark of Dey Pharma, L.P.
Durable Medical Equipment
Rentals and sales of durable medical equipment represent 10.6% of our net revenues for the year ended December 31, 2011.
We provide a comprehensive line of durable medical equipment, such as hospital beds, wheelchairs, walkers, patient aids and other ancillary supplies, for rental or sale, to serve the specific needs of our patients. Typically, lower cost items, such as patient aids and walkers, are sold and higher cost items, such as hospital beds and wheelchairs, are rented. We consider durable medical equipment to be a complementary offering to respiratory therapy equipment and related services.
Our Operations
Organization

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We have approximately 425 operating locations, which we currently operate through three geographic divisions, nine regions and 50 areas. We have division vice presidents, as well as region and area managers who are responsible for operational and sales assessment and oversight for their respective operating locations. Each operating location is typically staffed with a location manager, patient service technicians, customer service representatives and a sales representative. Each operating location is also covered by a respiratory therapist or other clinical staff as required by applicable state laws. Location managers are responsible for the day-to-day management of their operating location. The division vice presidents report to our Chief Operating Officer.
Billing and collections functions are centralized into seven billing centers, each managed by a billing center director. Our Vice President of Billing and Collections provides oversight for all billing and collections functions. Our Vice President of Billing and Collections reports to our Chief Operating Officer.
Sales and marketing functions are managed through the operating teams with central oversight, as well as sales and marketing program development, being provided by our Chief Sales Officer. Our Chief Sales Officer reports to our Chief Operating Officer.
In addition to these areas, we also provide centralized corporate control over purchasing, payables, payroll, human resources, compliance, development of policies and procedures, real estate, information systems, accounting, legal and financial reporting.
We believe that this management structure provides control and consistency among our divisions and operating locations and allows us to implement standard policies and procedures across a large number of geographically remote operating locations, while preserving the localized operating structure necessary to maintain the personalized customer and referral relationships characteristic of the home health care business.
Operating Systems and Controls
Our operating systems provide management with information to measure and evaluate key components of our operations. During 2011, we completed implementation of our new order intake system. In conjunction with our new electronic medical record system implemented in 2009, we have redesigned our front-end order intake processes. As a result, we have been able to automate and consolidate many of our historically paper-based processes. We believe that this new intake system will result in significant improvements in our operating efficiency.
We have a proprietary billing system that is scalable and is used for substantially all of our billing sources, including Medicare, our largest source of revenues. All Medicare claims are aggregated, processed, archived and transmitted to Medicare on a daily basis. We also utilize a third-party web-based billing management system for managing and transmitting electronic claims to certain other payors. These processes are highly automated and have proven to be reliable and cost-effective. We currently transmit approximately 70% of our claims electronically (excluding Department of Veterans Affairs claims which require invoice-based billing).
Our billing and collection departments work closely with the personnel at our operating locations and third-party payors and are responsible for the review of patient coverage, the adequacy and timeliness of documentation and the follow-up with third-party payors to expedite reimbursement payments. We communicate with our operating locations through an intranet-based system that provides our managers with detailed information that allows us to address operating efficiencies. We believe this reporting capability allows our managers to operate their businesses more effectively and allocate their resources more appropriately.
 
Strategic Initiatives
We expect that we will continue to evaluate and explore strategic alternatives and opportunities as they may arise, including potential acquisitions, business combination transactions, strategic partnerships or similar transactions. In addition, either in connection with or independent of such a transaction, we expect that we may engage in financing activities through public or private offerings of equity, debt or convertible securities, including common stock, preferred stock, warrants, convertible notes or other instruments. We may repurchase our common stock from time to time in open market purchases or in privately negotiated transactions subject to the limitations provided in our respective debt agreements. The timing and actual number of shares repurchased is at the discretion of management of the Company and will depend on a variety of factors, including stock price, corporate and regulatory requirements, market conditions, the relative attractiveness of other capital deployment opportunities and other corporate priorities. Our 2012 financial plan calls for continued improvements in financial performance compared to 2011.
On June 28, 2011, we submitted our application for relisting of our common stock on the NASDAQ Global Market. The

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application review by NASDAQ’s Listing Qualifications department for compliance with all NASDAQ Stock Market standards is substantially complete. However, we do not currently meet the $4.00 per share minimum bid price required for initial listing on the NASDAQ Global Market. While we intend to satisfy all of NASDAQ’s requirements for relisting, there can be no assurance that our application will be approved, or of when or if our common shares will be listed on the NASDAQ Stock Market or another stock exchange. Our common stock will continue to trade on the OTC Bulletin Board under our current symbol, ROHI, during the NASDAQ listing process.

Payors
We derive our revenues principally from reimbursement by third-party payors. We accept assignment of insurance benefits from patients and, in most instances, invoice and collect payments directly from Medicare, Medicaid and private insurance carriers, as well as directly from patients under co-insurance provisions. The following table sets forth our payor mix for each of the years ended December 31:
 
 
2011
 
2010
 
2009
Medicare
39
%
 
41
%
 
42
%
Commercial payors
38
%
 
38
%
 
38
%
Department of Veterans Affairs
11
%
 
10
%
 
10
%
Medicaid
7
%
 
7
%
 
6
%
Private payors
5
%
 
4
%
 
4
%
We contract with insurers and managed care entities on a local, regional and national basis. We generally contract with those insurers and managed care entities having a significant patient population in the areas served by us, typically on a fee-for-service basis. Pursuant to our contracts with the Department of Veterans Affairs (VA), we provide equipment and services to persons eligible for VA benefits in the regions covered by the contracts. The VA contracts typically provide for an annual term, subject to three, four or five one-year renewal periods unless terminated or not renewed by the VA.
Our Company History
Rotech Healthcare Inc. was incorporated in the State of Delaware on March 15, 2002. Rotech Medical Corporation, our predecessor, was founded in 1981. In October 1997, Rotech Medical Corporation was acquired by Integrated Health Services, Inc. (IHS), a large, publicly-held provider of post-acute and related specialty health care services and products. Following the acquisition, Rotech Medical Corporation operated as a wholly owned subsidiary of IHS. On February 2, 2000, IHS and substantially all of its subsidiaries, including Rotech Medical Corporation filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court in the District of Delaware. The principal reason for the commencement of Rotech Medical Corporation’s Chapter 11 case was that Rotech Medical Corporation had jointly guaranteed approximately $2.3 billion of obligations of IHS, under credit agreements with IHS’ senior creditors. IHS defaulted on its obligations under those agreements in 1999. Rotech Medical Corporation’s plan of reorganization was confirmed on February 13, 2002, became final on February 25, 2002 and became effective on March 26, 2002. As a result of the reorganization, substantially all of Rotech Medical Corporation’s assets, business and operations were transferred to us, an independent company. On December 20, 2004, the Bankruptcy Court entered a final decree closing Rotech Medical Corporation’s bankruptcy case.
On October 24, 2011, the Company executed four Supplemental Indentures adding two new subsidiary entities, Ellis County Home Medical Equipment, LLC and Qualicare Home Medical, Inc., as subsidiary guarantors under the Company's First Lien Indenture, dated October 6, 2010, and the Second Lien Indenture, dated March 17, 2011.
Senior Secured Notes
On October 6, 2010, we issued $230.0 million in aggregate principal amount of 10.75% Senior Secured Notes due 2015 (the “Senior Secured Notes”) pursuant to an indenture (the “Indenture”) among ourselves, the subsidiary guarantors and The Bank of New York Mellon Trust Company, N.A., as trustee (in such capacity, the “Trustee”). The Senior Secured Notes were offered and sold in a private placement to Credit Suisse Securities (USA) LLC (the “Initial Purchaser”) in reliance on the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”), and resold by the Initial Purchaser to qualified buyers pursuant to exemptions from registration provided by Rule 144A and Regulation S of the Securities Act.
The Senior Secured Notes were issued at a discount of $6.5 million and we incurred transaction costs of approximately

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$8.0 million. The discount and transaction costs associated with the Senior Secured Notes will be amortized as interest expense over the term of those notes. Interest is payable semi-annually on April 15 and October 15. We used the proceeds from the offering of the Senior Secured Notes, together with $13.7 million of cash on hand, to repay all of the outstanding indebtedness under our former payment-in-kind term loan facility (the “Senior Facility”) and pay associated fees and expenses. As a result of the termination in 2010, of the Senior Facility dated March 30, 2007, we recorded a $4.4 million loss on extinguishment of debt related to unamortized debt issuance costs of $2.1 million and prepayment premiums of $2.3 million.
The Senior Secured Notes will mature on October 15, 2015. In connection with the issuance of the Senior Secured Notes, we entered into a registration rights agreement with the Initial Purchaser of the Senior Secured Notes, dated October 6, 2010 (the “Registration Rights Agreement”). Pursuant to the Registration Rights Agreement, we agreed to register the exchange of the Senior Secured Notes for freely tradable notes with terms that are substantially identical to the Senior Secured Notes. We also agreed, in limited circumstances, to file a shelf registration statement with respect to the Senior Secured Notes. On January 14, 2011, we completed the registered exchange offer with respect to the Senior Secured Notes.
The indenture governing the Senior Secured Notes contains covenants that limit our ability and the ability of our restricted subsidiaries to, among other things: sell assets; pay dividends or make other distributions or repurchase or redeem our stock; incur or guarantee additional indebtedness; incur certain liens; make loans and investments; enter into agreements restricting our subsidiaries’ ability to pay dividends; consolidate, merge or sell all or substantially all of our assets, and enter into transactions with affiliates.
Senior Second Lien Notes
On March 17, 2011, we issued $290.0 million in aggregate principal amount of Senior Second Lien Notes. The Senior Second Lien Notes were offered and sold in a private placement to Credit Suisse Securities (USA) LLC and Jefferies & Company, Inc. (the “Initial Purchasers”) in reliance on the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”), and resold by the Initial Purchasers to qualified buyers pursuant to exemptions from registration provided by Rule 144A and Regulation S of the Securities Act. The Senior Second Lien Notes were also offered and sold to certain directors of the Company who are accredited investors as defined in Rule 501(a) under the Securities Act.
The Senior Second Lien Notes were issued at a discount of $5.2 million and we incurred transaction costs of approximately $8.9 million. The discount and transaction costs associated with the Senior Second Lien Notes are being amortized as interest expense over the term of these notes. Interest is payable semi-annually on March 15 and September 15. We used the proceeds from the offering of the Senior Second Lien Notes, together with $24.5 million of cash on hand, to repay all of our outstanding Senior Subordinated Notes and pay associated fees and expenses. In conjunction with the closing of the Senior Second Lien Notes on March 17, 2011, we deposited $301.9 million with Bank of New York Mellon N.A., as trustee (the “Trustee”), to satisfy our obligation with respect to the Senior Subordinated Notes including the principal amount of $287.0 million and accrued interest through April 18, 2011 of $14.9 million. We were legally released of our liability effective March 17, 2011. Upon completion of the 30-day notice period required under the indenture governing our Senior Subordinated Notes, on April 18, 2011, the Trustee redeemed and canceled the Senior Subordinated Notes. As a result of the termination of the Senior Subordinated Notes we recorded a $1.2 million loss on extinguishment of debt related to unamortized debt issuance costs.
The Senior Second Lien Notes will mature on March 15, 2018. In connection with the issuance of the Senior Second Lien Notes, we entered into a registration rights agreement with the Initial Purchasers of the Senior Second Lien Notes, dated March 17, 2011 (the “Senior Second Lien Notes Registration Rights Agreement”). Pursuant to the Senior Second Lien Notes Registration Rights Agreement, we agreed to exchange the Senior Second Lien Notes for freely tradable notes with terms that are substantially identical to the Senior Second Lien Notes. We also agreed, in limited circumstances, to file a shelf registration statement with respect to the Senior Second Lien Notes. On July 12, 2011, we completed the registered exchange offer with respect to the Senior Second Lien Notes.
The indenture governing the Senior Second Lien Notes contains covenants that limit our ability and the ability of our restricted subsidiaries to, among other things: sell assets; pay dividends or make other distributions or repurchase or redeem our stock; incur or guarantee additional indebtedness; incur certain liens; make loans and investments; enter into agreements restricting our subsidiaries’ ability to pay dividends; consolidate, merge or sell all or substantially all of or our assets, and enter into transactions with affiliates. The Senior Second Lien Notes are collateralized by a second priority security interest in substantially all of the Company’s assets. The Senior Second Lien Notes are guaranteed by all of our wholly owned subsidiaries. Each guarantee is full and unconditional and joint and several. We hold all of our assets and conduct all of our operations through our wholly owned subsidiaries and the parent does not have independent assets and operations.

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Government Regulation
The health care industry is subject to extensive regulation by a number of governmental entities at the federal, state and local levels. The industry also is subject to frequent legislative and regulatory changes. Our business is impacted not only by those laws and regulations that are directly applicable to us, but also by certain laws and regulations that are applicable to our managed care payors and patients. 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. If we fail to comply with the laws and regulations applicable to our business, we could suffer civil and/or criminal penalties and we could be excluded from participating in Medicare, Medicaid and other federal and state health care programs.
In addition, numerous federal and state privacy and security laws and regulations, including the Federal Health Insurance Portability and Accountability Act of 1996 , as amended by the Health Information Technology For Economic and Clinical Health Act (collectively HIPAA), govern the collection, dissemination, security, use and disclosure of patients’ individually-identifiable health information. As part of our provision of, and billing for, health care equipment and services, we are required to collect and maintain such protected patient-identifiable health information. New health information standards, whether implemented pursuant to HIPAA, congressional action, state legislative actions or otherwise, could have a significant effect on the manner in which we handle health care related data and communicate with payors. Moreover, the cost of complying with these standards could be significant. While we believe we comply in all material respects with HIPAA, and comparable state privacy and security requirements, we cannot provide any assurance that governmental authorities will find that our business practices comply with current or future administrative or judicial interpretations of these regulations. Sanctions for failure to comply with these federal and state laws include significant civil and criminal penalties. A violation could subject us to penalties, fines or possible exclusion from the Medicare or Medicaid programs. Such sanctions could adversely impact our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations.
The federal government has made a policy decision to significantly increase the financial resources allocated to enforcing the health care fraud and abuse laws. Private insurers and various state enforcement agencies also have increased their level of scrutiny of health care claims in an effort to identify and prosecute fraudulent and abusive practices in the health care area.
Medicare and Medicaid Reimbursement.
As part of the Social Security Amendments of 1965, Congress enacted the Medicare program which provides for hospital, physician and other statutorily-defined health benefits for qualified individuals, including persons 65 and older and the disabled. The Medicaid program, also established by Congress in 1965, is a joint federal and state program that provides certain statutorily-defined health benefits to financially needy individuals who are blind, disabled, aged or members of families with dependent children. In addition, Medicaid may cover financially needy children, refugees and pregnant women. In 2011, Medicare, Medicaid and other federally funded programs (primarily VA contracts) accounted for approximately 57.0% of our revenues.
Medicare Laws and Regulations.
Under existing Medicare laws and regulations, the sale and rental of our products generally are reimbursed by the Medicare program according to prescribed fee schedule amounts calculated using statutorily-prescribed formulas. Significant legislation affecting home medical equipment (HME) reimbursement has been signed into law, including the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Affordability Reconciliation Act (collectively, the “PPACA”), the Medicare Improvement for Patients and Providers Act of 2008 (MIPPA), the Medicare, Medicaid and State Children’s Health Insurance Program 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), each of which contain provisions that negatively impact reimbursement for the primary HME products that we provide. The PPACA, MIPPA, the SCHIP Extension Act, DRA and MMA provisions (each of which is discussed in more detail below), when fully implemented, could have a material adverse effect on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations.
The PPACA includes, among other things, annual, non-deductible fees on any entity that manufacturers or imports certain prescription drugs and biologics, beginning in 2011; a deductible excise tax on any entity that manufactures or imports medical devices offered for sale in the United States, with limited exceptions, beginning in 2013; new face-to-face encounter requirements for HME and home health services; and a requirement that by 2016, the competitive bidding process must be nationalized or prices in non-competitive bidding areas must be adjusted to match competitive bidding prices.
MIPPA retroactively delayed the implementation of competitive bidding for eighteen months and decreased the 2009

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fee schedule payment amounts by 9.5% for product categories included in competitive bidding.
The SCHIP Extension Act reduced Medicare reimbursement amounts for covered Medicare Part B drugs, including inhalation drugs that we provide, which reductions went into effect April 1, 2008.
The DRA capped the Medicare rental period for oxygen equipment at 36 months of continuous use, after which time title of the equipment would transfer to the beneficiary. For purposes of this cap, the DRA provided for a new 36-month rental period that began January 1, 2006 for all oxygen equipment. With the passage of MIPPA, transfer of title of oxygen equipment at the end of the 36-month rental cap was repealed, although the rental cap remained in place.
The MMA significantly reduced reimbursement for inhalation drug therapies beginning in 2005, reduced payment amounts for five categories of HME, including oxygen, beginning in 2005, froze payment amounts for other covered HME items through 2007, established a competitive bidding program for HME, and implemented quality standards and accreditation requirements for HME suppliers.
We cannot predict the impact that any federal legislation enacted in the future will have on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations.
Further, changes in the law or new interpretations of existing laws could have a dramatic effect on permissible activities, the relative costs associated with doing business and the amount of reimbursement by government and other third-party payors. Reimbursement we receive from Medicare and other government programs is subject to federal and state statutory and regulatory requirements, administrative rulings, interpretations of policy, implementation of reimbursement procedures, renewal of VA contracts, retroactive payment adjustments and governmental funding restrictions. Our levels of revenue and profitability, like those of other health care companies, are affected by the continuing efforts of government payors to contain or reduce the costs of health care, including competitive bidding initiatives, measures that impose quality standards as a prerequisite to payment, policies reducing certain HME payment rates and restricting coverage and payment for inhalation drugs, and refinements to payments for oxygen and oxygen equipment.
(1) Competitive Bidding Program for HME. On April 2, 2007, the Centers for Medicare & Medicaid Services (CMS), the agency responsible for administering the Medicare program, issued its final rule implementing a competitive bidding program for certain HME products under Medicare Part B. This nationwide competitive bidding program is designed to replace the existing fee schedule payment methodology. Under the competitive bidding program, suppliers compete for the right to provide items to beneficiaries in a defined geographic region. CMS selects contract suppliers that agree to receive as payment the “single payment amount” calculated by CMS after bids are submitted. Round 1 of the competitive bidding program began on July 1, 2008 in ten high-population competitive bidding areas (CBAs). As a winning bidder in nine of the ten CBAs, we signed contracts with CMS to become a contracted supplier for the Round 1 contract period of July 1, 2008 through June 30, 2011. The competitive bidding program was scheduled to expand to 70 additional CBAs for a total of 80 CBAs in 2009 and additional areas thereafter.
However, on July 15, 2008, the United States Congress, following an override of a Presidential veto, enacted MIPPA. MIPPA retroactively delayed the implementation of competitive bidding for eighteen months, and terminated all existing contracts previously awarded. MIPPA included a 9.5% nationwide reduction in reimbursement effective January 1, 2009 for the product categories included in competitive bidding, as a budget-neutrality offset for the eighteen month delay.
On January 16, 2009, CMS published an interim final rule with comment period (IFC) addressing the MIPPA provisions that affect Round 1 of the competitive bidding program. This IFC announced the delay of Round 1 of the program from 2007 to 2009. The Round 1 competition, also known as the Round 1 rebid, occurred in the same CBAs as the 2007 Round 1 bidding, excluding Puerto Rico. The product categories for 2009 were the same as those selected for the 2007 Round 1 bidding, with the exception of negative pressure wound therapy and Group 3 complex rehabilitative wheelchairs. The IFC also announced the delay of Round 2 of the program from 2009 to 2011, the national mail order program until after 2010 and competition in additional areas, other than mail order, until after 2011. Suppliers are required to meet all applicable eligibility, financial, quality and accreditation standards. The MIPPA changes that were addressed in this IFC did not alter the fundamental requirements of the final regulation for the competitive bidding program published on April 10, 2007.
On July 2, 2010 CMS announced the single payment amount for each of the respective Round 1 rebid CBAs and product categories and began offering contracts to certain bidders in the CBAs. We were awarded and accepted 17 contracts. In addition on July 1 and September 9, 2011, we completed two acquisitions in two of the Round 1 rebid CBAs. As part of these acquisitions, we assumed six additional competitive bid contracts, for a total of 23, as follows:
7 CBAs for oxygen supplies and equipment;
6 CBAs for enteral nutrients, equipment and supplies;
5 CBAs for continuous positive airway pressure, respiratory assist devices and related supplies and accessories;

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2 CBAs for walkers;
1 CBA for hospital beds and related supplies; and
2 CBAs for standard power wheelchairs, scooters and related accessories.
CMS announced the participating providers in November 2010. The contracts became effective January 1, 2011 and have a term of three years. The average reduction from current Medicare payment rates in this round of competitive bidding across the CBAs was 32%. Suppliers that were not contracted by CMS may continue to provide certain rental and oxygen equipment for those beneficiaries that were patients at the time the program begins and are known as “grandfathered suppliers”. In the CBAs and product categories where we are not a contracted supplier, we continue to service our Medicare patients as grandfathered suppliers under applicable guidelines. Based upon CMS released information, it appears that approximately 70% of the existing number of providers across the Round 1 Rebid CBAs were not awarded competitive bidding contracts and are therefore not able to provide competitive bid products to new Medicare patients during the term of these contracts in the respective CBAs. We have experienced volume increases in the CBAs where we were awarded contracts, which we attribute in part to an increase in market share, during the year ended December 31, 2011 and we believe that the revenue associated with these volume increases will more than offset the impact of the associated reductions in reimbursement rates over time. The application of the new competitive bid rates in the Round 1 rebid reduced our net revenue by approximately $5.1 million for the year ended December 31, 2011.
In addition, on November 2, 2010, CMS finalized certain changes impacting competitive bidding and current payment policies for certain items of durable medical equipment, prosthetics, orthotics and supplies, including:
Implementation of certain statutory provisions under MIPPA and the PPACA, including: (1) the subdivision of metropolitan statistical areas (MSAs) with populations over 8,000,000 into smaller CBAs, as required under MIPPA; (2) the addition of 21 MSAs to the 70 MSAs already designated as included in Round 2, for a total of 91 MSAs, as required under the PPACA; and (3) the implementation of payment policies adopted under the PPACA for power wheelchairs, which eliminated the lump sum purchase option for standard power wheelchairs furnished on or after January 1, 2011, and adjusted the amount of the capped rental payments for power wheelchairs. Effective January 1, 2011, rental payments under the adjusted fee schedule are 15% (instead of 10%) of the purchase price for the first three months and 6% (instead of 7.5%) for the remaining rental months not to exceed 13 months; and
The establishment of an appeals process for competitive bidding contract suppliers that are notified that they are in breach of contract.
CMS also solicited comments on whether to reduce the maximum number of payments a contract supplier would receive beyond the 13-month (for capped rental) and 36-month (for oxygen and oxygen equipment) caps when a beneficiary who is receiving the equipment from a non-contract supplier elects to switch to the contract supplier. To date CMS has not made any changes.
CMS is currently undertaking Round 2 of competitive bidding in 91 additional markets, with contracts expected to be effective in July 2013. Our Medicare revenues from the product categories in the 91 additional markets to be included in Round 2 of competitive bidding were approximately $54.0 million in 2011. The PPACA legislation requires CMS to expand competitive bidding further to additional geographic markets (certain markets may be excluded at the discretion of CMS) or to use competitive bid pricing information to adjust the payment amounts otherwise in effect for areas that are not competitive bidding areas by January 1, 2016.
(2) Certain Clinical Conditions, Accreditation Requirements and Quality Standards. The MMA required establishment and implementation of new clinical conditions of coverage for HME products and quality standards for HME suppliers. Some clinical conditions have been implemented, such as the requirement for a face-to-face visit by treating physicians for beneficiaries seeking power mobility devices. CMS published its quality standards and criteria for accrediting organizations for HME suppliers in 2006 and revised some of these standards in October 2008. As an entity that bills Medicare and receives payment from the program, we are subject to these standards. We have revised our policies and procedures to ensure compliance in all material respects with the quality standards. These standards, which are applied by independent accreditation organizations, include business-related standards, such as financial and human resources management requirements, which would be applicable to all HME suppliers, and product-specific quality standards, which focus on product specialization and service standards. The product specific standards address several of our products, including oxygen and oxygen equipment, CPAP and power and manual wheelchairs and other mobility equipment.
Currently, all of our operating locations are accredited by the Joint Commission (formerly referred to as the Joint Commission on Accreditation of Healthcare Organizations). The Joint Commission is a CMS recognized accrediting organization. Round 1 re-bid competitive bid suppliers were required to be accredited by September 30, 2009.

On January 2, 2009, CMS published its final rule on surety bond requirements for HME suppliers, effective March 3,

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2009. For each National Provider Identifier (NPI) number subject to Medicare billing privileges, suppliers must obtain a surety bond in the amount of $50,000. Each of our 425 operating locations is required to have its own NPI number. There may be an upward adjustment for suppliers that have had adverse legal actions imposed on them in the past. HME suppliers already enrolled in Medicare were required to obtain a surety bond by October 2, 2009, and newly enrolled suppliers or those changing ownership were subject to the provisions of the new rule on May 4, 2009. We maintain surety bonds covering all of our NPI numbers at each of our operating locations.
(3) Reduction in Payments for HME and Inhalation Drugs. The MMA changes also included a reduction in reimbursement rates beginning in January 2005 for oxygen equipment and certain other items of home medical equipment (including wheelchairs, nebulizers, hospital beds and air mattresses) based on the percentage difference between the amount of payment otherwise determined for 2002 and the 2002 median reimbursement amount under the Federal Employee Health Benefits Program (FEHBP) as determined by the Office of Inspector General of the Department of Health and Human Services (OIG). The FEHBP adjusted payments remained “frozen” through 2008. With limited exceptions, items that were not included in competitive biddings received a 5.0% update for 2009. As discussed above, for 2009, MIPPA included a 9.5% nationwide reduction in reimbursement for the product categories included in competitive bidding, as a budget neutrality offset for the eighteen month delay.
The MMA also revised the payment methodology for certain drugs, including inhalation drugs dispensed through nebulizers. 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% 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% 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 resulted in a significant reduction in payment rates for inhalation drugs. Given the overall reduction in payment for inhalation drugs dispensed through nebulizers, CMS established a dispensing fee for inhalation drugs shipped to a beneficiary beginning in 2005. The current dispensing fee is $57 for the first 30-day period in which a Medicare beneficiary uses inhalation drugs and $33 for each subsequent 30-day period. The dispensing fee for a 90-day supply of inhalation drugs is $66. This dispensing fee has remained unchanged since 2006. Future changes from quarterly updates to ASP pricing, as well as any future dispensing fee reductions or eliminations, if they occur, could have a material adverse effect on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations.
Furthermore, because the ASP amounts vary from quarter to quarter, changes in market forces influence the Medicare payment rate. In late 2006, the United States Food and Drug Administration approved a first-time generic formulation for DuoNeb. The introduction of this generic product into the market has contributed to the reduction of the ASP for DuoNeb from $1.079 in the fourth quarter of 2007 to $0.281 in the first quarter 2012. The impact of this reduction to our profit margins, profitability, operating cash flows and results of operations was partially mitigated through the dispensing of generic DuoNeb and changes in nebulizer medication product mix.
(4) Reductions in Payments for Oxygen and Oxygen Equipment. The DRA which was signed into law on February 8, 2006, made certain changes to the way Medicare Part B pays for certain of our HME products, including oxygen and oxygen equipment. For oxygen equipment, prior to the DRA, Medicare made monthly rental payments indefinitely, provided medical need continued. The DRA capped the Medicare rental period for oxygen equipment at 36 months of continuous use, after which time ownership of the equipment would transfer to the beneficiary. For purposes of this cap, the DRA provided for a new 36-month rental period that began January 1, 2006 for all oxygen equipment. In addition to the changes in the duration of the rental period for capped rental items and oxygen equipment, the DRA permitted payments for servicing and maintenance of the products after ownership transfers to the beneficiary.

On November 1, 2006, CMS released a final rule to implement the DRA changes, which went into effect January 1, 2007. Under the rule, CMS clarified the DRA’s 36-month rental cap on oxygen equipment. CMS also revised categories and payment amounts for the oxygen equipment and contents during the rental period and for oxygen contents after equipment ownership by the beneficiary as described below. With the passage of MIPPA on July 15, 2008, transfer of title to oxygen equipment at the end of the 36-month rental cap was repealed, although the rental cap remained in place. Effective January 1, 2009, after the 36th continuous month during which payment is made for the oxygen equipment, the equipment is to continue to be furnished during any period of medical need for the remainder of the reasonable useful lifetime of the equipment. The reasonable useful lifetime for stationary or portable oxygen equipment begins when the oxygen equipment is first delivered to the beneficiary and continues until the point at which the stationary or portable oxygen equipment has been used by the beneficiary on a continuous basis for five years (60 months) provided there are no breaks in service due to medical necessity. Computation of the

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reasonable useful lifetime is not based on the age of the equipment. During the capped rental period from months 37 through 60 of continuous use, payment is made only for oxygen contents and for certain reasonable and necessary maintenance and service (for parts and labor not covered by the supplier’s or manufacturer’s warranty) (discussed in more detail below).
Payment for Rental Period. The monthly payment amount for stationary oxygen equipment was $173.31 for 2011, compared to $173.17 for 2010 and $175.79 for 2009. This amount will increase to $176.06 for 2012. The monthly add-on payment amount for portable oxygen was $28.74 for 2011, compared to $28.77 for 2010 and 2009. This amount will increase to $29.43 for 2012. The 2010, 2011 and 2012 monthly payment amount for oxygen-generating portable oxygen equipment remains unchanged from 2009 at $51.63.
Payment for Contents after 36-Month Rental Cap. Payment is based on the type of equipment owned and whether it is oxygen-generating. CMS pays separate monthly payment amounts of $77.45 each for stationary and portable oxygen content. If the beneficiary uses both stationary and portable equipment that is not oxygen-generating, the monthly payment amount for oxygen contents is $154.90. For stationary or portable oxygen equipment that is oxygen-generating, there is no monthly payment for contents.
Payment for maintenance and service after 36-Month Rental Cap. CMS pays for one in-home, maintenance and service visit for oxygen concentrators and transfilling equipment every six months, beginning six months after the end of the 36-month rental cap. This payment will be made if the supplier visits the beneficiary’s home, performs any necessary maintenance and service, and inspects the equipment to ensure that it will function safely for the next six months. CMS pays for such in-home maintenance and service visits every six months until medical necessity ends or the beneficiary elects to obtain new equipment. Beginning July 1, 2010, the six-month maintenance and service payment rate is capped at 10% of the cost of acquiring a stationary oxygen concentrator, which resulted in a payment of $66 for calendar year 2010. For calendar year 2011 and subsequent years, the maintenance and servicing fee is adjusted by the covered item update for DME, which resulted in a payment of $65.93 for calendar year 2011, and $67.51 for calendar year 2012.
Finally, CMS clarified that though it retains title to the equipment, a supplier is required to continue to furnish needed oxygen equipment and contents for liquid or gaseous equipment after the 36-month rental cap until the end of the equipment’s reasonable useful lifetime. CMS determined the reasonable useful lifetime for oxygen equipment to be five years provided there are no breaks in service due to medical necessity, computed based on the date the equipment is delivered to the beneficiary. On January 27, 2009, CMS posted further instructions on the implementation of the 36-month rental cap, including guidance on payment for oxygen contents after month 36 and the replacement of oxygen equipment that has been in continuous use by the patient for the equipment’s reasonable useful lifetime (as defined above). In accordance with these instructions, and consistent with the final rule published on October 30, 2008, suppliers may bill for oxygen contents on a monthly basis after the 36-month rental cap, and the supplier can deliver up to a maximum of three months of oxygen contents at one time. Additionally, in accordance with these instructions, and consistent with the final rule published on October 30, 2008, we provide replacement equipment to our patients that exceed five years of continuous use.
The ongoing financial impact of the 36-month rental cap will depend upon a number of variables, including, (i) the number of Medicare oxygen patients reaching 36 months of continuous service, (ii) the number of patients receiving 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 mortality rates of patients on service beyond 36 months, (iv) the incidence of patients with equipment deemed to be beyond its reasonable 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 a new rental period, (v) any breaks in continuous use due to medical necessity, and (vi) payment amounts established by CMS to reimburse suppliers for maintenance of oxygen equipment. We cannot predict the impact that any future rulemaking by CMS will have on our business. If payment amounts for oxygen equipment and contents are further reduced in the future, this could have a material adverse effect on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations.
CMS also has authority to make other adjustments to reimbursement for HME. With the passage of the Balanced Budget Act of 1997, CMS may determine to increase or reduce the reimbursement for HME, including oxygen, by up to 15% each year under an inherent reasonableness procedure. The regulation implementing the inherent reasonableness authority establishes a process for adjusting payments for certain items and services covered by Medicare Part B when the existing payment amount is determined to be grossly excessive or deficient. The regulation lists factors that may be used by CMS and its Medicare contractors to determine whether an existing reimbursement rate is grossly excessive or deficient and to determine what a realistic and equitable payment amount is. Also, under the regulation, CMS and its contractors will not consider a payment amount to be grossly excessive or deficient and make an adjustment if they determine that an overall payment adjustment of less than 15% is necessary to produce a realistic and equitable payment amount. The implementation of the inherent reasonableness procedure itself does not trigger payment adjustments for any items or services and to date, no payment adjustments have occurred or been proposed under this inherent reasonableness procedure.

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Though the inherent reasonableness authority has not been exercised, in past years, CMS historically has reduced the published Medicare reimbursement rates for HME to an amount based on the payment amount for the least costly alternative (LCA) treatment that met the Medicare beneficiary’s medical needs. LCA determinations have been applied to particular products and services by CMS and its contractors through the notice and comment process used in establishing local coverage policies for HME. With respect to LCA policies, on October 16, 2008, a U.S. District Court in the District of Columbia held that CMS did not have the authority to implement LCA determinations in setting payment amounts for an inhalation drug. This decision was upheld by the U.S. Court of Appeals and, as a result, CMS and its contractors withdrew their LCA policy for the inhalation drug. In addition, CMS instructed its contractors that they may no longer apply LCA policies to any HME. Effective February 4, 2011, all coverage policies have been revised to eliminate their LCA provisions.

FDA Requirements
Under the Federal Food Drug and Cosmetic Act (FFDCA), the Food and Drug Administration (FDA) imposes stringent regulations on the distribution, labeling, and other aspects of our medical gas and pharmacy operations. In particular, our medical gas facilities and operations are subject to the FDA’s current Good Manufacturing Practice (cGMP) regulations, and similar state regulations, which impose certain quality control, documentation, labeling and recordkeeping requirements on the receipt, processing and distribution of medical gas. We are required to register our medical gas facilities with the FDA and with regulatory authorities in the states in which we do business, and are subject to periodic, unannounced inspections by the FDA and state authorities for compliance with the cGMP and other regulatory requirements. Our sites have historically been subject to regular inspections by federal and state regulatory authorities. We have received notices of inspectional observations at the conclusion of some of these inspections. Where required, we have taken corrective actions to address the inspectional observations identified during these inspections. We continue to expend significant time, money and other resources in our effort to achieve substantial compliance with the FDA’s cGMP regulations and the state laws applicable to our medical gas operations in the jurisdictions in which we do business. Failure to comply with the FDA and other federal and state regulatory requirements could subject us to possible legal or regulatory action, such as warning letters, product seizure or recalls, suspension of operations at a single facility or several facilities, temporary or permanent injunctions, or possible civil or criminal penalties.
Pharmacy Licensing, Registration and Regulatory Requirements
Under state law, our pharmacy location must be licensed as an in-state pharmacy to dispense pharmaceuticals in the relevant state. We deliver pharmaceuticals from our pharmacy location in Kentucky to customers in 49 states, and, where required by state pharmacy law, we must obtain and maintain licenses from each state to which we deliver pharmaceuticals. Most states, and the FDA, adopt and enforce the official standards of the US Pharmacopeia (USP) as the official compendia of drug standards. We are subject to state boards of pharmacy laws and regulations in nearly all jurisdictions where we do business. These laws vary from state to state and state lawmakers regularly propose and, at times, enact new legislation establishing changes in state pharmacy laws and regulations. We continuously monitor state activities and the USP and we have policies in place that we believe substantially comply with all state licensing and pharmacy laws currently applicable to our business, although there can be no assurance that we always operate in full compliance with our policies. Further, there can be no assurance that we are fully and immediately in compliance with all laws, regulations or standards at all times, as licenses may lapse and laws may change or be misinterpreted or overlooked. Failure to comply with applicable regulatory requirements can result in enforcement action, including fines, revocation, suspension of or refusal to renew licensure, injunctions, seizures, and civil or criminal penalties. Further, we are required to maintain state licenses and permits in those states in which we are doing business to meet Medicare and Medicaid requirements. A finding that the state requirements have not been met can result in the recoupment of reimbursement or revocation of our supplier numbers. If we are unable to obtain and maintain our licenses in one or more states, or if such states place burdensome restrictions or limitations on pharmacies, our ability to operate in such states, including doing Medicare and Medicaid business in such state or states, would be limited, which could adversely impact our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations.
Professional Licensure
Nurses, pharmacists and other health care professionals employed by us are required to be individually licensed or certified under applicable state law. We take steps to assure that our employees possess all necessary licenses and certifications, and we believe that our employees comply in all material respects with applicable licensure or certification laws.
Claims Audits
Durable Medical Equipment Medicare Administrative Contractors (DME MACs), Recovery Audit Contractors (RACs) and Zone Program Integrity Contractors (ZPICs) are private organizations that contract to serve as the government’s agents for

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processing of claims and for conducting periodic pre-payment and post-payment reviews and other audits of claims for home medical equipment and inhalation drugs dispensed through a nebulizer under Part B of the Medicare program. The RACs are empowered by CMS to audit claims submitted by health care providers on a post-payment basis and to recover amounts deemed as improperly paid, including in cases where the reimbursement rules are unclear or subject to differing interpretations. The ZPICs are responsible for ensuring the integrity of all Medicare-related claims and are empowered to audit claims submitted by health care providers on a pre-payment basis. Industry-wide, ZPIC audit activity has increased substantially throughout 2010 and 2011 and that activity is expected to continue to increase for the foreseeable future as additional ZPICs become operational across the country. The industry trade associations are advocating for more standardized audit procedures, contractor transparency and consistency surrounding all government audit activity directed toward the DME industry. This activity, as well as the activity of intermediaries and others involved in government reimbursement, may include changes in long-standing interpretations of reimbursement rules, which could have a material adverse effect on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations. Furthermore, reviews and/or similar audits or investigations of our claims and related documentation could result in denials of claims for payment submitted by us. The government could demand significant refunds or recoupments of amounts paid by the government for claims which, upon subsequent investigation, are determined by the government to be inadequately supported by the required documentation.
The Anti-Kickback Statute
As a provider of services under the Medicare and Medicaid programs, we are subject to the Medicare and Medicaid fraud and abuse laws (sometimes referred to as the “Anti-Kickback statute”). At the federal level, the Anti-Kickback statute prohibits any person from knowingly and willfully soliciting, receiving, offering or providing any remuneration, including a bribe, kickback or rebate, directly or indirectly, in return for or to induce the referral of patients, or the furnishing, recommending, or arranging for products or services covered by federal health care programs. Further, the recently enacted PPACA, among other things, amends the intent requirement of the federal Anti-Kickback and criminal health care fraud statutes. A person or entity no longer needs to have actual knowledge of this statute or specific intent to violate it. In addition, the PPACA provides that the government may assert that a claim including items or services resulting from a violation of federal Anti-Kickback statute constitutes a false or fraudulent claim for purposes of the false claims statutes. Federal health care programs have been defined to include plans and programs that provide health benefits funded by the federal government, including Medicare and Medicaid, among others. Violations of the Anti-Kickback statute may result in civil and criminal penalties including fines of up to $25,000 per violation, civil monetary penalties of up to $50,000 per violation, assessments of up to three times the amount of the prohibited remuneration, imprisonment, and exclusion from participation in the federal health care programs. The OIG has published regulations that identify a limited number of specific business practices that fall within safe harbors which are deemed not to violate the Anti-Kickback statute. Although we attempt to structure our business relationships to meet safe harbor requirements, it is possible that not all of our business relationships comply with the elements of one or more safe harbors. Conformity with the safe harbors is not mandatory and failure to meet all of the requirements of an applicable safe harbor does not make conduct per se illegal. The OIG is authorized to issue advisory opinions regarding the interpretation and applicability of the federal Anti-Kickback statute, including whether an activity constitutes grounds for the imposition of civil or criminal sanctions. However, we have not sought such an opinion.
In addition, a number of states in which we operate have anti-fraud and anti-kickback laws similar to the Anti-Kickback Statute that prohibit certain direct or indirect payments if such arrangements are designed to induce or encourage the referral of patients or the furnishing of goods or services. Some states’ anti-fraud and anti-kickback laws apply only to goods and services covered by Medicaid. Other states’ anti-fraud and anti-kickback laws apply to all health care goods and services, regardless of whether the source of payment is governmental or private. Further, many states prohibit revenue sharing or fee splitting arrangements between physicians and other third parties. Possible sanctions for violation of these restrictions include exclusion from state-funded health care programs, loss of licensure and civil and criminal penalties. Such statutes vary from state to state, are often vague and have seldom been interpreted by the courts or regulatory agencies.
Physician Self-Referrals
Certain provisions of the Omnibus Budget Reconciliation Act of 1993, commonly known as the “Stark Laws,” prohibit us, subject to certain exceptions, from submitting claims to the Medicare and Medicaid programs for “designated health services” if we have a financial relationship with the physician making the referral for such services or with a member of such physician’s immediate family. The term “designated health services” includes several services commonly performed or supplied by us, including durable medical equipment, home health services and parenteral and enteral nutrition. In addition, “financial relationship” is broadly defined to include any ownership or investment interest or compensation arrangement involving remuneration between us and the physician at issue. Violations of the Stark Laws may result in loss of Medicare and Medicaid reimbursement, civil penalties and exclusion from participation in the Medicare and Medicaid programs. A person who engages in a scheme to circumvent the Stark Law’s referral prohibition may be subject to penalties as well.

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In addition, a number of the states in which we operate have similar or broader prohibitions on physician self-referrals. Finally, enforcement activity and resulting case law developments have increased the legal risks of physician compensation arrangements that do not satisfy the terms of an exception to the Stark Laws, especially in the area of joint venture arrangements with physicians.
False Claims
We are subject to state and federal laws that govern the submission of claims for reimbursement. The federal False Claims Act imposes civil liability on individuals or entities that submit false or fraudulent claims for payment to the government. Violations of the False Claims Act may result in treble damages, civil monetary penalties for each false claim submitted and exclusion from the Medicare and Medicaid programs. In addition, we could be subject to criminal penalties under a variety of federal statutes to the extent that we knowingly violate legal requirements under federal health programs or otherwise present false or fraudulent claims or documentation to the government.
The False Claims Act also allows a private individual to bring a qui tam suit on behalf of the government against a health care provider for violations of the False Claims Act. A qui tam suit may be brought by, with only a few exceptions, any private citizen who has material information of a false claim that has not yet been disclosed previously. Even if disclosed, the original source of the information leading to the public disclosure may still pursue such a suit. Although a corporate insider is often the plaintiff in such actions, an increasing number of outsiders are pursuing such suits.
In a qui tam suit, the private plaintiff is responsible for initiating a lawsuit that may eventually lead to the government recovering money of which it was defrauded. After the private plaintiff has initiated the lawsuit, the government must decide whether to intervene in the lawsuit and become the primary prosecutor. In the event the government declines to join the lawsuit, the private plaintiff may choose to pursue the case alone, in which case the private plaintiff’s counsel will have primary control over the prosecution (although the government must be kept apprised of the progress of the lawsuit and will still receive at least 70% of any recovered amounts). In return for bringing the suit on the government’s behalf, the statute provides that the private plaintiff is to receive up to 30% of the recovered amount from the litigation proceeds if the litigation is successful. The number of qui tam suits brought against health care providers has increased dramatically. In addition, at least five states—California, Illinois, Florida, Tennessee and Texas—have enacted laws modeled after the False Claims Act that allow those states to recover money which was fraudulently obtained by a health care provider from the state (e.g., Medicaid funds provided by the state).
Compliance Program
We have several voluntary programs to monitor compliance with federal and state laws and regulations applicable to health care entities which are designed to minimize the likelihood that we would engage in conduct or enter into contracts in violation of the fraud and abuse laws. While we believe that our compliance program meets the relevant guidance provided by the OIG, we cannot provide any assurance that current or future administrative or judicial interpretations of existing laws or legislative enactment of new laws will not have a material adverse effect on our business.

Health Care Reform Legislation
Economic, political and regulatory influences are subjecting the health care industry in the United States to fundamental change. Health care reform proposals have been formulated by the legislative and administrative branches of the federal government. In addition, some of the states in which we operate periodically consider various health care reform proposals. We anticipate that federal and state government bodies will continue to review and assess alternative health care delivery systems and payment methodologies and public debate of these issues will continue in the future. Due to uncertainties regarding the ultimate features of reform initiatives and their enactment and implementation, we cannot predict, which, if any, of such reform proposals will be adopted or when they may be adopted or whether or not any such reforms will have a material adverse effect on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations.
Health care is an area of extensive and dynamic regulatory change. Changes in the law or new interpretations of existing laws can have a dramatic effect on permissible activities, the relative costs associated with doing business and the amount of reimbursement by government and other third-party payors.
Corporate Integrity Agreements
On May 16, 2008, we entered into a three-year Corporate Integrity Agreement (the “2008 CIA”) with the OIG in connection with the resolution of a qui tam complaint brought by one of our former employees. The action was filed on April 6, 2004 and alleged violations of the False Claims Act between February 22, 1996 and April 30, 2003. In settling the litigation, we did not admit wrongdoing but paid $2.0 million plus interest to the United States Treasury Department and $1.4 million to the former employee for expenses and attorney’s fees and costs. The settlement amount was paid on May 19, 2008; the associated

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expense was previously recorded as legal settlement in the statement of operations for the three months and year ended December 31, 2007. The 2008 CIA expired in May 2011. We have maintained our existing compliance program beyond the term of the 2008 CIA.
Suppliers
We purchase our patient service equipment and supplies from a variety of independent suppliers, with whom we generally have long-standing relationships. Although we are not dependent upon any one supplier, we do currently purchase approximately 75% of our patient service equipment and supplies from five suppliers. We typically focus on one or two suppliers in each product category in an effort to maximize delivery efficiency and gross margins. We do believe that most of our supplies can be provided by multiple suppliers; however, loss or disruption of a supplier relationship could cause delays in service delivery which could adversely affect our financial condition, revenues, profit margins, profitability, operating cash flows and result of operations.
Sales
We believe that the sales and marketing skills of our employees are instrumental to the success of our business. We provide marketing, training, product and service information to all of our technical personnel through our intranet and through seminars conducted on a company-wide basis so that they can communicate effectively with physicians and other referral sources about our equipment and services. We emphasize the cross-marketing of all our equipment and services to physicians and other referral sources with which we have already developed professional relationships.

Quality Control
We are committed to providing consistently high quality equipment and services. Our quality control procedures and training programs are designed to promote greater responsiveness and sensitivity to individual patient needs and to provide a high level of quality assurance and convenience to the patient and the referring physician. Licensed respiratory therapists and registered nurses provide professional health care support. The Joint Commission is a nationally recognized organization which develops standards for various health care industry segments and monitors compliance with those standards through voluntary surveys of participating providers. Accreditation by the Joint Commission entails a lengthy review process that is conducted at least every three years. We believe that our accreditation by the Joint Commission is indicative of our commitment to providing consistently high quality equipment and services. Currently, all of our operating locations are accredited by the Joint Commission.
Competition
The home medical equipment market is highly competitive and divided among a large number of providers, some of which are national providers, but most of which are either regional or local providers. Our largest national home medical equipment provider competitors are Apria Healthcare Group, Inc., Lincare Holdings, Inc. and American Home Patient, Inc. The rest of the market consists of several medium-size competitors, as well as hundreds of smaller companies with each having under $5 million in estimated annual revenues. We also face competition from other types of health care providers, including hospitals, home health agencies and health maintenance organizations. We believe that the most important competitive factors in the regional and local markets are:
reputation with referral sources, including local physicians and hospital-based professionals;
service quality and responsiveness;
overall ease of doing business;
quality of patient care, including clinical expertise;
range of home medical equipment and services; and
being a low cost provider.
We believe that it is important to be able to offer a broad range of complementary equipment and services to provide patients access through a single source. We believe that we compete effectively with respect to all of the above factors and that we have an established record as a quality provider of a range of complementary home medical equipment and services.
Insurance
Our business is subject to general and professional liability, management liability, products liability, employment practices liability, workers’ compensation, automobile liability, personal injury and other liability claims that are generally covered by insurance. We have insurance policies that contain various customary levels of deductibles and self-insured

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retentions and provide us with protection against claims alleging bodily injury or property damage arising out of our operations. Furthermore, the losses that are insured through commercial insurance are subject to the credit risk of those insurance companies. While we believe our commercial insurance providers are currently credit worthy, there can be no assurance that such insurance companies will remain so in the future. These insurance policies are subject to annual renewal. We believe that our insurance coverage is appropriate based upon historical claims and the nature and risks of our business.
Employees
As of December 31, 2011, we have approximately 3,800 full time employees. Our employees are not currently represented by a labor union or other labor organization. We believe our relations with our employees are good.

Principal Executive Office and Website Access to Information
Our principal executive offices are located at 2600 Technology Drive, Suite 300, Orlando, Florida, 32804 and our telephone number there is (407) 822-4600. Our internet website address is www.rotech.com.
We make available free of charge on or through our website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission (SEC). Our reports are also available free of charge on the SEC’s website, www.sec.gov. Also available free of charge on our website are the following corporate governance documents:
Certificate of Incorporation
Bylaws
Audit Committee Charter
Compensation Committee Charter
Nominating and Corporate Governance Committee Charter
Corporate Governance Guidelines
Code of Ethics for Directors, Senior Executive, Financial and Accounting Officers
Policy Statement on Business Ethics and Conflicts of Interests
Related Party Transactions Policy
All of our reports and corporate governance documents may also be obtained without charge, upon written request directed to the Chief Legal Officer, Rotech Healthcare Inc., 2600 Technology Drive, Suite 300, Orlando, Florida, 32804. Information contained on our website is not incorporated by reference into this annual report and is not a part of this annual report.
Executive Officers of the Registrant
Our executive officers and their respective ages and positions are as follows:
 
Name
 
Age
 
Position
Philip L. Carter
 
63
 
President, Chief Executive Officer and Director
Steven P. Alsene
 
42
 
Chief Operating Officer and Interim Chief Financial Officer and Treasurer
Philip L. Carter became President, Chief Executive Officer and a director of our company in December 2002. From March 2002 to November 2002, Mr. Carter was self-employed. From May 1998 to February 2002, Mr. Carter was the Chief Executive Officer and a director of Apria Healthcare Group Inc. Prior to joining Apria Healthcare Group Inc., Mr. Carter had served as President and Chief Executive Officer of Mac Frugal’s Bargains Close-Outs Inc., a chain of retail discount stores, since 1995.
Steven P. Alsene became Chief Operating Officer of our company in January 2012 after serving as the Chief Financial Officer and Treasurer of our company since September 2006. Prior to his formal appointment as Chief Financial Officer and Treasurer, Mr. Alsene served in such capacity on an interim basis since June 2006. Mr. Alsene will continue to serve on an interim basis as the Chief Financial Officer and Treasurer until the appointment of a successor in that position. Mr. Alsene joined our company in June 2003 as the Vice President of Internal Audit and has also served as our Vice President of Finance. From June 1999 to June 2003, Mr. Alsene was the Head of Corporate Audit Services of Harcourt Education, a division of Reed Elsevier PLC. From 1992 to 1999, Mr. Alsene served in various audit department capacities including audit manager with

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PricewaterhouseCoopers LLP. Mr. Alsene is a certified public accountant in the State of Florida. He received his Bachelor of Science in Accounting from Florida State University and holds a Masters in Accounting from Florida State University.


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ITEM 1A.
RISK FACTORS
You should carefully consider each of the following risks and all of the other information set forth in this Annual Report on Form 10-K. Based on the information currently known to us, we believe that the following information identifies the most significant risk factors affecting our company in each of these categories of risk. However, the risks and uncertainties our company faces are not limited to those described below. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also adversely affect our business. Past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods.
Risks related to our liquidity, financing, and capital structure
Our indebtedness could limit our ability to plan for or respond to changes in our business, and we may be unable to generate sufficient cash flow to satisfy significant debt service obligations.
As of December 31, 2011, our total consolidated long-term debt (including current maturities) exceeds our total assets. The degree to which we are leveraged continues to have substantial negative consequences, because:
a substantial portion of our cash flow from operations is required to be dedicated to interest payments and therefore is not available for operations, working capital, capital expenditures, expansion, acquisitions, or general corporate or other purposes;
we are more highly leveraged than our major national competitors, which places us at a competitive disadvantage in terms of our ability to capitalize on business opportunities and to react to competitive pressures and changes in our industry as compared to our competitors; and
it makes us more vulnerable in the event of a downturn in our business, our industry, or the economy in general.
The degree to which we are leveraged may also have substantial future negative consequences, because:
it could affect our ability to satisfy our obligations under our 10.75% Senior Secured Notes due 2015 (the “Senior Secured Notes”) and our 10.5% Senior Second Lien Notes due 2018 (the “Senior Second Lien Notes”), including our ability to make interest payments thereunder when due and payable;
our ability to finance and consummate transactions that may be critical to our strategic and financial condition could be limited;
our ability to obtain additional financing in the future may be impaired; and
our flexibility in planning for, or reacting to, changes in our business and industry may be limited.
Although the indentures related to our Senior Secured Notes and Senior Second Lien Notes limit our ability to incur additional debt, these limitations are subject to a number of exceptions and, under certain circumstances, we may be able to incur a significant amount of additional debt. The incurrence of such additional debt could increase the risks described above.
Our failure to comply with the financial covenants contained in our Senior Secured Notes and Senior Second Lien Notes would likely have a material adverse effect on our operating results and financial condition, including the possibility that we may not be able to make payments on the Senior Secured Notes and Senior Second Lien Notes.
Our indentures for our Senior Secured Notes and Senior Second Lien Notes contain covenants limiting our ability and the ability of our restricted subsidiaries to, among other things: sell assets; pay dividends or make other distributions or repurchase or redeem our stock; incur or guarantee additional indebtedness; incur certain liens; make loans and investments; enter into agreements restricting our subsidiaries’ ability to pay dividends; consolidate, merge or sell all or substantially all of our assets, and enter into transactions with affiliates. Any of these restrictions could limit our ability to plan for or react to market conditions or meet extraordinary capital needs and could otherwise restrict corporate activities.
Our ability to comply with these covenants may be affected by events beyond our control, and an adverse development affecting our business could require us to seek waivers or amendments of covenants, alternative or additional sources of financing or reductions in expenditures. We cannot assure you that such waivers, amendments or alternative or additional financings could be obtained on acceptable terms or at all. In addition, the holders of the Senior Secured Notes and Senior Second Lien Notes will have no control over any waivers or amendments with respect to any debt outstanding other than the Senior Secured Notes and Senior Second Lien Notes. Therefore, we cannot assure you that even if the holders of the Senior Secured Notes and Senior Second Lien Notes agree to waive or amend the covenants contained in the indenture relating to the Senior Secured Notes and Senior Second Lien Notes, that the holders of our other debt, including the Senior Secured Notes, will agree to do the same with respect to our debt instruments held by them.
Failure to comply with the covenants in our indenture could, under certain circumstances, result in declarations that all outstanding borrowings, together with accrued interest and other fees, be immediately due and payable, lenders could elect to

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exercise control over our cash through their rights under applicable deposit account control agreements, and foreclosure proceedings could be instituted against those assets that secure our Senior Secured Notes and Senior Second Lien Notes. If our debt were accelerated upon an event of default, our assets and cash flow would be insufficient to fully repay our outstanding borrowings.
Servicing our indebtedness will require a significant amount of cash. Our ability to generate sufficient cash depends on numerous factors beyond our control, and we may be unable to generate sufficient cash flow to service our debt obligations.
Our ability to make payments on or to refinance our indebtedness will depend on our ability to generate cash in the future. This to a certain extent, is subject to general economic, political, financial, competitive, legislative, regulatory and other factors that are beyond our control.
Our current annual interest payments are approximately $55.2 million to service our existing indebtedness. We cannot assure you that our business will generate cash flow from operations in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. If our cash flows and capital resources are insufficient to allow us to make scheduled payments on our indebtedness, we may need to reduce or delay capital expenditures, sell assets, seek additional capital or restructure or refinance all or a portion of our indebtedness on or before maturity. We cannot assure you that we will be able to refinance any of our indebtedness on commercially reasonable terms, or at all, or that these measures would satisfy our scheduled debt service obligations. If we are unable to generate sufficient cash flow or refinance our debt on favorable terms, it could have a material adverse effect on our financial condition, the value of the Senior Secured Notes and Senior Second Lien Notes and our ability to make any required cash payments under our indebtedness, including the Senior Secured Notes and Senior Second Lien Notes.
Failure to maintain current levels of collectability of our accounts receivable likely would have a significant negative impact on our profitability and cash flow.
We derive a significant majority of our revenues from reimbursement by third-party payors. We accept assignment of insurance benefits from patients and, in most instances, invoice and collect payments directly from Medicare, Medicaid and private insurance carriers, as well as from patients under co-insurance provisions. 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 after which they will not pay submitted claims. As such, there can be no assurance that we will be able to maintain our current levels of collectability or that third-party payors will not experience financial difficulties. We may be unable to collect our accounts receivable on a timely basis, which likely would result in a significant decline in our operating cash flows.
Trading on the OTC Bulletin Board may be volatile and sporadic, which could depress the market price of our common stock and make it difficult for our stockholders to resell their shares.
Our common stock is currently quoted on the OTC Bulletin Board, a service sponsored and operated by The Financial Industry Regulatory Authority (FINRA), which is an inter-dealer automated quotation system for equity securities not included in the NASDAQ Stock Market. Trading in stock quoted on the OTC Bulletin Board is often thin and characterized by wide fluctuations in trading prices, due to many factors that may have little to do with our operations or business prospects. This volatility could depress the market price of our common stock for reasons unrelated to operating performance. Moreover, the OTC Bulletin Board is not a stock exchange, and trading of securities on the OTC Bulletin Board is often more sporadic than the trading of securities listed on a quotation system like NASDAQ or a stock exchange like Amex. Accordingly, shareholders may have difficulty reselling any of the shares. In addition, as an OTC Bulletin Board listed company, we do not attract the extensive analyst coverage that accompanies companies listed on NASDAQ or any other regional or national exchange. Further, institutional and other investors may have investment guidelines that restrict or prohibit investing in securities traded in the over-the-counter market. These and other factors may have an adverse impact on the trading and price of our securities, and may make it difficult for our stockholders to sell their shares in the open market when eligible to do so.

The wide fluctuations in trading prices, as well as general economic, market and political conditions such as interest rate increases, recessions or military or political conflicts, may materially and adversely affect the market price of our common stock, thereby causing you to lose some or all of your investment.
Our stock is a penny stock. Trading of our stock may be restricted by the Securities and Exchange Commission’s (SEC) penny stock regulations and FINRA’s sales practice requirements, which may limit a stockholder’s ability to buy and sell our stock.

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Our stock is a penny stock. The SEC has adopted Rule 3a51-1 which generally defines “penny stock” to be any equity security that has a market price (as defined) less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. Our securities are covered by the penny stock rules, including Rule 15g-9, which impose additional sales practice requirements on broker-dealers who sell to persons other than established customers and “accredited investors.” The term “accredited investor” refers generally to institutions with assets in excess of $5,000,000 or individuals with a net worth, or joint net worth with the person’s spouse, that exceeds $1,000,000 (excluding the value of the person’s primary residence) or annual income exceeding $200,000 or $300,000 jointly with their spouse. The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document in a form prepared by the SEC which provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction and monthly account statements showing the market value of each penny stock held in the customer’s account. The bid and offer quotations, and the broker-dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer’s confirmation. In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from these rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for the stock that is subject to these penny stock rules. Consequently, these penny stock rules may affect the ability of broker-dealers to trade our securities. We believe that the penny stock rules discourage investor interest in and limit the marketability of our common stock, and some investors may perceive our securities to be less attractive because they are traded in the over-the-counter market.
In addition to the “penny stock” rules promulgated by the SEC, FINRA has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative low priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer’s financial status, tax status, investment objectives and other information. Under interpretations of these rules, FINRA believes that there is a high probability that speculative low priced securities will not be suitable for at least some customers. The FINRA requirements make it more difficult for broker-dealers to recommend that their customers buy our common stock, which may limit your ability to buy and sell our stock.
A significant number of our outstanding shares of common stock are concentrated in a small number of stockholders which, acting together, could exercise significant influence over certain aspects of our business.
As of December 31, 2011, our 6 largest stockholders held in the aggregate approximately 42% of our outstanding common stock. These stockholders, acting together, could exercise significant influence on all matters requiring stockholder approval, including the election of directors and the approval of significant corporate transactions. In addition, any of these large stockholders acting independently could work to frustrate the majority.

Risks related to our reliance on Medicare, Medicaid and other third-party reimbursement
A significant percentage of our business is derived from patients with primary health coverage under Medicare Part B, and as such, any decreases in Medicare Part B reimbursement rates are likely to have a material adverse effect on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations.
As a home medical equipment (HME) provider, we are heavily dependent on Medicare reimbursement with approximately 39.1% of our revenue reimbursed 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.
Legislation containing provisions that directly impact reimbursement for the primary HME products that we provide have had a material adverse affect on our financial condition, revenues, profitability, profit margins, operating cash flows and results of operations. The most recent health care reform enacted in March 2010 is discussed in more detail below. Prior legislation with continued impact on our business includes, but is not limited to:
Medicare Improvements for Patients and Providers Act of 2008 (MIPPA). MIPPA delayed the implementation of a Medicare competitive bidding program for oxygen equipment and certain other HME items that was scheduled to begin on July 1, 2008 and instituted a 9.5% price reduction nationwide for these items as of January 1, 2009.
Medicare, Medicaid and SCHIP Extension Act of 2007 (“SCHIP Extension Act”). The SCHIP Extension Act

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reduced Medicare reimbursement amounts for certain covered Part B drugs, including inhalation drugs that we provide, beginning April 1, 2008.
Deficit Reduction Act of 2005 (DRA). DRA provisions negatively impacted reimbursement for oxygen equipment beginning in 2009 and negatively impacted reimbursement for HME items subject to capped rental payments beginning in 2007.
Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA). MMA significantly reduced reimbursement for inhalation drug therapies beginning in 2005, reduced payment amounts for certain categories of durable medical equipment (DME), including oxygen, beginning in 2005, froze payment amounts for other covered HME items through 2007, established a competitive acquisition program for HME and implemented quality standards and accreditation requirements for HME suppliers.
These legislative provisions, as currently in effect and when fully implemented, have had and will have a material adverse effect on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations. The impact of these reimbursement changes are discussed in more detail under the heading “Business—Government Regulation” in Part I, Item 1.
Health care reform, including recently enacted legislation, may have a material adverse effect on our industry and our results of operations.
In March 2010, the President signed into law the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Affordability Reconciliation Act (collectively, the PPACA), which substantially changes the way health care is financed by both governmental and private insurers, and significantly impacts the pharmaceutical and medical device industries. The PPACA includes, amount other things, the following measures:
expansion of Round 2 of competitive bidding to 21 additional metropolitan areas (to a total of 91), and by 2016, the competitive bidding process must be nationalized or prices in non-competitive bidding areas must be adjusted to match competitive bidding prices;
annual, non-deductible fees on any entity that manufacturers or imports certain prescription drugs and biologics, beginning in 2011;
a deductible excise tax on any entity that manufactures or imports medical devices offered for sale in the United States, with limited exceptions, beginning in 2013;
a new Patient-Centered Outcomes Research Institute to oversee, identify priorities in and conduct comparative clinical effectiveness research;
elimination of the option to purchase power mobility devices, beginning January 1, 2011; and
new face-to-face encounter requirements for DME and home health services.
There are also current proposals at the federal level to impose additional measures involving our industry. President Obama’s budget for fiscal year 2012 includes measures to control expenditures that may require Medicare claims processors to review all power wheelchair claims before payment is made. Further, in January 2011 the U.S. Government Accountability Office released a report that found that Medicare payment rates for home oxygen generally exceeded other payors’ rates and recommended that the Centers for Medicare & Medicaid Services (CMS) unbundle payment for portable oxygen refills from the rental payment for stationary equipment. CMS disagreed with the recommendations on the grounds that such policy changes would not yield immediate savings to the program, but it remains uncertain whether CMS or Congress will take action to further reduce payments for home oxygen. We cannot predict at this time the impact of the PPACA and/or other healthcare reform measures that may be adopted in the future on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations.
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.
CMS has authority to make adjustments to reimbursement for HME. With the passage of the Balanced Budget Act of 1997 (BBA), CMS may determine to increase or reduce the reimbursement for HME, including oxygen, by up to 15% each year under an inherent reasonableness procedure. The regulation implementing the inherent reasonableness authority establishes a process for adjusting payments for certain items and services covered by Medicare Part B when the existing payment amount is determined to be grossly excessive or deficient. The regulation lists factors that may be used by CMS and its Medicare contractors to determine whether an existing reimbursement rate is grossly excessive or deficient and to determine what a realistic and equitable payment amount is. Also, under the regulation, CMS and its contractors will not consider a payment amount to be grossly excessive or deficient and make an adjustment if they determine that an overall payment

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adjustment of less than 15% is necessary to produce a realistic and equitable payment amount. The implementation of the inherent reasonableness procedure itself does not trigger payment adjustments for any items or services and to date, no payment adjustments have occurred or been proposed under this inherent reasonableness procedure.
Though the inherent reasonableness authority has not been exercised, in past years, CMS historically has reduced the published Medicare reimbursement rates for HME to an amount based on the payment amount for the least costly alternative (LCA) treatment that met the Medicare beneficiary’s medical needs. LCA determinations have been applied to particular products and services by CMS contractors who establish local coverage policies for HME. With respect to its LCA policies, on October 16, 2008, a U.S. District Court in the District of Columbia held that CMS did not have authority to implement LCA determinations in setting payment amounts for an inhalation drug. This decision was upheld by the U. S. Court of Appeals and, as a result, CMS and its contractors withdrew their LCA policy for the inhalation drug. In addition, CMS instructed its contractors that they may no longer apply LCA policies to any HME. Effective February 4, 2011, all coverage policies have been revised to eliminate their LCA provisions.

The implementation of the competitive bidding process under Medicare and proposed payment policy changes for certain HME items could negatively affect our business and financial condition.
In 2003, the MMA instructed CMS to establish and implement a competitive bidding program throughout the United States under which a contract award process would be used for the furnishing of competitively priced items of HME, including oxygen equipment. However, on July 15, 2008, the United States Congress, following an override of a Presidential veto, enacted MIPPA, which: (1) retroactively delayed the implementation of competitive bidding for eighteen months; (2) terminated all existing contracts previously awarded; and (3) included a 9.5% nationwide reduction in reimbursement effective January 1, 2009 for the product categories included in competitive bidding, as a budget-neutrality offset for the eighteen month delay. MIPPA negatively impacted our revenue and net income by approximately $17.8 million for the year ended December 31, 2009.
On January 16, 2009, CMS published an interim final rule with comment period (IFC) which announced the delay of Round 1 of the program from 2007 to 2009. The Round 1 competition, also known as the Round 1 rebid, occurred in the same competitive bidding areas (CBAs) as the 2007 Round 1 bidding, excluding Puerto Rico. The product categories for 2009 were the same as those selected for the 2007 Round 1 bidding, with the exception of negative pressure wound therapy and Group 3 complex rehabilitative wheelchairs. We submitted our bids for each of the respective CBAs and product categories prior to the deadline.
On July 2, 2010 CMS announced the single payment amount for each of the respective Round 1 rebid CBAs and product categories and began offering contracts to certain bidders. CMS announced the participating providers in November 2010. We were awarded and have accepted 17 contracts. The contracts became effective January 1, 2011 and have a term of three years. On July 1 and September 9, 2011, we completed two acquisitions in two of the Round 1 rebid CBAs. As part of these acquisitions, we assumed 6 additional competitive bidding contracts, for a total of 23, as follows:
7 CBAs for oxygen supplies and equipment;
6 CBAs for enteral nutrients, equipment and supplies;
5 CBAs for continuous positive airway pressure and respiratory assist devices, and related supplies and accessories;
2 CBAs for walkers;
1 CBA for hospital beds and related supplies; and
2 CBAs for standard power wheelchairs, scooters and related accessories.
The average reduction from current Medicare payment rates in this round of competitive bidding across the CBAs is 32%. Suppliers that were not contracted by CMS may continue to provide certain rental and oxygen equipment for those beneficiaries that were patients at the time the program begins and will be known as “grandfathered suppliers.” In CBAs and for product categories where we may not be a contracted supplier, we intend to service our Medicare patients as grandfathered suppliers under applicable guidelines. Based upon CMS released information, it appears that approximately 70% of the existing number of providers across the Round 1 rebid CBAs were not awarded competitive bidding contracts and will therefore not be able to provide competitive bidding products to new Medicare patients during the term of these contracts in the respective CBAs. We have experienced volume increases in the CBAs where we were awarded contracts, which we attribute in part to an increase in market share, during the year ended December 31, 2011 and we believe, however, that these volume increases our market share gains in the cities where we were awarded contracts will more than offset the reductions in reimbursement rates over time. The application of the new competitive bid rates in the Round 1 rebid reduced our net revenue by approximately $5.1 million for the year ended December 31, 2011.
In addition, on November 2, 2010, CMS finalized certain changes impacting competitive bidding and current payment

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policies for certain items of durable medical equipment, prosthetics, orthotics and supplies, including:
Implementation of certain statutory provisions under MIPPA and the PPACA, including: (1) the subdivision of metropolitan statistical areas (MSAs) with populations over 8,000,000 into smaller CBAs, as required under MIPPA; (2) the addition of 21 MSAs to the 70 MSAs already designated as included in Round 2, for a total of 91 MSAs, as required under the PPACA; and (3) the implementation of payment policies adopted under the PPACA for power wheelchairs, which eliminated the lump sum purchase option for standard power wheelchairs furnished on or after January 1, 2011, and adjusted the amount of the capped rental payments for power wheelchairs. Effective January 1, 2011, rental payments under the adjusted fee schedule are 15% (instead of 10%) of the purchase price for the first three months and 6% (instead of 7.5%) for the remaining rental months not to exceed 13 months; and
The establishment of an appeals process for competitive bidding contract suppliers that are notified that they are in breach of contract.
CMS also solicited comments on whether to reduce the maximum number of payments a contract supplier would receive beyond the 13-month (for capped rental) and 36-month (for oxygen and oxygen equipment) caps when a beneficiary who is receiving the equipment from a non-contract supplier elects to switch to the contract supplier. To date CMS has not made any changes.
CMS is currently undertaking Round 2 of competitive bidding in 91 additional markets, with contracts expected to be effective in July 2013. Our Medicare revenues from the product categories in the 91 additional markets to be included in Round 2 of competitive bidding were approximately $54.0 million in 2011. The PPACA legislation requires CMS to expand competitive bidding further to additional geographic markets (certain markets may be excluded at the discretion of CMS) or to use competitive bid pricing information to adjust the payment amounts otherwise in effect for areas that are not competitive bidding areas by January 1, 2016.
Until such time that competitive bidding is fully implemented, we will not be able to determine the program’s full impact. In the event that changes are made to current policies or we do not experience the anticipated increases in volume and market share in the future or we are unsuccessful in subsequent rounds of competitive bidding, the Medicare competitive bidding program could have a material adverse effect on our financial condition, profit margins, profitability, operating cash flows and results of operations.
CMS’s final program safeguards for HME suppliers could have a material adverse effect on our industry and our results of operations.
On August 27, 2010, CMS issued a final rule (first proposed in January 2008) that clarifies, expands and adds to the existing enrollment requirements that HME suppliers must satisfy to establish and maintain billing privileges in the Medicare program. Effective September 27, 2010 (unless otherwise noted), the final rule implements, among other things, the following measures:
Prohibits suppliers from contracting with an individual or entity to provide a licensed service, unless permitted by the state where the licensed services are being performed. This requirement does not apply to contract suppliers participating in the competitive bidding program that are using subcontractors to meet this standard. CMS has released policy guidelines that further clarified that suppliers may use contractors to provide licensed services in states that do not expressly prohibit such contracting arrangements;
Requires HME suppliers to obtain oxygen from a state-licensed oxygen supplier (which applies only in states that require oxygen licensure). Oxygen suppliers may continue to subcontract for the pickup and delivery of oxygen and oxygen related products;
Prohibits HME suppliers from sharing a practice location, defined as the physical space where a supplier operates its business and meets with customers and potential customers, with other Medicare providers and suppliers. This standard does not apply to physicians, non-physician practitioners, physical therapists or occupational therapists who furnish items to their own patients as part of their professional services. It also does not apply to HME suppliers who are co-located with and owned by an enrolled Medicare Part A provider that operate as a separate unit and meets all other applicable supplier standards;
Requires HME suppliers to maintain a physical facility on an appropriate site that: (1) measures at least 200 square feet (except for state-licensed orthotic and prosthetic personnel providing custom fabricated orthotics or prosthetics in private practice); (2) is in a location that is accessible to the public, Medicare beneficiaries, CMS, the National Supplier Clearinghouse (NSC) and its agents and not in a gated community or other area where access is restricted; (3) is accessible and staffed during posted hours of operation; (4) has a permanent visible sign in plain view and posts hours of operation; and (5) is in a location that contains space for storing business records, including the supplier’s delivery, maintenance, and beneficiary communication records, except for multisite suppliers who may have a centralized location for all business records and ordering and referring documentation. This standard is to be phased in

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over a three-year period for suppliers already enrolled in Medicare, but applies to all prospective suppliers (including those with pending enrollment applications with the NSC) on the effective date; and
Authorizes CMS or its contractor to reopen all Medicare claims paid on or after the effective date of a final adverse action that serves as a basis for CMS to revoke a supplier’s billing privileges in order to establish an overpayment determination.
We cannot predict at this time the impact of the final supplier standards, which could have a material adverse effect on our business, financial condition and results of operations.
Future reductions in reimbursement rates under Medicaid could negatively affect our business and financial condition.
Due to budgetary shortfalls, many states are considering, or have enacted, cuts to their Medicaid programs. 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. 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 condition, revenues, profit margins, profitability, operating cash flows and results of operations. Further, President Obama’s budget for fiscal year 2012 includes provisions that may limit Medicaid reimbursement of HME based on Medicare’s competitive bidding payment rates. We cannot predict at this time whether the President’s proposal or other measures may be adopted in the future and the impact of such legislation on our financial condition, revenues, profit margin, profitability, operating cash flows and results of operations.
Future reductions in reimbursement rates from third-party payors could negatively affect our business and financial condition.
Private payors continually seek to control the cost of providing health care services through direct contracts with health care providers, increased oversight and greater enrollment of patients in managed care programs and preferred provider organizations. These private payors are increasingly demanding discounted fee structures and the assumption by the health care provider of all or a portion of the financial risk. Reimbursement payments under private payor programs may not remain at current levels and may not be sufficient to cover the costs allocable to patients eligible for reimbursement pursuant to such programs, and we may suffer deterioration in pricing flexibility, changes in payor mix and growth in operating expenses in excess of increases in payments by private third-party payors. We may be compelled to lower our prices due to increased pricing pressures, which could have a material adverse effect on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations.
Medicare surety bond requirements could result in significant additional cost in operating our business.
Effective October 2, 2009, all HME suppliers, except those that are government operated, were required to obtain and furnish a $50,000 surety bond to the NSC, the Medicare contractor responsible for enrollment, for each Medicare supplier number held (one per operating location). The surety bond requirement is designed to limit the Medicare program risk from fraudulent equipment suppliers and help to ensure that those suppliers who remain in the program furnish only items to Medicare beneficiaries that are considered reasonable and necessary from legitimate HME suppliers. We maintain surety bonds covering all of our National Provider Identifier (NPI) numbers at each of our operating locations. While the annual cost of obtaining these surety bonds is not currently material, there can be no assurance that future changes in the surety bond market will not result in increases to such annual cost or any potential associated collateral requirements. If we are unable to maintain surety bonds for our operating locations or to the extent that the issuing surety requires substantial additional collateral, these surety bond requirements could have a material adverse effect on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations.
Reforms to the United States healthcare system may adversely affect our business.
From time to time, Congress has proposed and passed a number of legislative initiatives, impacting HME suppliers. Currently pending are initiatives that include possible repeal of PPACA. In addition, a number of states have challenged the constitutionality of certain provisions of PPACA and many of these challenges are still pending final adjudication in several jurisdictions. At this time, it remains unclear whether there will be any changes made to PPACA, whether to certain provisions or its entirety. We cannot assure you that PPACA, as currently enacted or as amended in the future, will not adversely affect our business and financial results, and we cannot predict how future federal or state legislative or administrative changes relating to healthcare reform will affect our business.
In addition, other legislative changes have been proposed and adopted since PPACA was enacted. Most recently, on August 2, 2011, the President signed into law the Budget Control Act of 2011, which, among other things, created the Joint Select

23


Committee on Deficit Reduction to recommend proposals in spending reductions to Congress. The Joint Select Committee did not achieve a targeted deficit reduction of at least $1.2 trillion for the years 2013 through 2021, triggering the legislation's automatic reductions to several government programs. This includes aggregate reductions to Medicare payments to providers of up to 2% per fiscal year, starting in 2013. The full impact on our business of PPACA and the new law is uncertain. Any reductions in Medicare or Medicaid reimbursement could materially adversely affect our profitability.
Risks related to our compliance with federal and state regulatory agencies, as well as accreditation standards
Our pharmacy location and operations are subject to extensive regulation by state and federal authorities and there can be no assurance that we are fully compliant with such regulations.
Under the Federal Food Drug and Cosmetic Act, the Food and Drug Administration (FDA) imposes stringent regulations on the distribution, labeling, and other aspects of our medical gas and pharmacy operations. Under state law, our pharmacy locations must be licensed as in-state pharmacies to dispense pharmaceuticals in the relevant state of location. We deliver pharmaceuticals from our pharmacy location in Kentucky to customers in 49 states, and, where required by state pharmacy law, we must obtain and maintain licenses from each state to which we deliver such pharmaceuticals. We are therefore subject to state boards of pharmacy laws and regulations in nearly all jurisdictions where we do business. These laws can vary significantly from state to state and, while we continuously monitor state activities and changes in the law, there can be no assurance that we are fully compliant with all laws and regulations that may apply to our pharmacy operations in particular jurisdictions. Many states enforce their pharmacy laws through periodic facility inspections. State authorities may also raise inquiries or complaints regarding our pharmacy practices in connection with the renewal of our license in a particular state or for other reasons. Failure to comply with applicable FDA and other federal regulatory requirements can result in possible legal or regulatory action, such as warning letters, product seizure or recalls, suspension of operations, temporary or permanent injunctions, or possible civil or criminal penalties. Failure to comply with applicable state regulatory requirements can result in enforcement action, including fines, revocation, suspension or failure to renew our state pharmacy licenses, injunctions, seizures, and civil or criminal penalties.
Our business, including our participation in the Medicare and Medicaid program, is subject to extensive laws and government regulations. Failure by us to comply with these laws and regulations could subject us to severe sanctions and have a significant negative impact on our operations.
We are subject to stringent laws and regulations at both the federal and state levels, including:
billing practices including substantiation and record keeping requirements;
prohibitions on fraud and abuse, kickbacks, rebates and fee splitting;
licensing and certification requirements;
confidentiality, privacy and security issues in connection with medical records and patient information;
relationships with physicians and other referral sources;
operating policies and procedures;
qualifications of health care and support personnel;
quality of durable medical equipment and other medical equipment;
handling, distribution and disposal of pharmaceutical products and medical waste;
quality assurance; and
occupational safety.

Existing United States laws governing Medicare and state health care programs such as Medicaid, as well as similar laws enacted in many states, impose a broad variety of prohibitions on soliciting, receiving, offering or paying, directly or indirectly, any form of remuneration, payment or benefit for the referral of a patient for services or products reimbursable by Medicare or a state health care program. The federal government has published regulations that provide exceptions or “safe harbors” for business transactions that will be deemed not to violate these prohibitions. Further, the recently enacted PPACA, among other things, amends the intent requirement of the federal anti-kickback and criminal health care fraud statutes. A person or entity no longer needs to have actual knowledge of this statute or specific intent to violate it. In addition, the PPACA provides that the government may assert that a claim including items or services resulting from a violation of federal anti-kickback statute constitutes a false or fraudulent claim for purposes of the false claims statutes. Violation of these prohibitions may result in civil and criminal penalties and exclusion from participation in Medicare and state health care programs.
The PPACA also imposes new reporting and disclosure requirements on device and drug manufacturers for any “transfer of value” made or distributed to prescribers and other healthcare providers, effective March 30, 2013. Such information will be

24


made publicly available in a searchable format beginning September 30, 2013. In addition, device and drug manufacturers will also be required to report and disclose any investment interest held by physicians and their immediate family members during the preceding calendar year. Failure to submit required information may result in civil monetary penalties of up to an aggregate of $150,000 per year (and up to an aggregate $1 million per year for “knowing failures”), for all payments, transfers of value or ownership or investment interests not reported in an annual submission. On December 14, 2011, CMS released its proposed rule implementing these provisions, providing further clarification to ambiguous or unclear statutory language and providing instructions for manufacturers to comply with such requirements. In addition, CMS estimates that approximately 1,000 device and medical supply companies will be required to comply with the disclosure requirements and that the average cost per entity will be approximately $170,000 in the first year. CMS closed its comment period to the proposed rule on February 17, 2012.
The Stark Laws (and comparable state laws) impose a broad range of restrictions upon referring physicians (and their immediate families) and providers of certain designated health services under Medicare and state health care programs, including restrictions on financial relationships between the referring physicians and the providers of the designated health care services. Services that we provide are classified as designated health services and fall within the regulatory scope of the Stark Laws. Significant criminal, civil and administrative penalties may be imposed for violation of these laws.
We are also subject to strict licensing and safety requirements by the federal government and many states. Furthermore, many state laws prohibit physicians from sharing professional fees with non-physicians and prohibit non-physician entities, such as us, from practicing medicine and from employing physicians to practice medicine.
In addition, both federal and state government agencies have heightened and coordinated civil and criminal enforcement efforts as part of numerous ongoing investigations of health care companies, as well as their executives and managers. These investigations relate to a wide variety of matters, including referral and billing practices.
Further, amendments to the False Claims Act have made it easier for private parties to bring “qui tam” whistleblower lawsuits against companies. Some states have adopted similar state whistleblower and false claims provisions.
The Office of the Inspector General of the DHHS and the Department of Justice (DOJ) have, from time to time, established national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse. Some of our activities could become the subject of governmental investigations or inquiries. In addition, we or our executives could be included in other governmental investigations or named as defendants in private litigation, resulting in adverse publicity against us.
If we fail to comply with the laws and regulations relevant to our business, we could be subject to civil and/or criminal penalties, demands from the government for refunds or recoupment of amounts previously paid to us by the government, facility shutdowns and possible exclusion from participation in federal health care programs such as Medicare and Medicaid, any of which could have a significant negative impact on our operations. Some statutory and regulatory provisions, principally in the area of billing, have not been interpreted by the courts and may be interpreted or applied in a manner that might adversely affect us. Changes in health care laws or new interpretations of existing laws could have a material adverse effect on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations.
Lack of accreditation of our operating locations or failure to meet government standards for coverage and payment could result in a decline in our revenues.
Currently, all of our operating locations are accredited by the Joint Commission (formerly referred to as the Joint Commission on the Accreditation of Healthcare Organizations). If future reviews by the Joint Commission do not result in continued accreditation of our operating locations, we would likely experience a decline in our revenues. Further, as required by the MMA, any entity or individual that bills Medicare for home medical equipment and certain supplies and has a Medicare supplier number for submission of claims must be accredited as meeting quality standards issued by CMS as a condition of receiving payment from the Medicare program. The standards for HME suppliers consist of business-related standards, such as financial and human resources management requirements, which are applicable to all HME suppliers, and product-specific quality standards, and which focus on product specialization and service standards. The product-specific standards address several of our products, including oxygen and oxygen equipment, CPAP and power and manual wheelchairs and other mobility equipment. We have revised our policies and procedures to ensure compliance in all material respects with the quality standards though there can be no assurance that we will be able to comply with the quality standards in all instances.
The MMA also authorized CMS to establish clinical conditions for payment for home medical equipment. These clinical conditions for payment could limit or reduce the number of individuals who can sell or provide our products and could restrict coverage for our products. Some clinical conditions have been implemented, such as the requirement for a face-to-face visit by treating physicians for beneficiaries seeking power mobility devices. In addition, the PPACA requires a face-to-face encounter by certain providers prior to certification for home health services or DME. Because we have Medicare supplier numbers and

25


are subject to clinical conditions for payment, our failure to meet such conditions could affect our ability to bill and, therefore, could have a material adverse effect on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations. At this time, we cannot predict the full impact that the clinical conditions will have on our business.
We are subject to periodic audits by governmental and private payors and as such we could be subject to fines, criminal penalties or program exclusions which could have a negative impact on revenues and operations.
We are subject to periodic audits by the Medicare and Medicaid programs, and the oversight agencies for these programs have authority to assert remedies against us if they determine we have overcharged the programs or failed to comply with program requirements. These agencies could seek to require us to repay any overcharges or amounts billed in violation of program requirements, or could make deductions from future amounts otherwise due to us from these programs. Further, the PPACA now requires that overpayments be reported and returned within 60 days of identification of the overpayment. Any overpayment retained after this deadline will now be considered an “obligation” for purposes of the False Claims Act and subject to fines and penalties. In February 2012, CMS proposed a rule to implement the PPACA requirement that would also create a ten-year “lookback period,” for reporting and returning the “identified” overpayment. The proposed rule, if finalized, could require us to expand our recordkeeping, compliance and reporting processes to comply with the rule’s requirements. We could also be subject to fines, criminal penalties or program exclusions. Private payors also reserve rights to conduct audits and make monetary adjustments. See “Business—Government Regulation” for a discussion of recent efforts by government payors to reduce health care costs.
Compliance with regulations under the federal Health Insurance Portability and Accountability Act of 1996 and related rules (“HIPAA”) relating to the transmission and privacy of health information could impose additional significant costs on our operations.
Numerous federal and state privacy and security laws and regulations, including HIPAA as amended by the Health Information Technology for Economic and Clinical Health Act (HITECH), govern the use and disclosure of patients’ individually-identifiable health information. HIPAA requires us to comply with privacy standards concerning the use and disclosure of such health information within our company and with third parties. HIPAA also requires the adoption of standards for common health care electronic transactions and code sets, such as the processing of claims information, plan eligibility, payment information and the use of electronic signatures. Each set of HIPAA regulations requires health care providers, including us, to develop and maintain policies and procedures with respect to protected health information that is used or disclosed. Moreover, HITECH requires us to report certain breaches of unsecured, individually identifiable health information to the extent such breaches occur. In addition, many states have enacted comparable laws addressing the privacy and security of health information, some of which are more stringent than HIPPA.
If we do not comply with existing or new laws and regulations related to patient health information, we could be subject to significant 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.
Risks related to operational and financial performance
Inability to maintain significant vendor relationships could result in a significant disruption in our business, materially adversely affect our results of operations and result in an inability to serve our patients if we lose these relationships.
We currently have certain critical vendor relationships. Although we have been able to maintain such relationships without material interruption in the past, there can be no assurance that such relationships will continue. Should any of these vendors elect not to provide services, equipment, inhalation drugs or supplies to us, there would likely be a significant disruption to our business, a material adverse effect on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations and an inability to serve our patients until such time as a replacement vendor could be identified. This would likely occur if there is a deterioration or perceived deterioration in our financial position, including our standing with respect to our senior subordinated debt. Moreover, there can be no assurance that the pricing structure that we currently enjoy would be matched by a replacement vendor. Additionally, any future issues with liquidity, debt covenant compliance or declines in our results of operations, could adversely impact our ability to leverage our purchasing activities with new or existing vendors.
Failure to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our business, operating results and stock price.
Effective internal control over financial reporting is necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports, our business and operating results could be harmed. The Sarbanes-Oxley Act of 2002, as well

26


as related rules and regulations implemented by the SEC, have required changes in the corporate governance practices and financial reporting standards for public companies. These laws, rules and regulations, including compliance with Section 404 of the Sarbanes-Oxley Act of 2002, have increased our legal and financial compliance costs and made many activities more time-consuming and more burdensome. The costs of compliance with these laws, rules and regulations have adversely affected our financial results. Moreover, we run the risk of non-compliance, which could have a material adverse effect on our financial condition, revenues, profit margins, profitability, operating cash flows, results of operations or the trading price of our stock.
We have in the past discovered, and may in the future discover, areas of our internal control over financial reporting that need improvement. We have devoted significant resources to remediate any deficiencies we have discovered and improve our internal control over financial reporting. Based upon management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2011, management concluded that our internal control over financial reporting was not effective as of such date because of a material weakness in review and reconciliation procedures designed to ensure that certain period end balances reflected in our financial statements agreed to the underlying detailed calculations of such amounts and that associated amounts were reflected in proper accounting periods. Effective in February 2012, our management believes that it has corrected the primary issues that led to this material weakness by implementing the additional review and reconciliation procedures. We cannot be certain that these measures will ensure that we implement and maintain adequate controls over our financial processes and reporting in the future. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. Ineffective internal control over financial reporting could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock.
If we do not enhance and maintain effective and efficient information systems, then our operations may be disrupted and our anticipated operating efficiency may not be realized.
Our operations are dependent on the enhancement and uninterrupted performance of our information systems. Failure to enhance and maintain reliable information systems or disruptions in our information systems could cause disruptions in our business operations, including billing and collections, loss of existing patients and difficulty in attracting new patients, patient and payor disputes, regulatory problems, increases in administrative expenses or other adverse consequences, any or all of which could disrupt our operations and prevent us from achieving operating efficiency.
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. We compete with other health care providers to attract and retain qualified or skilled personnel. We also compete with various industries for lower-wage 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.
We may write off additional intangible assets.
On an ongoing basis, we evaluate whether facts and circumstances indicate any impairment of value of intangible assets. If we determine that a significant impairment has occurred, we would be required to write-off the impaired portion of the unamortized intangible assets, which could have a material adverse effect on our results of operations in the period in which the write-off occurs.
We may be subject to claims arising from investigations and legal proceedings, which could have a significant negative impact on our results of operations and profitability.
The nature of our business subjects us to investigations and litigation in the ordinary course of our business. In addition, we are from time to time involved in other legal proceedings. While management does not believe that any lawsuit we (or our predecessor) are a party to, if resolved adversely, would have a material adverse affect on our financial condition or results of operations, investigations and litigation could arise in the future which could have a significant negative impact on our results of operations and profitability. Further, since the date of confirmation of the plan of reorganization, we have not and our predecessor has not received any correspondence from a state challenging the pre-petition discharge of claims.
Inadequate insurance coverage limits, continuing increases in our insurance costs, or losses due to one or more of our insurance carriers defaulting on their obligations could have a material adverse effect on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations.

27


Participants in the health care industry, including us, are subject to substantial claims and litigation in the ordinary course, often involving large claims and significant defense costs. As a result of the liability risks inherent in our lines of business we maintain liability insurance intended to cover such claims. Our insurance policies are subject to annual renewal. The coverage limits of our insurance policies may not be adequate, and we may not be able to obtain liability insurance in the future on acceptable terms or at all. In addition, we have been advised by our insurance broker that our insurance premiums will be subject to increases in the future, which increases may be material. Furthermore, the losses that are insured through commercial insurance are subject to the credit risk of those insurance companies. While we believe our commercial insurance providers are currently credit worthy, there can be no assurance that such insurance companies will remain so in the future. Inadequate insurance coverage limits, increases in our insurance costs or losses suffered due to one or more of our insurance carriers defaulting on their obligations, could have a material adverse effect on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations.
In the event that we purchase equipment from competitors exiting the HME market and are unable to successfully transition and retain the associated patients on service with our Company, we may not be able to achieve our growth objectives in 2012 and beyond.
Since 2009, we have purchased $31.9 million of new and used rental equipment, inventory and identifiable intangible assets from competitors exiting the home medical equipment market. Some of the equipment purchased in these transactions is currently on rent and located in a patient’s home. We have been successful, and we expect that we will continue to be successful, in transitioning and retaining a high percentage of the associated patients onto service with our Company. We believe that we will be successful in identifying additional equipment and asset purchase opportunities during 2012, however the degree to which we pursue such opportunities during 2012 will depend upon a variety of factors, including consideration of markets that will be impacted by competitive bidding, availability of cash and market valuation multiples. However, in the event that we are unable to successfully transition and retain the associated patients on service with our Company or we are unable to identify or pursue additional equipment and asset purchase opportunities, we may not be able to achieve our growth objectives in 2012 and beyond.
We are highly dependent upon information technology systems and infrastructure.
We regularly back up our data and maintain detailed disaster recovery plans. However, a major physical disaster or other calamity that causes significant damage to information systems could adversely affect our business. Additionally, loss of information systems for a sustained period of time could have a negative impact on our performance and ultimately on cash flow in the event we were unable to process transactions and/or provide services to our customers.
Risks related to competition and referral sources
If we lose relationships with managed care organizations or other third-party payors, then we could lose access to patients and our revenue would likely decline.
Managed care organizations and other third-party payors have continued to consolidate in order to enhance their ability to influence the delivery of health care services and to build volume that justifies discounted prices. Consequently, the health care needs of a large percentage of the United States population are now provided by a small number of managed care organizations and third-party payors. These organizations, including the Veterans Administration, generally enter into service agreements with a limited number of providers for needed services. To the extent such organizations terminate or do not renew agreements with us and/or engage our competitors, our business could be materially adversely affected. If we lose relationships with managed care organizations or other third-party payors, including the Veterans Administration, then we could lose access to patients and our revenue would likely decline.
If we fail to cultivate new or maintain established relationships with physicians and other referral sources, then our revenues may decline.
Our success, in part, is dependent upon referrals and our ability to maintain good relations with physicians and other referral sources. Physicians and other medical personnel that refer patients to us are not our employees, and are free to refer their patients to our competitors. If we are unable to successfully cultivate new referral sources and maintain strong relationships with our current referral sources, then our revenues may decline.
We experience competition from numerous other home medical equipment providers, and this competition could result in deterioration in our revenues and business.
The home medical equipment market is highly competitive and divided among a large number of providers, some of which are national providers but most of which are either regional or local providers. Home respiratory companies compete

28


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 patients are highly dependent upon our reputation within each local health care market for providing responsive, professional and high-quality service, a professional staff with clinical and technical expertise and achieving strong customer satisfaction.
Some of our competitors may now or in the future have greater financial or marketing resources than we do. Our largest national home medical equipment provider competitors are Apria Healthcare Group, Inc., Lincare Holdings, Inc. and American Home Patient, Inc. The rest of the market consists of several medium-size competitors, as well as hundreds of smaller companies with each having under $5 million in estimated annual revenues. Many of the smaller, owner-operated home medical equipment providers may have a higher level of service quality that is difficult to replicate. There are relatively few barriers to entry in local home health care markets. The competitive nature of the home medical equipment environment could result in deterioration in our revenues and our business.
Risks related to recruiting, hiring and retaining qualified employees and directors
We are highly dependent on our key personnel.
Our performance is substantially dependent on the performance and continued efforts of our senior management team. The loss of the services of any of our executive officers or other key employees could result in a decline in our business, results of operations and financial condition. In particular, the loss of the services of our Chief Executive Officer, Philip L. Carter, could have a material adverse effect on our business and results of operations. Our future success is dependent on the ability of our managers and sales personnel to manage and promote our business, operations and growth. Any inability to manage our operations effectively could have a material adverse effect on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations.
If we are not able to hire qualified management and other personnel, or if costs of compensation or employee benefits increase substantially, then our ability to deliver equipment and services effectively could suffer and our profitability would likely decline.
The success of our business depends upon our ability to attract and retain highly motivated, well-qualified management and other personnel. Our highest cost is in the payment of salaries to our approximately 3,800 full time employees. We face significant competition in the recruitment of qualified employees. If we are unable to recruit or retain a sufficient number of qualified employees, or if the costs of compensation or employee benefits increase substantially, our ability to deliver services effectively could suffer and our profitability would likely decline. Further, in the event that our business operations or financial condition further deteriorate, we may not be able to maintain or recruit critical employees.
We may be unable to recruit independent individuals to serve as members of our Board of Directors.
Our board of directors is currently comprised of five members. Due to our current financial condition and the regulatory environment in which we operate, we may be unable to recruit independent individuals to serve on our board if required.


29


ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.

ITEM 2.
PROPERTIES
We lease all of our offices and facilities. Our corporate headquarters currently consists of approximately 21,000 square feet in an office building located at 2600 Technology Drive, Orlando, Florida, 32804. In addition to our corporate headquarters, we lease facilities for our operating locations, transfill centers, billing centers, pharmacy and call center operations, information technology center, and divisional, regional and area management offices. All facilities are leased pursuant to operating leases. We believe that our facilities are suitable and adequate for our planned needs.

ITEM 3.
LEGAL PROCEEDINGS
Due to the nature of our business, we are involved in lawsuits that arise in the ordinary course of business. Management does not believe that any lawsuit we are a party to, if resolved adversely, would have a material adverse effect on our financial condition or results of operations.
As a health care provider, we are subject to extensive government regulation, including numerous laws directed at preventing fraud and abuse and laws regulating reimbursement under various government programs. The marketing, billing, documentation 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 us for payment of services rendered to patients. 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.
On May 16, 2008, we entered into a three-year term Corporate Integrity Agreement (the “2008 CIA”) with the OIG in connection with the resolution of a previously reported qui tam complaint brought by one of our former employees. The action was filed on April 6, 2004 and alleged violations of the False Claims Act between February 22, 1996 and April 30, 2003. In settling the litigation, we did not admit wrongdoing but paid $2.0 million plus interest to the United States Treasury Department and $1.4 million to the former employee for expenses and attorney’s fees and costs. The settlement amount was paid on May 19, 2008. The 2008 CIA expired in May 2011. We have maintained our existing compliance program beyond the term of the 2008 CIA.

ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable.


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PART II

ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER REPURCHASES OF EQUITY SECURITIES
Our common stock is currently quoted on the OTC Bulletin Board, a service sponsored and operated by The Financial Industry Regulatory Authority (FINRA), which is an inter-dealer automated quotation system for equity securities not included in the NASDAQ Stock Market. Between February 28, 2008 and June 12, 2008 our common stock was traded on the NASDAQ Capital Market under the trading symbol “ROHI”. Between November 8, 2005 and February 27, 2008, our common stock was listed on the NASDAQ Global Market. Prior to November 8, 2005, there was no established trading market for our common stock and our common stock traded in interdealer and over-the-counter transactions and price quotations were provided in the “pink sheets” by Pink Sheets LLC.
Upon effectiveness of our predecessor’s plan of reorganization on March 26, 2002, all of our outstanding common stock was distributed to our predecessor for further distribution to its senior creditors as contemplated by the plan of reorganization. Our common stock was issued pursuant to an exemption from the registration requirements of the Securities Act provided by Section 1145 of the Bankruptcy Code. Although we received no cash proceeds from the initial distribution of our common stock pursuant to the plan of reorganization, we received substantially all of the assets of our predecessor in consideration of the issuance of such stock.
The following table sets forth the high and low sale prices of our common stock for the periods indicated as reported by the OTC Bulletin Board:
 
 
High
 
Low
Fiscal 2011
 
 
 
First Quarter
$
4.55

 
$
1.87

Second Quarter
$
4.93

 
$
3.50

Third Quarter
$
4.65

 
$
2.02

Fourth Quarter
$
2.10

 
$
1.11

Fiscal 2010
 
 
 
First Quarter
$
0.66

 
$
0.35

Second Quarter
$
3.65

 
$
0.57

Third Quarter
$
2.00

 
$
0.68

Fourth Quarter
$
1.99

 
$
1.20

As of March 5, 2012, there were 25,907,310 shares of our common stock outstanding and approximately 73 holders of record of our common stock. This number was derived from our stockholder records and does not include beneficial owners of our common stock whose shares are held in the names of various dealers, clearing agencies, banks, brokers and other fiduciaries.
We did not pay any cash dividends on our common stock for the fiscal years ended December 31, 2011, 2010 or 2009, and it is unlikely that we will pay any cash dividends on our common stock in the foreseeable future. The payment of cash dividends on our common stock will depend on, among other things, our earnings, capital requirements, financial condition and general business conditions. We are precluded from paying dividends on our common stock and limited in our ability to acquire our common stock by certain covenants contained in the indenture governing our 10.75% Senior Secured Notes due 2015 and the indenture governing our 10.50% Senior Second Lien Notes due 2018.
Each outstanding share of our Series A convertible redeemable preferred stock (Series A Preferred) has a stated value of $20 and entitles the holder to an annual cumulative dividend equal to 9% of its stated value, payable semi-annually at the discretion of our board of directors in cash or in additional shares of Series A Preferred. In the event dividends are declared by our board of directors but not paid for six consecutive periods, the holders of the Series A Preferred are entitled to vote as a separate class to elect one director to serve on our board of directors. Effective December 5, 2003, our board of directors adopted a policy of declaring dividends to the holders of the Series A Preferred under the Rotech Healthcare Inc. Employees Plan on an annual basis, with each such declaration to be made at the meeting of the board of directors following the annual meeting of the shareholders with respect to dividends payable for the preceding year. Such policy commenced at a 2004 meeting of the board of directors and dividends on the Series A Preferred have been declared and paid as follows:
 

31


(in thousands)
Amount
 
Declaration Date
 
Payment Date
Dividend
$
900

 
June 2004
 
March 2005
Dividend
$
450

 
September 2005
 
December 2005
Dividend
$
450

 
June 2006
 
January 2007
Dividend
$
450

 
June 2007
 
January 2008
Dividend
$
450

 
June 2008
 
December 2008
Dividend
$
450

 
June 2009
 
December 2009
Dividend
$
435

 
June 2010
 
January 2011
Dividend
$
431

 
June 2011
 
January 2012
Equity Compensation Plan Information
 
Plan Category1
Number of securities to be issued upon exercise of outstanding options, warrants and rights
 
Weighted-average exercise price of outstanding options, warrants and rights
 
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Equity compensation plans approved by security holders
2,951,148

 
$
1.65

 
2,822,488

Equity compensation plans not approved by security holders

 
$

 

Total
2,951,148

 
$
1.65

 
2,822,488

1 
For more detailed information regarding the Company’s equity compensation plans see Footnote 12 to the Consolidated Financial Statements.

Performance Graph
The following stock performance graph shows a comparison of the total cumulative stockholder return on our common stock (including reinvestment of dividends) from December 31, 2006 through December 31, 2011 to the NASDAQ Stock Market (US Companies) and the NASDAQ Health Services Index.

32


ITEM 6.
SELECTED FINANCIAL DATA
You should read the following selected financial data along with the section captioned “Management’s discussion and analysis of financial condition and results of operations” and the audited consolidated financial statements and the related notes included in this report. The consolidated statement of operations data and consolidated balance sheet data as of and for the years ended December 31, 2011, 2010 and 2009 have been derived from our audited financial statements included in this report. The consolidated statement of operations data and consolidated balance sheet data as of and for the years ended December 31, 2008 and 2007 have been derived from our audited financial statements not included in this report.
 
(dollars in thousands except per share data)
2011
 
2010
 
2009
 
2008
 
2007
Statement of Operations Data:
 
 
 
 
 
 
 
 
 
Net revenues
$
483,791

 
$
496,426

 
$
479,869

 
$
544,533

 
$
559,354

Costs and expenses
 
 
 
 
 
 
 
 
 
Cost of net revenues
149,213

 
157,854

 
174,872

 
201,442

 
213,680

Provision for doubtful accounts
26,244

 
23,355

 
16,234

 
19,314

 
18,458

Selling, general and administrative
253,020

 
262,332

 
255,952

 
300,846

 
301,573

Depreciation and amortization(1)
9,573

 
8,674

 
9,780

 
12,673

 
14,589

Goodwill impairment(2)

 

 

 
207,030

 

Legal settlement

 

 

 

 
3,450

Interest expense, net
60,265

 
47,680

 
45,401

 
48,691

 
46,606

Other income, net
(791
)
 
(3,598
)
 
(1,276
)
 
(2,106
)
 
(350
)
Loss on debt extinguishment
1,216

 
4,401

 

 

 
12,171

Restructuring expense(3)

 

 

 
3,960

 

Total costs and expenses
498,740

 
500,698

 
500,963

 
791,850

 
610,177

Loss before income taxes
(14,949
)
 
(4,272
)
 
(21,094
)
 
(247,317
)
 
(50,823
)
Federal and state income tax benefit
(190
)
 
(69
)
 
(13
)
 
(391
)
 
(4,749
)
Net loss
$
(14,759
)
 
$
(4,203
)
 
$
(21,081
)
 
$
(246,926
)
 
$
(46,074
)
Net loss per common share basic and diluted
$
(0.58
)
 
$
(0.18
)
 
$
(0.84
)
 
$
(9.70
)
 
$
(1.82
)
(dollars in thousands)
2011
 
2010
 
2009
 
2008
 
2007
Balance Sheet Data
 
 
 
 
 
 
 
 
 
Current assets
$
125,751

 
$
147,089

 
$
142,716

 
$
152,552

 
$
153,346

Working capital
66,634

 
90,496

 
85,100

 
87,349

 
84,705

Total assets
277,044

 
291,062

 
298,541

 
315,419

 
546,773

Total debt, including current portion
512,579

 
511,411

 
514,673

 
500,087

 
481,011

Convertible redeemable preferred stock
3,017

 
5,116

 
5,173

 
5,343

 
5,343

Stockholders’ deficiency
(297,189
)
 
(282,685
)
 
(278,405
)
 
(257,398
)
 
(10,517
)
(dollars in thousands)
2011
 
2010
 
2009
 
2008
 
2007
Selected Historical Financial Data:
 
 
 
 
 
 
 
 
 
Capital expenditures
$
48,922

 
$
53,257

 
$
46,861

 
$
48,374

 
$
52,336

Cash flows provided by operating activities
35,370

 
66,968

 
38,333

 
68,415

 
47,690

Cash flows used in investing activities
(53,295
)
 
(47,991
)
 
(52,707
)
 
(45,287
)
 
(65,666
)
Cash flows (used in)/provided by financing activities
(14,648
)
 
(14,835
)
 
(1,422
)
 
(3,436
)
 
62,719

 
(1)
Depreciation and amortization excludes patient service equipment depreciation included in cost of net revenues.
(2)
During the year ended December 31, 2008 we recorded a non-cash impairment charge of $207.0 million. The 2008 impairment is due to reductions in Medicare reimbursement rates, including reductions associated with: (1) nebulizer medications that occurred during 2008; (2) the 36-month rental cap for oxygen equipment which will begin to impact our reimbursement on January 1, 2009; and (3) the 9.5% reimbursement cut associated with the delay in competitive bidding.

33


This 2008 impairment charge did not result in cash expenditures and will not result in future cash expenditures.
(3)
In response to the significant reductions in Medicare reimbursement, we have completed a restructuring of our operational management structure, clinical programs and pharmacy operations. In conjunction with this restructuring, we recorded $4.0 million of restructuring expense for the year ended December 31, 2008, which primarily consists of severance amounts payable to former employees.

34


ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the financial statements, related notes and other financial information appearing elsewhere in this report. In addition, see “Part I—Item 1A—Risk Factors” and Exhibit 99.1—Forward-Looking Statements, which is incorporated herein by reference.

Introduction
Background
We are one of the largest providers of home medical equipment and related products and services in the United States, with a comprehensive offering of respiratory therapy and durable home medical equipment and related services. We provide home medical equipment and related products and services principally to older patients with breathing disorders, such as chronic obstructive pulmonary diseases (COPD), which include chronic bronchitis, emphysema, obstructive sleep apnea and other cardiopulmonary disorders. We provide equipment and services in 48 states through approximately 425 operating locations located primarily in non-urban markets.
Our revenues are principally derived from respiratory equipment rental and related services, which accounted for 87.5%, 86.5% and 87.7% of net revenues for the years ended December 31, 2011, 2010 and 2009, respectively. Revenues from respiratory equipment rental and related services include rental of oxygen concentrators, liquid oxygen systems, portable oxygen systems, ventilator therapy systems, nebulizer equipment and sleep disorder breathing therapy systems, and the sale of nebulizer medications. We also generate revenues through the rental and sale of durable medical equipment, which accounted for 10.6%, 11.1% and 11.3% of net revenues for the years ended December 31, 2011, 2010 and 2009, respectively. Revenues from rental and sale of durable medical equipment include hospital beds, wheelchairs, walkers, patient aids and ancillary supplies. We derive our revenues principally from reimbursement by third-party payors, including Medicare, Medicaid, the Veterans Administration (VA) and private insurers.
We are focused on specific initiatives to continue the growth in patient and product counts experienced over the past three years.
Executive Summary
We face significant financial and Medicare reimbursement related challenges that continue to negatively affect our financial position (the risks and uncertainties related to the Deficit Reduction Act of 2005’s (DRA) 36-month rental cap, as well as the impact of recent reimbursement changes, are discussed in more detail under “Business—Government Regulation” and “Risk Factors”). We anticipate that we will continue to face such challenges in the near and long-term future. Most of these difficulties result from our highly leveraged capital structure, while others are the result of significant Medicare reimbursement reductions applicable to our industry, as well as current conditions in the capital markets. In particular:
Beginning in 2009, our net revenues were negatively impacted by approximately $45.1 million on an ongoing, annual basis as a result of the 36-month rental cap on oxygen equipment provided to Medicare beneficiaries, mandated as part of the DRA and the 9.5% reduction in reimbursement for oxygen and certain other durable medical equipment as part of the Medicare Improvement for Patients and Providers Act of 2008 (MIPPA), both of which went into effect on January 1, 2009.
Recent and potential future changes in Medicare policies, including freezes and reductions in reimbursement rates for home medical equipment and dispensing fee reductions, competitive bidding requirements, new clinical conditions for reimbursements, accreditation requirements and quality standards, could have a material adverse effect on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations.
In light of these challenges, our operational focus has been on reducing our cost structure while maintaining internal growth and seeking opportunities to gain market share through selective equipment and asset purchases from competitors exiting the home medical equipment market. In particular:
During 2008, we completed a series of operational restructuring initiatives, which included restructuring of our field operations, clinical programs and pharmacy operations and were primarily comprised of staffing reductions. These reductions, in addition to other cost saving initiatives, decreased our annual selling, general and administrative expenses and operating costs by approximately $52.9 million beginning in 2009. During 2010, we implemented several new initiatives intended to streamline our workflows and further leverage new internally developed systems and system enhancements. These reductions, in addition to other cost saving initiatives over the past three years, decreased our annual selling, general and administrative expenses and operating costs as a percentage of net revenue to 54.1% for the year ended December 31, 2011 compared to 58.5% for 2008.

35


During 2011, we completed implementation of our new order intake system. In conjunction with our new electronic medical record system implemented in 2009, we have redesigned our front-end order intake processes. As a result, we have been able to automate and consolidate many of our historically paper-based processes. We believe that this new intake system will result in significant improvements in our operating efficiency.
Since 2009, we have purchased $31.9 million of new and used rental equipment, inventory and identifiable intangible assets from competitors exiting the home medical equipment market. Some of the equipment purchased in these transactions is currently on rent and located in a patient’s home. We have been successful, and we expect that we will continue to be successful, in transitioning and retaining a high percentage of the associated patients onto service with our Company. We believe that we will be successful in identifying additional equipment and asset purchase opportunities during 2012, however the degree to which we pursue such opportunities during 2012 will depend upon a variety of factors, including consideration of markets that will be impacted by competitive bidding, availability of cash and market valuation multiples. Since 2009, we have recognized approximately $50.8 million of revenues associated with patients transitioned onto service with our Company through equipment and asset purchases.
These strategic and operational initiatives were implemented in order to best position the Company to address its 2011 debt maturities. Our 2012 financial plans call for continued improvements in financial performance compared to 2011.
Critical Accounting Policies
The preparation of our financial statements in accordance with generally accepted accounting principles requires us to make assumptions that affect the reported amounts of assets, liabilities and disclosure of contingencies as of the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Critical accounting policies are those that require the most complex or subjective judgments often as a result of the need to make estimates about the effects of matters that are inherently uncertain. Thus, to the extent that actual events differ from our estimates and assumptions, there could be a material impact to our financial statements. We believe that the critical accounting policies for our company are those we have described below. The below listing is not intended to be a comprehensive list of all our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles with limited or no need for management’s judgment. There are also areas in which management’s judgment in selecting available alternatives may or may not produce a materially different result. For more information, see our audited consolidated financial statements and notes thereto.
Revenue Recognition
Revenues are recognized when persuasive evidence of an arrangement exists; delivery has occurred; our price to the payor is fixed or determinable; and collectability is reasonably assured.
Our rental arrangements 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 rentals which limit the rental payment period in some instances). Once initial delivery is made to the patient (initial setup), a monthly billing is established based on the initial setup service date. We recognize rental arrangement revenues ratably over the monthly service period and defer revenue for the portion of the monthly bill which is unearned. No separate revenue is earned from the initial setup process. We have no lease with the patient or third-party payor. During the rental period we are responsible for providing oxygen refills and for servicing the equipment based on manufacturers’ recommendations. Revenues for the sale of durable medical equipment and related supplies, including oxygen equipment, ventilators, wheelchairs, hospital beds and infusion pumps, are recognized at the time of delivery. Revenues for the sale of nebulizer medications, which are generally dispensed by our pharmacies and shipped directly to the patient’s home, are recognized at the time of shipment. Revenues derived from capitation arrangements are insignificant.
Net Revenues
Net revenues are recorded at net realizable amounts estimated to be paid by patients and third-party payors. Our billing system contains payor-specific price tables that reflect the fee schedule amounts, as available, in effect or contractually agreed upon by various government and commercial payors for each item of equipment or supply provided to a customer. Net revenues are recorded based upon the applicable fee schedule. We track collections and adjustments as a percentage of related revenues. Historical collection and adjustment percentages serve as the basis for our provisions for contractual adjustments and doubtful accounts. The provision for contractual adjustments is recorded as a reduction to net revenues and consists of:
(1) Differences between non-contracted third-party payors’ allowable amounts and our usual and customary billing rate. We do not have contracts or fee schedules with all third-party payors. Accordingly, for non-contracted payors where no fee schedule is available, we record revenue based upon our usual and customary billing rates. Actual adjustments that result from differences between the non-contracted third-party payors’ allowable amounts and our usual

36


and customary billing rates are recorded against the allowance for contractual adjustments and are typically identified and recorded at the point of cash application.
(2) Services for which payment is denied by governmental or third-party payors, or otherwise deemed non-billable by us. Final payment under governmental programs, and most third-party contracts, is subject to administrative review and audit. Furthermore, the complexity of governmental and third-party billing reimbursement arrangements, including patient qualification and medical necessity requirements, may result in adjustments to amounts originally recorded. Such adjustments may be recorded as the result of the denial of claims billed to governmental or third-party payors, or as the result of our review procedures prior to submission of the claim to the governmental or third-party payor. Actual adjustments that result from services for which payment is denied by governmental or third-party payors, or otherwise deemed non-billable by us are recorded against the allowance for contractual adjustments.
The provision for contractual adjustments reduces amounts recorded through our billing system to estimated net realizable amounts. We record the provision for contractual adjustments based on a percentage of revenue using historical company-specific data. The percentage and amounts used to record the provision for contractual adjustments are supported by various methods including current and historical cash collections, as well as actual contractual adjustment experience. This percentage, which is adjusted at least on an annual basis, has proven to be the best indicator of expected realizable amounts.
We closely monitor our historical contractual adjustment rates, as well as changes in applicable laws, rules and regulations and contract terms to help assure that provisions are made using the most accurate information we believe to be available. Due to the nature of the industry and the reimbursement environment in which we operate, certain estimates are required in order to record net revenues at their net realizable values. Inherent in these estimates is the risk that they may have to be revised or updated as additional information becomes available. Specifically, the complexity of many third-party billing arrangements, patient qualification for medical necessity of equipment 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.
Net revenues also include advertising and other non-patient service revenue.
The provision for doubtful accounts is recorded as an operating expense and consists of billed charges that are ultimately deemed uncollectible due to the patient’s or third-party payor’s inability or refusal to pay, as described below.
Provision for Doubtful Accounts
Medicare and most other government and commercial payors that provide coverage to our patients include a 20% 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 patients 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 is ultimately responsible for payment of charges for all services rendered by us.

Collection of receivables from third-party payors and patients is our primary source of cash and is critical to our operating performance. Our primary collection risk, with regard to doubtful accounts, relates to patient accounts for which the primary insurance payor has paid, but patient responsibility amounts (generally deductibles and co-payments) remain outstanding. We record a provision for doubtful accounts based on a percentage of revenue using historical company-specific data. The percentage and amounts used to record the provision for doubtful accounts are supported by various methods including current and historical cash collections, actual write-offs, and accounts receivable agings. Accounts are written off against the allowance for doubtful accounts when all collection efforts have been exhausted. We routinely review accounts receivable balances in conjunction with our historical bad debt rates and other economic conditions which might ultimately affect the collectability of patient accounts when we consider the adequacy of the amounts we record as provision for doubtful accounts. Significant changes in payor mix, economic conditions or trends in federal and state governmental health care coverage could have a material adverse affect on our collection of accounts receivable, cash flows and results of operations.
Accounts Receivable, net
Accounts receivable are presented net of allowances for contractual adjustments and doubtful accounts. Allowances for contractual adjustments and doubtful accounts are initially recorded based upon historical collection experience through the provisions for contractual adjustment and doubtful accounts, as described above. If the payment amount received differs from the net realizable amount, an adjustment is made to the net realizable amount in the period that these payment differences are determined. Actual accounts receivable write-offs due to contractual adjustments or accounts deemed uncollectible are applied against these allowance accounts in the normal course of business. On a quarterly basis, we perform analyses to evaluate the

37


estimated net realizable value of accounts receivable. As a result of this quarterly review process, the allowances for contractual adjustments and doubtful accounts are adjusted, as necessary, to reflect that estimated net realizable value. Specifically, we consider historical collection data, accounts receivable aging trends, other operating trends and relevant business conditions. Due to the nature of the industry and the reimbursement environment in which we operate, certain estimates are required in order to record net revenues and accounts receivable at their net realizable values. Inherent in these estimates is the risk that they may have to be revised or updated as additional information becomes available. It is possible that management’s estimates could change, which could have an impact on operations and cash flows. For example, a 1% decline in the overall collection rate would reduce operating income, operating cash flows and associated net accounts receivable by $6.0 million (based upon $600.0 million in annual gross patient service revenue). Additionally, the complexity of many third-party billing arrangements, patient qualification for medical necessity of equipment and the uncertainty of reimbursement amounts for certain services from certain payors may result in adjustments to amounts originally recorded.
Intangible Assets
Intangible assets include trade names and Medicare licenses with indefinite lives which are not subject to amortization, but instead must be reviewed annually, or more frequently, if events or changes in circumstances indicate that the asset might be impaired. Fair values for intangible assets are determined based upon discounted cash flows, market multiples or appraised values as appropriate. An impairment loss is recorded if the fair value of the intangible asset is less than the carrying value. Intangible assets also include customer/physician relationships, computer software and other identifiable intangible assets which are amortized over a period of their expected useful lives, generally 2 to 20 years.
Impairment of Long-Lived Assets
Periodically, when indicators of impairment are present, we evaluate the recoverability of the net carrying value of our property and equipment and our other amortizable intangible assets by comparing the carrying values to the estimated future undiscounted cash flows. A deficiency in these cash flows relative to the carrying amounts is an indication of the need for a write-down due to impairment. The amount of the impairment, if any, is recognized by the amount by which the carrying value exceeds the fair value. Among other variables, we consider factors such as the effects of external changes to our business environment, competitive pressures, market erosion, technological and regulatory changes as factors which could provide indications of impairment.
Property and Equipment
Property and equipment are stated at cost, adjusted for the impact of fresh start reporting. Patient service equipment represents medical equipment rented or held for rental to in-home patients. Patient service equipment is accounted for using a composite method, due to its characteristics of high unit volumes of relative low dollar unit cost items. Under the composite method, the purchase cost of monthly purchases of certain patient service equipment are capitalized and depreciated over the applicable useful life under a straight-line convention, without specific physical tracking of individual items. Each grouping of patient service equipment is assigned a useful life intended to provide proper matching of the cost of patient service equipment with the patient service revenues generated from use of the equipment, when considering the conversion of rental equipment to purchase, wear and tear, damage, loss and ultimately scrapping of patient service equipment over its life. Whenever events or circumstances occur which change the estimated useful life of an asset, we account for the change prospectively. While we believe our current estimates of useful lives are reasonable, significant differences in actual experience or significant changes in assumptions may cause additional changes to future depreciation expense.
Other property and equipment is accounted for by a specific identification system. Depreciation for other property and equipment is provided on the straight-line method over the estimated useful lives of the assets, seven years for furniture and office equipment, five years for vehicles, three years for computer equipment, and the shorter of the remaining lease term or the estimated useful life for leasehold improvements.
Equipment and Asset Purchases from Competitors
We purchase new and used rental equipment and inventory from competitors exiting the home health care market. Some of the equipment purchased in these transactions is currently on rent and located in a patient’s home. As such, we have the opportunity to transition these patients onto service with our Company, subject to patient consent, physician approval and insurance authorization. The equipment and inventory purchased from these competitors represents only a limited subset of the assets and activities used in operating their respective businesses. Accordingly, these equipment purchases (“Equipment Purchases”) are recorded based upon the fair market value of the underlying equipment and inventory, and included in purchases of property and equipment in the accompanying consolidated statements of cash flows.
In addition, in certain circumstances, we purchase additional assets from competitors in conjunction with the purchase of

38


their rental equipment and inventory. These additional assets may include identifiable intangible assets such as non-competition agreements, patient files and the legal entity name. In these asset purchase transactions, we are able to continue billing and servicing the associated patients without interruption. Accordingly, these asset purchases (“Asset Purchases”) are accounted for as business combinations in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 805, Business Combinations (ASC 805). Pro forma results and other expanded disclosures required by ASC 805 have not been presented as these purchases individually and in the aggregate are not material.
Contingencies
Our business is subject to extensive laws and government regulations, including those related to the Medicare and Medicaid programs. Non-compliance with such laws and regulations could subject us to severe sanctions, including penalties and fines.
ASC Topic 450, Contingencies, provides guidance on the application of generally accepted accounting principles related to these matters. 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. We believe that our accrued liabilities related to such contingencies are appropriate and in accordance with generally accepted accounting principles.

Results of Operations
The following tables show our results of operations for the years ended December 31, 2011, 2010 and 2009.
 
 
For the Years Ended
December 31,
(dollars in thousands)
2011
 
2010
 
2009
Statements of Operations Data:
 
 
 
 
 
Net revenues
$
483,791

 
$
496,426

 
$
479,869

Costs and expenses:
 
 
 
 
 
Cost of net revenues:
 
 
 
 
 
Product and supply costs
90,253

 
97,698

 
111,498

Patient service equipment depreciation
50,454

 
51,541

 
53,667

Operating expenses
8,506

 
8,615

 
9,707

Total cost of net revenues
149,213

 
157,854

 
174,872

Provision for doubtful accounts
26,244

 
23,355

 
16,234

Selling, general and administrative
253,020

 
262,332

 
255,952

Depreciation and amortization
9,573

 
8,674

 
9,780

Total costs and expenses
438,050

 
452,215

 
456,838

Operating income
45,741

 
44,211

 
23,031

Interest expense, net
60,265

 
47,680

 
45,401

Other income, net
(791
)
 
(3,598
)
 
(1,276
)
Loss on debt extinguishment
1,216

 
4,401

 

Total other expenses
60,690

 
48,483

 
44,125

Loss before income taxes
(14,949
)
 
(4,272
)
 
(21,094
)
Income tax benefit
(190
)
 
(69
)
 
(13
)
Net loss
$
(14,759
)
 
$
(4,203
)
 
$
(21,081
)

The following tables show our results of operations as a percentage of net revenues for the years ended December 31, 2011, 2010 and 2009:
 

39


 
For the Years Ended
December 31,
 
Percent
Increase
(Decrease)
 
Percent
Increase
(Decrease)
 
2011
 
2010
 
2009
 
2011 vs. 2010
 
2010 vs. 2009
Statements of Operations Data:
 
 
 
 
 
 
 
 
 
Net revenues
100.0
 %
 
100.0
 %
 
100.0
 %
 
(2.5
)%
 
3.5
 %
Costs and expenses:
 
 
 
 
 
 
 
 
 
Cost of net revenues:
 
 
 
 
 
 
 
 
 
Product and supply costs
18.7
 %
 
19.7
 %
 
23.2
 %
 
(7.6
)%
 
(12.4
)%
Patient service equipment depreciation
10.4
 %
 
10.4
 %
 
11.2
 %
 
(2.1
)%
 
(4.0
)%
Operating expenses
1.8
 %
 
1.7
 %
 
2.0
 %
 
(1.3
)%
 
(11.2
)%
Total cost of net revenues
30.9
 %
 
31.8
 %
 
36.4
 %
 
(5.5
)%
 
(9.7
)%
Provision for doubtful accounts
5.4
 %
 
4.7
 %
 
3.4
 %
 
12.4
 %
 
43.9
 %
Selling, general and administrative
52.3
 %
 
52.8
 %
 
53.3
 %
 
(3.5
)%
 
2.5
 %
Depreciation and amortization
2.0
 %
 
1.7
 %
 
2.0
 %
 
10.4
 %
 
(11.3
)%
Total costs and expenses
90.6
 %
 
91.0
 %
 
95.1
 %
 
(3.1
)%
 
(1.0
)%
Operating income
9.4
 %
 
9.0
 %
 
4.9
 %
 
3.5
 %
 
92.0
 %
Interest expense, net
12.5
 %
 
9.6
 %
 
9.5
 %
 
26.4
 %
 
5.0
 %
Other income, net
(0.2
)%
 
(0.7
)%
 
(0.3
)%
 
(78.0
)%
 
182.0
 %
Loss on debt extinguishment
0.3
 %
 
0.9
 %
 
 %
 
(72.4
)%
 
100.0
 %
Total other expenses
12.6
 %
 
9.8
 %
 
9.2
 %
 
25.2
 %
 
9.9
 %
Loss before income taxes
(3.2
)%
 
(0.8
)%
 
(4.3
)%
 
249.9
 %
 
(79.7
)%
Income tax benefit
 %
 
 %
 
 %
 
175.4
 %
 
430.8
 %
Net loss
(3.2
)%
 
(0.8
)%
 
(4.3
)%
 
251.2
 %
 
(80.1
)%
Year ended December 31, 2011 as compared to year ended December 31, 2010
Total net revenues for the year ended December 31, 2011 were $483.8 million as compared to $496.4 million for the comparable period in 2010, a decrease of $12.6 million, or 2.5%. This decrease is primarily attributable to:
$12.2 million in decreases in nebulizer medication reimbursement and volume;
$5.1 million in reductions from competitive bidding; and
$5.6 million in decreases in non-patient service revenue, non-core product lines and other changes in Medicare reimbursement.
These decreases were partially offset by $5.7 million from organic growth in our core oxygen and CPAP product line patient counts and approximately $4.6 million increase in net revenue associated with patients transitioned onto service with us through Equipment and Asset Purchases. As of December 31, 2011 revenue generating patients (including patients from equipment and asset purchases) in the core product lines of oxygen and CPAP grew 8.8% compared to December 31, 2010.
Cost of net revenues for the year ended December 31, 2011 decreased $8.6 million, or 5.5%, to $149.2 million, from the comparable period in 2010. Product and supply costs decreased $7.4 million which was primarily attributable to $9.7 million decrease in nebulizer medication expenses consistent with the volume reductions in our nebulizer medication business partially offset by a $2.3 million increase in cost of net revenues consistent with the volume increases in our CPAP product line. In addition, patient service equipment depreciation decreased $1.1 million as a result of equipment becoming fully depreciated during the last twelve months Cost of net revenues as a percentage of net revenue was 30.9% for the year ended December 31, 2011 as compared to 31.8% for the comparable period in 2010.

The provision for doubtful accounts for the year ended December 31, 2011 totaled $26.2 million, a $2.9 million increase from the comparable period in 2010. As a percentage of net revenues, the provision for doubtful accounts was 5.4% and 4.7% for the years ended December 31, 2011 and 2010, respectively. Although we have implemented more stringent collection policies and procedures, the magnitude of balances shifting to patient responsibility has increased as a result of patients losing insurance coverage and increased copayment and deductible amounts under employer-based plans. We have increased our provision rate for doubtful accounts to reflect these changes.

40


Selling, general and administrative expenses for the year ended December 31, 2011 totaled $253.0 million, a decrease of $9.3 million or 3.5% from the comparable period in 2010. The decrease in selling, general and administrative expenses was primarily attributable to:
$5.0 million in reduced salary-related costs primarily from a 2.1% reduction in average full-time equivalent employee counts compared to the comparable period in 2010;
$4.3 million in decreased insurance costs as a result of lower claims incurrence and design changes to our health insurance plans;
$3.8 million in reduced fleet costs associated with the buy-out of our vehicle leases during 2010; and
$1.2 million in decreased telecom expenses associated with an excise tax refund claims ($0.6 million, net of associated fees) and renegotiated telecom contracts.
These decreases were partially offset by:
$2.2 million in increased contract labor costs as a result of transition costs associated with equipment purchases and higher utilization of respiratory therapists; and
$1.9 million in increased fuel costs as a result of higher gas prices.
Selling, general and administrative expenses as a percentage of net revenues decreased to 52.3% for the year ended December 31, 2011 from 52.8% for the year ended December 31, 2010.
Depreciation and amortization for the year ended December 31, 2011 totaled $9.6 million, an increase of $0.9 million from the comparable period in 2010. This increase was mainly the result of purchases vehicles, including those acquired in conjunction with certain equipment and asset purchase transactions. Depreciation and amortization as a percentage of net revenues increased to 2.0% as compared to 1.7% for the comparable period in 2010.
Net interest expense for the year ended December 31, 2011 increased $12.6 million from the comparable period in 2010. This increase is primarily a result of the replacement of the payment-in-kind term loan facility (the “Senior Facility”) in October 2010 with our Senior Secured Notes and the refinancing of the Senior Subordinated Notes with our Senior Second Lien Notes. The Senior Secured Notes bear interest at 10.75% and the Senior Second Lien Notes bear interest at 10.5% while the Senior Facility had an average variable interest rate of 6.3% and the Senior Subordinated Notes bore interest at 9.5%.
Other income, net for the year ended December 31, 2011 totaled $0.8 million, a decrease of $2.8 million from the comparable period in 2010. During the month of April 2010, we settled a commercial arbitration proceeding related to previously unpaid claims and associated interest, fees, expenses and legal costs. The net amount received as a result of this settlement, after consideration of all legal costs and expenses incurred, was approximately $2.9 million.
As a result of the redemption of the 9.5% Senior Subordinated Notes due 2012, we recorded a $1.2 million loss on extinguishment of debt related to unamortized debt issuance costs during the year ended December 31, 2011. Additionally, as a result of the termination of the Senior Facility dated March 30, 2007, we recorded a $4.4 million loss on extinguishment of debt related to unamortized debt issuance costs of $2.1 million and prepayment premiums of $2.3 million during the year ended December 31, 2010.
Net loss for the year ended December 31, 2011 was $14.8 million compared to a net loss of $4.2 million for the year ended December 31, 2010. This increase in net loss is primarily attributable to the above described increase in net interest expense and the loss on extinguishment of debt.
Year ended December 31, 2010 as compared to year ended December 31, 2009
Total net revenues for the year ended December 31, 2010 were $496.4 million as compared to $479.9 million for the comparable period in 2009, an increase of $16.5 million, or 3.5%. This increase is primarily attributable to $12.2 million from organic growth in our core oxygen and CPAP product line patient counts, approximately $9.5 million increase in net revenue associated with patients transitioned onto service with us through Equipment and Asset Purchases and $7.7 million associated with advertising revenue and other non-patient service revenue. These increases were partially offset by a $10.8 million impact of reductions in nebulizer medication reimbursement and volume and approximately $1.9 million impact from the 1.5% Medicare budget neutrality adjustment to stationary oxygen equipment reimbursement rates, which became effective January 1, 2010.
Cost of net revenues for the year ended December 31, 2010 decreased $17.0 million, or 9.7%, to $157.9 million, from the comparable period in 2009. Product and supply costs decreased $13.8 million which was primarily attributable to $11.9 million decrease in nebulizer medication expenses consistent with the volume reductions in our nebulizer medication business. In addition, patient service equipment depreciation decreased $2.1 million as a result of equipment becoming fully depreciated

41


during the last twelve months and operating costs decreased by $1.1 million as a result of continued reductions in our pharmacy personnel costs consistent with the associated decreases in nebulizer medications discussed above. Cost of net revenues as a percentage of net revenue was 31.8% for the year ended December 31, 2010 as compared to 36.4% for the comparable period in 2009.

The provision for doubtful accounts for the year ended December 31, 2010 totaled $23.4 million, a $7.1 million increase from the comparable period in 2009. As a percentage of net revenues, the provision for doubtful accounts was 4.7% and 3.4% for the years ended December 31, 2010 and 2009, respectively. Although we have implemented more stringent collection policies and procedures, the magnitude of balances shifting to patient responsibility has increased as a result of patients losing insurance coverage and increased copayment and deductible amounts under employer-based plans. We have increased our provision rate for doubtful accounts to reflect these changes. During 2009, we transitioned all patient-related collection activities to a third-party vendor. We experienced extended delays and implementation issues associated with this transition. During the quarter ended March 31, 2010, we completed the initial collection phases associated with the early patient balances most impacted by these transition issues and determined that an additional provision for doubtful accounts in the amount of $5.0 million was required to allow for a lower percentage of collection on patient receivables resulting from these transition issues.
Selling, general and administrative expenses for the year ended December 31, 2010 totaled $262.3 million, an increase of $6.4 million or 2.5% from the comparable period in 2009. The increase in selling, general and administrative expenses was primarily attributable to a $2.5 million reduction in marketing reimbursements which offset salary costs, a $2.1 million increase in contract and temporary labor costs due to increased utilization of respiratory therapists and transition costs associated with Equipment and Asset Purchases, a $1.2 million increase in sales commissions as a result of the increased levels of organic growth achieved during 2010, and increased collection service fees and expenses. These increases were partially offset by decreases in occupancy and telephone costs. Selling, general and administrative expenses as a percentage of net revenues decreased to 52.8% for the year ended December 31, 2010 from 53.3% for the year ended December 31, 2009.
Depreciation and amortization for the year ended December 31, 2010 totaled $8.7 million, a decrease of $1.1 million from the comparable period in 2009. This decrease is mainly the result of decreased capital expenditures on computer and other equipment, as well as certain computer and other equipment becoming fully depreciated during 2010. Depreciation and amortization as a percentage of net revenues decreased to 1.7% as compared to 2.0% for the comparable period in 2009.
Net interest expense for the year ended December 31, 2010 increased $2.3 million from the comparable period in 2009. This increase is primarily as a result of the replacement of the payment-in-kind term loan facility (the “Senior Facility”) in October 2010 with our Senior Secured Notes. The Senior Secured Notes bear interest at 10.75% while the Senior Facility had an average variable interest rate of 6.3%.
Other income, net for the year ended December 31, 2010 totaled $3.6 million, an increase of $2.3 million from the comparable period in 2009. During the month of April 2010, we settled a commercial arbitration proceeding related to previously unpaid claims and associated interest, fees, expenses and legal costs. The net amount received as a result of this settlement, after consideration of all legal costs and expenses incurred, was approximately $2.9 million.
As a result of the termination of the Senior Facility dated March 30, 2007, we recorded a $4.4 million loss on extinguishment of debt related to unamortized debt issuance costs of $2.1 million and prepayment premiums of $2.3 million.
Net loss for the year ended December 31, 2010 was $4.2 million compared to a net loss of $21.1 million for the year ended December 31, 2009. This improvement is attributable to the changes in revenue, costs and expenses and other income, net described above partially offset by the loss on debt extinguishment.

Non-GAAP Financial Measure
We present Adjusted EBITDA as a supplemental measure of our performance that is not required by, or presented in accordance with, generally accepted accounting principles (GAAP) in the United States of America.
We define Adjusted EBITDA as net earnings (loss) adjusted for (i) income tax (benefit) expense, (ii) interest expense and (iii) depreciation and amortization, as further adjusted to eliminate the impact of certain items that we do not consider indicative of our ongoing operating performance. These further adjustments are itemized below. You are encouraged to evaluate these adjustments and the reasons we consider them appropriate for supplemental analysis. We believe Adjusted EBITDA assists investors and securities analysts in comparing our performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance. In addition we use Adjusted EBITDA to evaluate the effectiveness of our business strategies. In evaluating Adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual or non-

42


recurring items.
The following table is a reconciliation of Adjusted EBITDA to net loss (in thousands):
 
 
Year ended
December 31,
 
2011
 
2010
 
2009
Net loss
(14,759
)
 
$
(4,203
)
 
$
(21,081
)
Income tax benefit
(190
)
 
(69
)
 
(13
)
Interest expense
60,450

 
47,761

 
45,608

Depreciation and amortization, including patient service equipment depreciation
60,028

 
60,215

 
63,447

Accounts receivable adjustment(1)

 
5,000

 

Non-cash equity-based compensation expense
516

 
212

 
475

Restructuring related costs(2)
86

 
463

 

Settlement costs(3)
121

 
103

 
(17
)
Loss on extinguishment of debt(4)
1,216

 
4,401

 

Other adjustments(5)

 

 
337

 
$
107,468

 
$
113,883

 
$
88,756

 
(1)
Accounts receivable adjustments associated with specific collection issues that are not considered indicative of our ongoing operation performance. During 2009, we transitioned all patient-related collection activities to a third-party vendor. We experienced extended delays and implementation issues associated with this transition. During the quarter ended March 31, 2010, we completed the initial collection phases associated with the early patient balances most impacted by these transition issues and determined that an additional provision for doubtful accounts in the amount of $5.0 million was required to allow for a lower percentage of collection on patient receivables resulting from these transition issues.
(2)
Restructuring related costs generally consist of severance and location closure costs.
(3)
Settlement costs incurred outside our ordinary course of business which we do not believe reflect the current and ongoing cash charges related to our operating cost structure.
(4)
We redeemed our 9.5% Senior Subordinated Notes due April 2012 on March 17, 2011, and recorded a $1.2 million loss on extinguishment of debt related to unamortized debt issue costs. We terminated our Senior Facility dated March 30, 2007, and recorded a $4.4 million loss on extinguishment of debt related to unamortized debt issuance costs of $2.1 million and prepayment premiums of $2.3 million.
(5)
Other adjustments not considered indicative of our ongoing operating performance.
Adjusted EBITDA should not be considered as a measure of financial performance under GAAP, and the items excluded from EBITDA are significant components in understanding and assessing financial performance. Adjusted EBITDA has limitations as an analytical tool. Some of these limitations are:
Adjusted EBITDA does not reflect our cash expenditures, future requirements, for capital expenditures or contractual commitments;
Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
Adjusted EBITDA does not reflect significant interest expense, or the cash requirements necessary to service interest or principal payments on our debts;
although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements;
non-cash compensation is and will remain a key element of our overall long-term incentive compensation package, although we exclude it as an expense when evaluating our ongoing operating performance for a particular period;
Adjusted EBITDA does not reflect the impact of certain cash charges resulting from matters we consider not to be indicative of our ongoing operations; and
other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.
Because of these limitations, Adjusted EBITDA should not be considered in isolation or as a substitute for performance measures calculated in accordance with GAAP. We compensate for these limitations by relying primarily on our GAAP results and using Adjusted EBITDA only supplementally.
Liquidity and Capital Resources
Our continuation as a going concern is dependent upon our ability to generate sufficient cash flow to meet our obligations

43


on a timely basis. Our working capital requirements relate primarily to the working capital needed for general corporate purposes. Our business requires us to make significant capital expenditures relating to the purchase and maintenance of the medical equipment used in our business. In addition, we continue to monitor and evaluate our current and projected financial performance to assess whether the cash generated from our operations in future years will continue to meet our working capital, capital expenditure and other cash needs going forward. We believe based upon our current cash projections that current cash balances together with cash generated from our operations and available credit under our revolving credit facility will be sufficient to meet our working capital, capital expenditure and other cash needs through 2012. Cash flows and cash on hand were sufficient to fund operations, capital expenditures and required repayments of debt during the years ended December 31, 2011 and 2010.
Net cash provided by operating activities was $35.4 million and $67.0 million for the years ended December 31, 2011 and 2010, respectively.
Accounts receivable before allowance for doubtful accounts increased to $90.5 million at December 31, 2011 from $78.5 million at December 31, 2010. Days sales outstanding (DSO) (calculated as of each period end by dividing accounts receivable, less allowance for doubtful accounts, by the 90-day rolling average of net revenue) were 58.5 days at December 31, 2011 and 49.5 days at December 31, 2010. There are several factors that continue to impact our DSO, including, but not limited to:
Significant increases in the number of claims subject to prepayment review, primarily by the Durable Medical Equipment Medicare Administrative Contractors (DME MACs) and Zone Program Integrity Contractors (ZPICs).
Temporary delays in obtaining certain required payor-specific documentation required to release claims. Such delays were caused by unanticipated operational backlogs associated with our conversion to a new order intake system, as further described below.
Increased patient co-payments and deductibles due from customers who are finding it difficult to pay their out-of-pocket charges due to loss of insurance coverage, increases in deductibles and co-payment amounts or reductions in their investment or employment income.
Lengthened initial collection cycles for patients transitioned onto service with our Company through Equipment Purchases. When we purchase equipment from competitors and transition their patients onto service with our Company, we are required to obtain revised paperwork from the patient’s physician, which requires additional resources and time to obtain and thereby extends the collection cycle during the transition period.
More stringent patient collection standards. We have implemented more stringent collection standards with respect to balances due from patients including enhanced internal collection efforts and utilization of a third-party collection resource. While these changes may result in higher DSO, we believe that our efforts will ultimately result in greater collection of amounts due from patients.
During 2009, we transitioned all patient-related collection activities to a third-party vendor. We experienced extended delays and implementation issues associated with this transition. During the quarter ended March 31, 2010, we completed the initial collection phases associated with the early patient balances most impacted by these transition issues and determined that an additional provision for doubtful accounts in the amount of $5.0 million was required to allow for a lower percentage of collection on patient receivables resulting from these transition issues.
The following table sets forth the percentage breakdown of our accounts receivable by payor and aging category as of December 31, 2011 and 2010:
December 31, 2011
Accounts receivable by payor and
aging category:
Government
 
Managed Care
and Other
 
Patient
Responsibility
 
Total
Aged 0-90 days
37
%
 
20
%
 
8
%
 
65
%
Aged 91-180 days
7
%
 
5
%
 
7
%
 
19
%
Aged 181-360 days
5
%
 
3
%
 
7
%
 
15
%
Aged over 360 days
%
 
%
 
1
%
 
1
%
Total
49
%
 
28
%
 
23
%
 
100
%
December 31, 2010
 

44


Accounts receivable by payor and
aging category:
Government
 
Managed Care
and Other
 
Patient
Responsibility
 
Total
Aged 0-90 days
38
%
 
21
%
 
8
%
 
67
%
Aged 91-180 days
5
%
 
5
%
 
7
%
 
17
%
Aged 181-360 days
4
%
 
4
%
 
7
%
 
15
%
Aged over 360 days
%
 
1
%
 
%
 
1
%
Total
47
%
 
31
%
 
22
%
 
100
%
Included in accounts receivable are earned but unbilled receivables of $28.1 million, and $18.9 million at December 31, 2011 and 2010, respectively. These amounts include $7.0 million at December 31, 2011 and $3.6 million at December 31, 2010 of receivables for which a prior authorization is required but has not yet been received. Delays, ranging from a day to several weeks, between the date of service and billing can occur due to delays in obtaining certain required payor-specific documentation from internal and external sources. During 2011, we completed implementation of our new order intake system. As a result of this implementation, we experienced unanticipated operational backlogs which led to an increase of $9.2 million in earned but unbilled accounts receivable. Subsequent to December 31, 2011, we have implemented numerous operational initiatives designed to eliminate this backlog and as of February 29, 2012, we have reduced the total earned but unbilled receivables to $24.4 million. In addition to the aforementioned delays, we are required to obtain revised documentation for patients transitioned onto service with us through Equipment Purchases which results in increased initial billing cycles for these patients. Earned but unbilled receivables are aged from the date of service and are considered in our analysis of historical performance and collectability.
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. 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.
Management performs analyses to evaluate the net realizable value of accounts receivable. Specifically, management 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 management’s estimates could change, which could have an impact on operations and cash flows.
We derive a significant portion of our revenues from the Medicare and Medicaid programs and from managed care health plans. Payments for services rendered to patients covered by these programs may be less than billed charges. Revenue is recognized at net realizable amounts estimated to be paid by patients and third-party payors. Our 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 the equipment or supply provided to a customer. For Medicare and Medicaid revenues, as well as most other managed care and private payors, final payment is subject to administrative review and audit. Management makes estimated provisions for adjustments, which may result from administrative review and audit, based upon historical experience. Management closely monitors its historical collection rates as well as changes in applicable laws, rules and regulations and contract terms to help assure that provisions are made using the most accurate information management believes to be available. However, due to the complexities involved in these estimations, actual payments we receive could be different from the amounts we estimate and record.
Collection of receivables from third-party payors and patients is our primary source of cash and is critical to our operating performance. We manage billing and collection of accounts receivable through our own billing and collection centers. In addition, we utilize, third-party collection resources to manage collection of amounts due from patients. Our primary collection risks relate to patient accounts for which the primary insurance payor has paid, but patient responsibility amounts (generally deductibles and co-payments) remain outstanding. 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. Accounts are written off against the allowance when all collection efforts (including payor appeals processes) have been exhausted. We routinely review accounts receivable balances in conjunction with our historical contractual adjustment and bad debt rates and other economic conditions which might ultimately affect the collectability of patient accounts when we consider the adequacy of the amounts we record as provision for doubtful accounts. Significant changes in payor mix, business office operations, economic conditions or trends in federal and state governmental health care coverage could affect our collection of accounts receivable and management’s associated estimates, which could have an

45


impact on cash flows and results of operations. Further, even if our billing procedures comply with all third-party payor requirements, some of our payors may experience financial difficulties, may delay payments or may otherwise not pay accounts receivable when due, which would result in increased write-offs or provisions for doubtful accounts. In addition, we periodically experience inconsistent payment patterns from CMS and its contractors and other third-party payors. As such, we may not be able to maintain our current levels of collectability. If we are unable to collect our accounts receivable on a timely basis, our revenues, profitability and cash flow likely will significantly decline.
Net cash used in investing activities was $53.3 million and $48.0 million for the years ended December 31, 2011 and 2010, respectively. We currently have no contractual commitments for capital expenditures over the next twelve months other than to acquire equipment as needed to supply our patients. Our business requires us to make significant capital expenditures relating to the purchase and maintenance of the medical equipment used in our business. Cash used for capital expenditures totaled approximately $48.9 million (10.1% of our net revenues) for the year ended December 31, 2011 as compared to $53.3 million (10.7% of our net revenues) for the same period in 2010. In addition, cash used for capital expenditures for the years ended December 31, 2011 and 2010 includes $6.1 million and $4.6 million paid for new and used rental equipment from competitors exiting the home health care market, respectively. Most of the equipment purchased in these transactions is currently on rent and located in a patient’s home. As such, we have the opportunity to transition such patients onto service with our Company. In addition, we paid $9.5 million for the year ended December 31, 2011 for asset purchases from competitors.
On March 17, 2011, we issued $290.0 million in aggregate principal amount of Senior Second Lien Notes. The Senior Second Lien Notes were offered and sold in a private placement to Credit Suisse Securities (USA) LLC and Jefferies & Company, Inc. (the “Initial Purchasers”) in reliance on the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”), and resold by the Initial Purchasers to qualified buyers pursuant to exemptions from registration provided by Rule 144A and Regulation S of the Securities Act. The Senior Second Lien Notes were also offered and sold to certain directors of the Company who are accredited investors as defined in Rule 501(a) under the Securities Act.
The Senior Second Lien Notes were issued at a discount of $5.2 million and we incurred transaction costs of approximately $8.9 million. The discount and transaction costs associated with the Senior Second Lien Notes are being amortized as interest expense over the term of these notes. Interest will be payable semi-annually on March 15 and September 15 commencing on September 15, 2011. We used the proceeds from the offering of the Senior Second Lien Notes, together with $24.5 million of cash on hand, to repay all of our outstanding Senior Subordinated Notes and pay associated fees and expenses. In conjunction with the closing of the Senior Second Lien Notes on March 17, 2011, we deposited $301.9 million with Bank of New York Mellon N.A., as trustee (the “Trustee”), to satisfy our obligation with respect to the Senior Subordinated Notes including the principal amount of $287.0 million and accrued interest through April 18, 2011 of $14.9 million. We were legally released of our liability effective March 17, 2011. Upon completion of the 30-day notice period required under the indenture governing our Senior Subordinated Notes, on April 18, 2011, the Trustee redeemed and canceled the Senior Subordinated Notes. As a result of the termination of the Senior Subordinated Notes we recorded a $1.2 million loss on extinguishment of debt related to unamortized debt issuance costs.
The Senior Second Lien Notes will mature on March 15, 2018. In connection with the issuance of the Senior Second Lien Notes, we entered into a registration rights agreement with the Initial Purchasers of the Senior Second Lien Notes, dated March 17, 2011 (the “Senior Second Lien Notes Registration Rights Agreement”). Pursuant to the Senior Second Lien Notes Registration Rights Agreement, we agreed to exchange the Senior Second Lien Notes for freely tradable notes with terms that are substantially identical to the Senior Second Lien Notes. We also agreed, in limited circumstances, to file a shelf registration statement with respect to the Senior Second Lien Notes. On July 12, 2011, we completed the registered exchange offer with respect to the Senior Second Lien Notes.
The indenture governing the Senior Second Lien Notes contains covenants that limit our ability and the ability of our restricted subsidiaries to, among other things: sell assets; pay dividends or make other distributions or repurchase or redeem our stock; incur or guarantee additional indebtedness; incur certain liens; make loans and investments; enter into agreements restricting our subsidiaries’ ability to pay dividends; consolidate, merge or sell all or substantially all of or our assets, and enter into transactions with affiliates. The Senior Second Lien Notes are collateralized by a second priority security interest in substantially all of the Company’s assets. The Senior Second Lien Notes are guaranteed by all of our wholly owned subsidiaries. Each guarantee is full and unconditional and joint and several. We hold all of our assets and conduct all of our operations through our wholly owned subsidiaries and we do not have independent assets and operations.
Additionally, on March 17, 2011 we entered into a credit agreement with Credit Suisse AG, as administrative agent, Credit Suisse Securities (USA) LLC and Jefferies Finance LLC, as joint bookrunners and joint lead arrangers, and Jefferies Finance LLC, as documentation agent (the "Original Credit Agreement"). On March 7, 2012, we entered into an amendment to the Original Credit Agreement that extended the final maturity date from March 17, 2012 to March 17, 2014 (the Original Credit Agreement, as amended, the “Credit Agreement”). The Credit Agreement provides for a revolving credit facility

46


commitment of up to $10.0 million provided that the maximum outstanding aggregate principal balance at any one time does not exceed $10.0 million (the “Revolving Credit Facility”). There was no debt outstanding under the Revolving Credit Facility as of December 31, 2011.
The Revolving Credit Facility contains customary covenants similar to those in our indentures governing our Senior Secured Notes and Senior Second Lien Notes. The Revolving Credit Facility also includes a maximum leverage ratio above which level we would be precluded from making any additional draws. As of December 31, 2011, we were below the maximum leverage ratio threshold (as defined within the Credit Agreement).
All borrowings under the Revolving Credit Facility are secured by a first priority security interest in substantially all of the Company’s assets. The interest rate per annum applicable to the Revolving Credit Facility is adjusted LIBOR or, at our option, the alternate base rate, which is the higher of (a) the prime rate, (b) the federal funds effective rate plus 0.50%, and (c) the adjusted LIBOR plus 1.0% in each case, plus the applicable margin (as defined below). The applicable margin in the case of LIBOR advances is 5.0% and in the case of alternate base rate advances is 4.0%. The default rate on the Revolving Credit Facility is 2.0% above the otherwise applicable interest rate. We are also obligated to pay a commitment fee of 0.75% on the unused portion of our Revolving Credit Facility.
On October 6, 2010, we issued $230.0 million in aggregate principal amount of 10.75% Senior Secured Notes due 2015 (the “Senior Secured Notes”) pursuant to an indenture (the “Indenture”) among ourselves, the Subsidiary Guarantors and The Bank of New York Mellon Trust Company, N.A., as trustee (in such capacity, the “Trustee”). The Senior Secured Notes were offered and sold in a private placement to Credit Suisse Securities (USA) LLC (the “Initial Purchaser”) in reliance on the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”), and resold by the Initial Purchaser to qualified buyers pursuant to exemptions from registration provided by Rule 144A and Regulation S of the Securities Act.
The Senior Secured Notes were issued at a discount of $6.5 million and we incurred transaction costs of approximately $8.0 million. The discount and transaction costs associated with the Senior Secured Notes will be amortized as interest expense over the term of those notes. Interest will be payable semi-annually on April 15 and October 15 commencing on April 15, 2011. We used the proceeds from the offering of the Senior Secured Notes, together with $13.7 million of cash on hand, to repay all of the outstanding indebtedness under our existing Senior Facility and pay associated fees and expenses. As a result of the termination in 2010, of the Senior Facility dated March 30, 2007, we recorded a $4.4 million loss on extinguishment of debt related to unamortized debt issuance costs of $2.1 million and prepayment premiums of $2.3 million.
The Senior Secured Notes will mature on October 15, 2015. In connection with the issuance of the Senior Secured Notes, we entered into a registration rights agreement with the Initial Purchaser of the Senior Secured Notes, dated October 6, 2010 (the “Registration Rights Agreement”). Pursuant to the Registration Rights Agreement, we agreed to register the exchange of the Senior Secured Notes for freely tradable notes with terms that are substantially identical to the Senior Secured Notes. We also agreed, in limited circumstances, to file a shelf registration statement with respect to the Senior Secured Notes. On January 14, 2011, we completed the registered exchange offer with respect to the Senior Secured Notes.
The indenture governing the Senior Secured Notes contains covenants that limit our ability and the ability of our restricted subsidiaries to, among other things: sell assets; pay dividends or make other distributions or repurchase or redeem our stock; incur or guarantee additional indebtedness; incur certain liens; make loans and investments; enter into agreements restricting our subsidiaries’ ability to pay dividends; consolidate, merge or sell all or substantially all or our assets, and enter into transactions with affiliates.
We have outstanding letters of credit totaling $7.5 million and $8.8 million as of December 31, 2011 and 2010, respectively, which are cash collateralized at 100% of their face amount at December 31, 2011 and 105% of their face amount at December 31, 2010. The cash collateral for these outstanding letters of credit is included in restricted cash on our consolidated balance sheet as of December 31, 2011 and 2010.
Cash flows used in financing activities primarily relate to repayment of our Senior Subordinated Notes due 2012. As of December 31, 2011, we had the following outstanding debt:
$224.8 million in aggregate principal amount of Senior Secured Notes, the proceeds of which were used to repay our Senior Facility. The notes mature on October 15, 2015. Interest of 10.75% is payable semi-annually in arrears on April 15 and October 15 of each year. Accrued interest on the Senior Secured Notes totaled $5.2 million and $6.2 million at December 31, 2011 and 2010 , respectively.
$285.2 million in aggregate principal amount of Senior Second Lien Notes, the proceeds of which were used to repay our Senior Subordinated Notes. The notes mature on March 15, 2018. Interest of 10.5% is payable semi-annually in arrears on March 15 and September 15 of each year. Accrued interest on the Senior Second Lien Notes totaled $9.0 million at December 31, 2011.

47


The Company, either directly or through a subsidiary, may from time to time seek to purchase or retire our outstanding indebtedness through cash purchases, in the open market, privately negotiated transactions or otherwise. We will evaluate any such transactions in light of then-existing market conditions, taking into account contractual restrictions, our current liquidity and prospects for future access to capital. The amounts involved may be material.

Contractual Obligations
As of December 31, 2011, our future contractual cash obligations are as follows:

Contractual Obligations(1)(5)
Payments due by period (in thousands)
 
Total
 
Less than 1 year
 
1-3 years
 
3-5 years
 
More than 5 years
Long-term debt obligations(2)
$
841,550

 
$
55,175

 
$
110,350

 
$
340,350

 
$
335,675

Capital lease obligations
2,684

 
1,660

 
1,024

 

 

Operating lease obligations(3)
44,165

 
17,478

 
19,472

 
6,777

 
438

Other liabilities reflected under GAAP(4)
500

 
250

 
250

 

 

 
$
888,399

 
$
74,563

 
$
131,096

 
$
347,127

 
$
336,113

(1) We do not have any purchase obligations other than standard purchase orders in the ordinary course of business.
(2) Our debt is comprised of our 10.75% Senior Secured Notes due 2015, our 10.5% Senior Second Lien Notes due 2018 and related interest charges. See Note 10 to the consolidated financial statements included in this report for a discussion of our long-term debt.
(3) Our operating lease obligations are primarily comprised of building and vehicle lease commitments. See Note 11 to the consolidated financial statements included in this report for further discussion of our lease commitments.
(4) Our other liabilities reflected primarily relate to required future payments for contingent consideration related to asset purchases.
(5) We are unable to estimate the timing of payments that might be due related to our $0.3 million liability for uncertain tax positions. See Note 13 to the consolidated financial statements included in this report for further discussion of our tax liabilities.


Selected Quarterly Financial Data (unaudited)
The following tables present our unaudited quarterly results of operations for 2011 and 2010. The following table should be read in conjunction with the consolidated financial statements appearing elsewhere in this report. This unaudited information has been prepared on a basis consistent with the audited consolidated financial statements and includes all adjustments, consisting only of normal recurring adjustments, that are considered necessary for a fair presentation of our financial position and operating results for the quarters presented. No conclusions should be drawn about our future results from the results of operations for any quarter. The following is a summary of quarterly financial results for the years ended December 31, 2011 and 2010:

48


 
 
Three Months Ended
 
 
December 31,
2011
 
September 30,
2011
 
June 30,
2011
 
March 31,
2011
 
December 31,
2010
 
September 30,
2010
 
June 30,
2010
 
March 31,
2010
 
 
(in thousands, except per share data)
Summary Statement of Operations Information:
Net Revenue
 
$
117,042

 
$
122,806

 
$
122,437

 
$
121,506

 
$
123,772

 
$
124,973

 
$
124,315

 
$
123,366

Cost of net revenue
 
36,359

 
37,825

 
35,931

 
39,098

 
38,401

 
38,605

 
40,005

 
40,843

Net (loss) earnings
 
(8,441
)
(1) 
(1,655
)
 
(1,970
)
 
(2,693
)
 
(3,605
)
 
2,517

 
3,393

 
(6,508
)
Net (loss) earnings per common share - basic
 
(0.33
)
 
(0.06
)
 
(0.08
)
 
(0.11
)
 
(0.15
)
 
0.09

 
0.13

 
(0.26
)
Net (loss) earnings per common share - diluted
 
(0.33
)
 
(0.06
)
 
(0.08
)
 
(0.11
)
 
(0.15
)
 
0.09

 
0.12

 
(0.26
)
Market Prices:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
High
 
2.10

 
4.65

 
4.93

 
4.55

 
1.99

 
2.00

 
3.65

 
0.66

Low
 
1.11

 
2.02

 
3.50

 
1.87

 
1.20

 
0.68

 
0.57

 
0.35


(1) Net loss for the quarter ended December 31, 2011 was negatively impacted by reduced CPAP sales attributable to a temporary slow down in order processing caused by implementation of our new order intake system and increased levels of contractual and bad debt adjustments.
Off-balance Sheet Arrangements
We do not have off-balance sheet arrangements (as that term is defined in Item 303(a)(4)(ii) of Regulation S-K) that have or are reasonably likely to have a current or future effect on our financial condition, revenues, profit margins, profitability, operating cash flows and results of operations.

Inflation and Seasonality
Management believes that there has been no material effect on our operations or financial condition as a result of inflation during the past three fiscal years. However, we are impacted by rising costs for certain inflation-sensitive operating expenses, such as labor and employee benefits, facility and equipment leases, and vehicle fuel. 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. Management also believes that the seasonal impact on our business is not material.


ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our debt as of December 31, 2011 was primarily comprised of our 10.75% Senior Secured Notes due 2015 (the “Senior Secured Notes”) and our 10.5% Senior Second Lien Notes due 2018 (the "Senior Second Lien Notes"). These debts have fixed interest rates and, as such, changes in market interest rates affect the fair market value of such outstanding debt but do not impact our earnings or cash flows.

ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and other financial information that are required by Item 8 are listed in Item 15 of Part IV. The financial statements and supplementary financial information referenced in Item 15 are incorporated in this Item 8 by reference.

ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.

ITEM 9A.
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As required by Rule 13a-15(b) of the Exchange Act, our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, our principal executive officer and principal financial officer have concluded that the operation of our disclosure controls and procedures were not effective as of

49


the end of the period covered by this Annual Report because of the material weakness in internal control over financial reporting described below under the heading "Management’s Annual Report on Internal Control over Financial Reporting."
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on criteria established in the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, as required by Rule 13a-15(d) of the Exchange Act. Based on this evaluation, our management concluded that our internal control over financial reporting was not effective as of December 31, 2011 because of a material weakness in review and reconciliation procedures designed to ensure that certain period end balances reflected in our financial statements agreed to the underlying detailed calculations of such amounts. For example, controls designed to ensure that inventory purchasing discounts are reflected in the proper period between inventory and cost of sales as the associated product is utilized were not operating effectively as of December 31, 2011. As part of the year-end audit process, two adjustments totaling $1.6 million were identified with respect to the accounting for these purchasing discounts as of and for the quarter ended December 31, 2011. These audit adjustments were recorded by the Company in the accompanying financial statements.
A material weakness is defined within the Public Company Accounting Oversight Board's Auditing Standard No. 5 as a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.
In light of the foregoing conclusion, we undertook additional procedures in order that management could conclude that reasonable assurance exists regarding the reliability of financial reporting and the preparation of the consolidated financial statements contained in this filing. Accordingly, management believes that our consolidated financial statements included in this Annual Report on Form 10-K for the year ended December 31, 2011 fairly represent, in all material respects, our financial position, results of operations and cash flows for the periods presented.
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 risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Deloitte & Touche LLP, the independent registered public accounting firm that also audited the Company’s consolidated financial statements included in this Annual Report on Form 10-K, audited the effectiveness of internal control over financial reporting as of December 31, 2011, and issued their related attestation report as included herein which expressed an adverse opinion on the effectiveness of our internal control over financial reporting as of December 31, 2011.
Changes in Internal Control over Financial Reporting
During the fourth quarter of fiscal year 2011, there were no changes in our internal control over financial reporting. However, subsequent to the fourth quarter of fiscal year 2011 but prior to the filing of this Annual Report on Form 10-K, we implemented certain changes to our internal control over financial reporting to address the material weakness in our internal control over financial reporting that was identified during our year-end audit process as described above in “Management’s Annual Report on Internal Control over Financial Reporting." Specifically, during February 2012, our management implemented additional review and reconciliation procedures to ensure that underlying supporting schedules for inventory properly include consideration of purchasing discounts and that such schedules are agreed to the associated financial statement balances. In addition, our management performed additional training for the staff responsible for the preparation of these schedules. Our management also assessed all other monthly review and reconciliation procedures and added additional approval processes to ensure that underlying detailed schedules are fully reconciled and agreed to the associated financial statement balances.



50


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Rotech Healthcare Inc. and subsidiaries
Orlando, Florida

We have audited Rotech Healthcare Inc. and subsidiaries (the "Company's") internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. 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.” 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, testing and evaluating the design and operating effectiveness of internal control based on that risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel 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 the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management's assessment: Review and reconciliation procedures were not operating effectively to ensure that certain period end balances reflected in the Company's financial statements agreed to the underlying detailed calculations of such amounts. For example, controls designed to ensure that inventory purchasing discounts are reflected in the proper period between inventory and cost of sales as the associated product is utilized were not operating effectively as of December 31, 2011. As part of the year-end audit process, two adjustments totaling $1.6 million were identified with respect to the accounting for these purchasing discounts as of and for the quarter ended December 31, 2011. These audit adjustments were recorded by the Company in the consolidated financial statements as of and for the year ended December 31, 2011. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2011, of the Company and this report does not affect our report on such financial statements and financial statement schedule.

In our opinion, because of the effect of the material weakness identified above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2011, of the

51


Company and our report dated March 14, 2012 expressed an unqualified opinion on those financial statements and financial statement schedule.

/s/DELOITTE & TOUCHE LLP
Certified Public Accountants
Tampa, Florida

March 14, 2012


ITEM 9B.
OTHER INFORMATION
None.


52


PART III

ITEM 10.
DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Part III, Item 10, to the extent not provided herein, is incorporated herein by reference to our definitive proxy statement relating to the 2012 annual meeting of shareholders to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K. Information regarding our executive officers is set forth under the caption “Executive Officers” in Item 1 hereof.
Code of Ethics
We have adopted a code of ethics that applies to the members of our board of directors, principal executive officer, principal financial officer and other persons performing similar functions. We have also issued a Policy Statement on Business Ethics and Conflicts of Interests which is applicable to all employees. Our code of ethics and Policy Statement on Business Ethics and Conflicts of Interests are posted on our internet website, www.rotech.com, and are available, without charge, upon written request directed to the Chief Legal Officer, Rotech Healthcare Inc., 2600 Technology Drive, Suite 300, Orlando, Florida, 32804.

ITEM 11.
EXECUTIVE COMPENSATION
The information required by Part III, Item 11, to the extent not provided herein, is incorporated herein by reference to our definitive proxy statement relating to the 2012 annual meeting of shareholders to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K.

ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by Part III, Item 12, to the extent not provided herein, is incorporated herein by reference to our definitive proxy statement relating to the 2012 annual meeting of shareholders to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K.

ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by Part III, Item 13, to the extent not provided herein, is incorporated herein by reference to our definitive proxy statement relating to the 2012 annual meeting of shareholders to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K.

ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Part III, Item 14, to the extent not provided herein, is incorporated herein by reference to our definitive proxy statement relating to the 2012 annual meeting of shareholders to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K.


53


PART IV

ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)
The following documents are filed as part of this report.

 
  
 
  
Page
No.
1.
  
  
 
  
  
 
  
  
 
  
  
 
  
  
 
  
  
 
  
  
 
 
 
2.
  
Index to Financial Statement Schedule
  
 
 
 
 
 
 
Schedule II-Valuation and Qualifying Accounts for the years ended December 31, 2011, 2010 and 2009.
 
 
 
 
 
 
 
 
  
Schedules other than those listed above are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.
  
 
 
 
 
3.
  
Exhibits
  
 
 
 
 
 
  
The exhibits required by Item 601 of Regulation S-K filed as part of, or incorporated by reference in, this report are listed in the accompanying Exhibit Index found after the signature page to this report.
  
 
(b) See Item 15(a)(3).
(c) See Item 15(a)(2).

54


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.
Date: March 14, 2012
 
ROTECH HEALTHCARE INC.
 
 
 
 
 
 
 
By:
 
/s/    PHILIP L. CARTER        
 
 
 
 
Philip L. Carter, President and
Chief Executive Officer (Principal Executive Officer)


55


POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Philip L. Carter and Rebecca L. Myers, and each of them, as his true and lawful attorneys-in-fact, as agent with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any or all amendments (including post-effective amendments) to this Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting to each such attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully and to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
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.
 
/s/    PHILIP L. CARTER        
  
President, Chief Executive Officer and Director
 
March 14, 2012
Philip L. Carter
 
(Principal Executive Officer)
 
 
 
 
 
/s/    STEVEN P. ALSENE        
  
Chief Operating Officer and Interim Chief Financial Officer
 
March 14, 2012
Steven P. Alsene
 
(Principal Financial and Accounting Officer)
 
 
 
 
 
/s/    ARTHUR J. REIMERS        
  
Chairman of the Board
 
March 14, 2012
Arthur J. Reimers
 
 
 
 
 
 
 
/s/    JAMES H. BLOEM        
  
Director
 
March 14, 2012
James H. Bloem
 
 
 
 
 
 
 
/s/    EDWARD L. KUNTZ        
  
Director
 
March 14, 2012
Edward L. Kuntz
 
 
 
 
 
 
 
/s/    ARTHUR SIEGEL        
  
Director
 
March 14, 2012
Arthur Siegel
 
 
 
 

56



EXHIBIT INDEX
 
Exhibit
Number
 
Title
 
2.1(a)
 
Second Amended Joint Plan of Reorganization of Rotech Medical Corporation and its subsidiaries under Chapter 11 of the Bankruptcy Code dated February 7, 2002.
 
 
 
3.1(b)
 
Certificate of Incorporation of Rotech Healthcare Inc.
 
 
 
3.2(o)
 
Second Amended and Restated Bylaws of Rotech Healthcare Inc.
 
 
 
4.1(b)
 
Form of specimen common stock certificate.
 
 
 
4.2(p)
 
Indenture dated as of October 6, 2010 by and among Rotech Healthcare Inc. each of the subsidiary guarantors named therein and The Bank of New York Mellon Trust Company, NA.
 
 
 
4.3(r)
 
First Supplemental Indenture, dated October 24, 2011, by and among Rotech Healthcare Inc., the subsidiary guarantors named therein and the Bank of New York Mellon Trust Company, N.A., as trustee, to the Indenture, dated October 6, 2010, by and among Rotech Healthcare Inc., the subsidiary guarantors named therein, and the Bank of New York Mellon Trust Company, N.A.
 
 
 
4.4(r)
 
Second Supplemental Indenture, dated October 24, 2011, by and among Rotech Healthcare Inc., the subsidiary guarantors named therein and the Bank of New York Mellon Trust Company, N.A., as trustee, to the Indenture, dated October 6, 2010, by and among Rotech Healthcare Inc., the subsidiary guarantors named therein, and the Bank of New York Mellon Trust Company, N.A.
 
 
 
4.5
 
Reserved.
 
 
 
4.6(q)
 
Indenture, dated March 17, 2011, by and among the Company, the guarantors party thereto, and The Bank of New York Mellon Trust Company, N.A., including the form of Notes.
 
 
 
4.7(r)
 
First Supplemental Indenture, dated October 24, 2011, by and among Rotech Healthcare Inc., the subsidiary guarantors named therein and the Bank of New York Mellon Trust Company, N.A., as trustee, to the Indenture, March 17, 2011, by and among Rotech Healthcare Inc., the subsidiary guarantors named therein, and the Bank of New York Mellon Trust Company, N.A.
 
 
 
4.8(r)
 
Second Supplemental Indenture, dated October 24, 2011, by and among Rotech Healthcare Inc., the subsidiary guarantors named therein and the Bank of New York Mellon Trust Company, N.A., as trustee, to the Indenture, dated March 17, 2011, by and among Rotech Healthcare Inc., the subsidiary guarantors named therein, and the Bank of New York Mellon Trust Company, N.A.
 
 
 
10.1(c)
 
Rotech Healthcare Inc. Common Stock Option Plan.
 
 
 
10.2(c)
 
Amendment No. 1 to the Rotech Healthcare Inc. Common Stock Option Plan.
 
 
 
10.3(d)
 
Amendment No. 2 to the Rotech Healthcare Inc. Common Stock Option Plan.
 
 
 
10.4(e)
 
Amendment No. 3 to the Rotech Healthcare Inc. Common Stock Option Plan.
 
 
 
10.5(f)
 
Amendment No. 4 to the Rotech Healthcare Inc. Common Stock Option Plan.
 
 
 
10.6(g)
 
Form of Common Stock Option Agreement.
 
 
 
10.7(i)
 
Rotech Healthcare Inc. Amended and Restated Nonemployee Director Restricted Stock and Stock Option Plan.
 
 
 
10.8(c)
 
Form of Restricted Stock Award Agreement.
 
 
 
10.9(p)
 
Registration Rights Agreement dated as of October 6, 2010, by and among Rotech Healthcare Inc., each of the guarantors listed on Schedule A thereto, and Credit Suisse Securities (USA) LLC.
 
 
 
10.10(j)
 
Rotech Healthcare Inc. Performance Bonus Plan
 
 
 
10.11(v)
 
Credit Agreement dated as of March 17, 2011, by and among Rotech Healthcare Inc., the several banks and other financial institutions or entities from time to time parties to the Credit Agreement, Credit Suisse Securities (USA) LLC and Jefferies Finance LLC, as joint lead arrangers and jointbookrunners, Credit Suisse AG, as administrative agent and Jefferies Finance LLC as documentation agent.
 
 
 
10.12(q)
 
Registration Rights Agreement, dated March 17, 2011, by and among the Company, the guarantors party thereto and Credit Suisse (USA) LLC and Jefferies & Company, Inc.
 
 
 

57


10.13(a)
 
Registration Rights Agreement dated as of March 26, 2002, by and among Rotech Healthcare Inc., each of the entities listed on Schedule A thereto, and UBS Warburg LLC, Goldman, Sachs & Co., Deutsche Banc Alex. Brown Inc. and Scotia Capital (USA) Inc.
 
 
 
10.14(b)
 
Amended and Restated Registration Rights Agreement dated June 21, 2002, between Rotech Healthcare Inc., and Oaktree Capital Management, LLC and General Electric Capital Corporation.
 
 
 
10.15(a)
 
Transfer Agreement between Rotech Healthcare Inc. and Rotech Medical Corporation dated March 26, 2002.
 
 
 
10.16(a)
 
Tax Sharing Agreement among Integrated Health Services, Inc., Rotech Healthcare Inc. and Rotech Medical Corporation dated as of March 26, 2002.
 
 
 
10.17(o)
 
Trust Agreement by and among NorthStar Trust Company and Rotech Healthcare Inc. dated July 1, 2007 with respect to the Rotech Healthcare Inc. Employees Plan.
 
 
 
 
10.18(s)
 
Amendment and Restatement of the Rotech Healthcare Inc. Employees Plan effective January 1, 2011.
 
 
 
10.19(k)
 
Corporate Integrity Agreement with the Office of Inspector General of the United States Department of Health and Human Services dated May 19, 2008.
 
 
 
10.20(l)
 
Second Amended and Restated Employment Agreement with Philip L. Carter dated October 6, 2008.
 
 
 
10.21(u)
 
Rotech Healthcare Inc. Equity Award Plan
 
 
 
10.22(u)
 
Form of Equity Award Plan
 
 
 
10.23(v)
 
Amendment No. 1, dated and filed as of March 7, 2012, to the Credit Agreement dated March 17, 2011.
 
 
 
10.24
 
Reserved
 
 
 
10.25(i)
 
Amendment No. 5 to the Rotech Healthcare Inc. Common Stock Option Plan.
 
 
 
10.27(i)
 
Form of Chief Executive Officer Option Agreement.
 
 
 
10.28(i)
 
Form of Nonemployee Director Option Agreement.
 
 
 
10.29(i)
 
Form of Officer (other than CEO) Option Agreement.
 
 
 
10.30(r)
 
Employment Amendment Agreement to the Second Amended and Restated Employment Agreement with Philip L. Carter dated August 8, 2011.
 
 
 
10.31(t)
 
Amended and Restated Agreement with Respect to Rights upon Termination of Employment with Steven P. Alsene dated January , 2012.
 
 
 
10.32(n)
 
Form of Indemnification Agreement for directors and officers.
 
 
 
12.1
 
Ratio of Earnings to Fixed Charges
 
 
 
21.1
 
List of Subsidiaries.
 
 
 
23.1
 
Consent of Deloitte & Touche LLP, Independent Registered Public Accounting Firm.
 
 
 
24.1
 
Power of Attorney (included on signature page of this report).
 
 
 
31.1
 
Certification of principal executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2
 
Certification of principal financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.1
 
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
 
99.1
 
Forward-Looking Statements.
 
 
 
 

58


101
 
The following materials from the Annual Report on Form 10-K for Rotech Healthcare Inc. for the year ended December 31, 2011, formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Balance Sheets at December 31, 2011, 2010 and 2009; (ii) Consolidated Statement of Operations for the years ended December 31, 2011, 2010 and 2009; (iii) Consolidated Statement of Changes in Stockholders' Deficiency for the years ended December 31, 2011, 2010 and 2009; (iv) Consolidated Statement of Cash Flows for the years ended December 31, 2011, 2010 and 2009; and (v) Notes to Consolidated Financial Statements.*
 
 
 
 
*
 
Pursuant to Rule 406T of Regulations S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
 
(a)
Incorporated by Reference to our Registration Statement on Form S-4 (file No. 333-100750) filed with the Securities and Exchange Commission on October 25, 2002, as amended January 27, 2003, February 10, 2003 and February 13, 2003.
(b)
Incorporated by Reference to our Registration Statement on Form 8-A (file No. 000-50940) filed with the Securities and Exchange Commission on September 15, 2004.
(c)
Incorporated by Reference to our Registration Statement on Form S-8 (file No. 333-119008) filed with the Securities and Exchange Commission on September 15, 2004.
(d)
Incorporated by Reference to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2003 filed with the Securities and Exchange Commission on November 14, 2003.
(e)
Incorporated by Reference to our Annual Report on Form 10-K for the year ended December 31, 2003 filed with the Securities and Exchange Commission on April 14, 2004.
(f)
Incorporated by Reference to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 filed with the Securities and Exchange Commission on November 9, 2006.
(g)
Incorporated by Reference to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 filed with the Securities and Exchange Commission on November 15, 2004.
(h)
Incorporated by Reference to our Quarterly Report on Form 10-Q for the quarter ended March 30, 2007 filed with the Securities and Exchange Commission on May 10, 2007.
(i)
Incorporated by Reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 filed with the Securities and Exchange Commission on August 13, 2007.
(j)
Incorporated by Reference to our Annual Report on Form 10-K for the year ended December 31, 2006 filed with the Securities and Exchange Commission on March 16, 2007.
(k)
Incorporated by Reference to our Current Report on Form 8-K dated May 19, 2008 filed with the Securities and Exchange Commission on May 21, 2008.
(l)
Incorporated by Reference to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2008 filed with the Securities and Exchange Commission on November 12, 2008.
(m)
Incorporated by Reference to our Quarterly Report on Form 10-Q for the quarter ended March 31, 2008 filed with the Securities and Exchange Commission on May 15, 2008
(n)
Incorporated by Reference to our Annual Report on Form 10-K/A for the year ended December 31, 2005 filed with the Securities and Exchange Commission on May 1, 2006.
(o)
Incorporated by Reference to our Annual Report on From 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission on March 7, 2008.
(p)
Incorporated by Reference to our Current Report on From 8-K filed with the Securities and Exchange Commission on October 8, 2010.
(q)
Incorporated by Reference to our Current Report on Form 8-K filed with the Securities and Exchange Commission on March 18, 2011.
(r)
Incorporated by Reference to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2011 filed with the Securities and Exchange Commission on November 10, 2011.
(s)
Incorporated by Reference to our Annual Report on Form 10-K for the year ended De